Credit rating agency Fitch affirms its ratings on the Australian parents of NZ's big 4 banks

International credit rating agency Fitch Ratings has affirmed its AA- long-term ratings on the Australian parents of New Zealand's big four banks, but highlighted their high relative reliance on wholesale funding and high household indebtedness in Australia.

Fitch says its review focused on the Australia-domiciled entities - ANZ Banking Group, which owns New Zealand's ANZ and National banks, ASB's parent Commonwealth Bank of Australia, BNZ's parent National Australia Bank, and the Westpac Banking Corporation - and doesn't include their overseas subsidiaries. The ratings on these, the New Zealand banks, will be reviewed at a later date as part of Fitch's normal review process, the credit rating agency says.

The outlook on the Australian parents' long-term ratings is stable. See credit ratings explained here.

"The rating affirmations reflect the banks' dominant franchises in Australia and New Zealand, strong and stable profitability, generally robust risk management, solid liquidity management and adequate capitalisation," Fitch says.

"The agency also takes comfort from the banks' straightforward and transparent business models, and the conservative and hands-on approach of the Australian prudential regulator. Offsetting these factors are a structural reliance on wholesale funding, particularly from offshore markets, and high household indebtedness in Australia."

Fitch notes the big Australian banks have improved their funding profiles since 2008, growing the proportion of deposits, reducing their use of short-term wholesale funding, particularly from offshore sources, and increasing the duration of their wholesale funding portfolios.

"Nevertheless, at just under 40% of total funding, the reliance on wholesale funding is high relative to international peers and exposes the banks to dislocation in international wholesale funding markets. Fitch expects the banks to focus on improving funding stability - either through further lengthening of wholesale funding and/or increased use of customer deposits. Structural issues, such as Australia's compulsory pension scheme, mean wholesale funding is likely to remain an important part of the banks' funding structures."

It says the risks associated with the banks' profiles are generally well managed, with wholesale funding diversified by geography, product, investor and maturity, fully collateralised swaps used to hedge all foreign currency borrowings and through the maintenance of significant holdings of high-quality liquid assets eligible for central bank repo-facilities.

Potential hard landing in China a threat

However, Fitch expects revenue growth to come under some pressure this year given modest credit growth and continued "elevated" funding costs, especially for deposits.

"In addition, the agency expects a mild deterioration in the operating environment in Australia, which may place some modest pressure on asset quality and result in impairment charges. A hard landing in China could produce a more significant deterioration in asset quality although Fitch believes this scenario is unlikely."

Fitch says the big banks' capital positions are adequate for their business mix and risks. That said, rating upside for the major Australian banks is limited, given their existing high ratings and weaker funding profile relative to those of similarly rated international peers. Their ratings could be adversely affected by a material deterioration in their funding and liquidity profiles, leaving them susceptible to lengthy funding market dislocation, and a more significant asset quality deterioration, such as could occur after a hard landing in China, which negatively impacts profitability and capitalisation.

"Rating downside may also result if there were a major loosening of credit underwriting standards in the pursuit of loan growth in a modest credit growth environment," Fitch says.

"In addition, ANZ and NAB face some risks that are less evident at the more domestically focused CBA and Westpac. To date, ANZ's Asian expansion has been measured and the overall risk profile of the group has not increased materially. However, if the group materially deviates from its current strategy or were to pursue a large acquisition, thereby increasing its risk profile, negative rating action could occur."

"NAB's UK operations leave it more susceptible to a downturn in Europe than its major Australian bank peers and this is reflected in the group's lower-than-peer profitability. This exposure could leave NAB's asset quality more exposed to deterioration than domestic peers, particularly if there were a downturn in the UK, and negative rating action could result," Fitch says.

Here's some further comments from Fitch & the banks' various credit ratings

RATING DRIVERS AND SENSITIVITIES - Support Ratings and Support Rating Floors

The Support Ratings and Support Rating Floors of the major Australian banks reflect their systemic importance, and an extremely high probability of support from the Australian authorities, if needed. A change in the ability of the Australian authorities to provide support may result in a change in these ratings - this is likely to be reflected in a downgrade of the Australian sovereign (AAA/Stable). The Support Ratings and Support Rating Floors of all four banks are vulnerable to global regulatory initiatives aimed at reducing implicit government support available to banks.

RATING DRIVERS AND SENSITIVITIES - Government-guaranteed Debt

The government-guaranteed debt of the major Australian banks carries the same rating as the Australian sovereign. Any change in the sovereign rating will be reflected in the ratings of the government-guaranteed debt.

RATING DRIVERS AND SENSITIVITIES - Senior Unsecured Debt

The ratings of the major Australian banks' senior unsecured debt are aligned with each entity's Long- and Short-Term issuer default ratings (IDRs). Any change in the IDRs will be reflected in the ratings of the senior unsecured debt.

RATING DRIVERS AND SENSITIVITIES - Subordinated Debt and Hybrid Instruments

The ratings of the major Australian banks' subordinated debt are notched one level down from the viability ratings (VRs) for loss severity - no notching has been applied for non-performance risk. Hybrid capital instruments are notched five levels from the respective banks' VRs - two notches to reflect loss severity and three to reflect non-performance risk. These instrument ratings are likely to move in line with the VRs of the banks.

RATING DRIVERS AND SENSITIVITIES - Domestic Subsidiaries

Colonial Finance Limited (CFL) is a wholly-owned subsidiary of CBA and is the only domestic subsidiary of the four major Australian banks rated by Fitch. CFL's ratings reflect its strategic importance to CBA. Any change in CBA's Long-Term IDR is likely to result in a similar notch movement in CFL's ratings.

The four major Australian banks dominate the Australian and New Zealand banking systems. At 31 December 2012, the four banks combined held 79% of Australian banking system assets, while in New Zealand this was 87% at 30 September 2012.

The ratings are as follows:

Australia & New Zealand Banking Group (ANZ)

-- Long-Term IDR: affirmed at 'AA-'; Stable Outlook

-- Short-Term IDR: affirmed at 'F1+'

-- VR: affirmed at 'aa-'

-- Support Rating: affirmed at '1'

-- Support Rating Floor: affirmed at 'A'

-- Government-guaranteed debt: affirmed at 'AAA'

-- USD60bn euro medium-term note programme: affirmed at 'AA-'/'F1+'

-- USD10bn 3(a)(2) medium-term note programme: affirmed at 'AA-'

-- USD25bn 144A medium-term note programme: assigned at 'AA-'/'F1+'

-- Non-guaranteed senior unsecured debt: affirmed at 'AA-'

-- Subordinated debt: affirmed at 'A+'

Commonwealth Bank of Australia (CBA)

-- Long-Term IDR: affirmed at 'AA-'; Stable Outlook

-- Short-Term IDR: affirmed at 'F1+'

-- VR: affirmed at 'aa-'

-- Support Rating: affirmed at '1'

-- Support Rating Floor: affirmed at 'A'

-- Government-guaranteed debt: affirmed at 'AAA'

-- AUD debt issuance programme: affirmed at 'AA-'

-- USD70bn Euro medium-term note programme: affirmed at 'AA-'

-- USD25bn 3(a)(2) medium-term note programme: affirmed at 'AA-'

-- Non-guaranteed senior unsecured debt: affirmed at 'AA-'

-- Short-term debt: affirmed at 'F1+'

-- Subordinated debt: affirmed at 'A+'

-- Preferred stock: affirmed at 'BBB'

Colonial Finance Ltd. (CFL)

-- Long-Term IDR: affirmed at 'A+'; Stable Outlook

-- Short-Term IDR: affirmed at 'F1'

-- AUD debt issuance programme: affirmed at 'A+'/'F1'

-- Non-guaranteed senior unsecured debt: affirmed at 'A+'

National Australia Bank Limited (NAB)

-- Long-Term IDR: affirmed at 'AA-'; Stable Outlook

-- Short-Term IDR: affirmed at 'F1+'

-- VR: affirmed at 'aa-'

-- Support Rating: affirmed at '1'

-- Support Rating Floor: affirmed at 'A'

-- Government-guaranteed debt: affirmed at 'AAA'

-- Non-guaranteed senior unsecured debt: affirmed at 'AA-'

-- Short-term debt: affirmed at 'F1+'

-- Subordinated debt: affirmed at 'A+'

-- Preferred stock: affirmed at 'BBB'

Westpac Banking Corporation (WBC)

-- Long-Term IDR: affirmed at 'AA-'; Stable Outlook

-- Short-Term IDR: affirmed at 'F1+'

-- VR: affirmed at 'aa-'

-- Support Rating: affirmed at '1'

-- Support Rating Floor: affirmed at 'A'

-- Government-guaranteed debt: affirmed at 'AAA'

-- USD70bn euro medium-term note programme: affirmed at 'AA-/F1+'

-- Non-guaranteed senior unsecured debt: affirmed at 'AA-'

-- Market-linked debt: affirmed at 'AA-emr'

-- Short-term debt: affirmed at 'F1+'

-- Subordinated debt: affirmed at 'A+'

-- Hybrid capital: affirmed at 'BBB'