Standard & Poor's ratings revamp could see New Zealand bank credit ratings downgraded

By Gareth Vaughan

Changes to the methodology Standard & Poor's (S&P) uses to rate banks could potentially see its credit ratings on New Zealand banks lowered.

The international credit rating agency announced plans in early January to revamp the way it rates banks.

Peter Sikora, S&P's analytical manager for financial institutions in the Pacific, told interest.co.nz the changes were both a continuing evolution of its analysis and the incorporation of lessons learnt from the Global Financial Crisis.

"The biggest thing we learnt from the Global Financial Crisis is that the operating environment plays a more significant part of an individual entity’s credit profile," said the Melbourne-based Sikora, who is visiting New Zealand this week.

"While we always believed that, that gets a far more significant weighting in the new criteria. It’s akin to the example of having the best house in the street, but at the end of the day the quality of your house is also a function of the neighbourhood it’s in."

S&P is seeking comment on its new proposed methodology by March 7. Sikora said it then aims to release the new criteria, and the ratings under it, at the same time, probably in the third quarter of the year. 

Sikora says the rating criteria begins with an assessment of the operating environment through what's known as a BICRA (Bank Industry Credit Risk Analysis). This covers macro economic and industry risk factors, establishing an anchor point. An individual entity is then assessed relative to that anchor point.

"It’s a building block methodology compared to our current criteria which is more a blended factor approach," said Sikora. "Then it provides a capability to be more explicit about the exact extraordinary support that’s factored into the rating, be that government or group or shareholder support."

Although these things were currently "baked into a rating," the way the new methodology is structured will provide greater visibility about where and how much the individual criteria have been factored in, he added.

More ability to make cross border comparisons; NZ benchmark ranking lower than Australia's

Sikora said this would provide a far deeper capability to make cross border comparisons between institutions.

"So you’ll be able to clearly see what the real difference is between an institution in New Zealand versus one in Canada etc."

Under S&P's proposed new criteria, Australia's BICRA group ranking will drop to a two from a one and New Zealand's group ranking to a three from a two placing it alongside the United States, Spain, Britain, Germany, South Korea and Taiwan. The rankings range from one (highest) to 10 (lowest).

Canada, Hong Kong, Sweden and Switzerland have been given preliminary one rankings and Kazakhstan, where three of the biggest 10 banks defaulted in 2009 and a third of the sector's total loans are non-performing, a nine. See more on New Zealand's and other countries risk assessments here.

The BICRA is determined by an economic risk rating and an industry risk rating. New Zealand scores a four for economic risk and a three for industry risk. The economic risk factors are determined by an assessment of economic stability and resilience, economic imbalances, and credit risk in the economy. The industry risk is determined by assessing the institutional framework, competitive dynamics and systems wide funding.

Sikora said New Zealand having a lower BICRA than Australia didn't automatically mean that ratings given to institutions here will be more negatively affected by the introduction of the new criteria.  He noted that the big four banks here - ANZ, ASB, BNZ and Westpac, which combined hold 92% of New Zealand's banking assets, are all subsidiaries of Australian banks.

"Our (new) criteria has within it a category where we access group support. Certainly we don’t anticipate that the anchors or the ceilings that the criteria put in place will prevent us continuing to view the subsidiary operations of the New Zealand banks the same as they were previously," said Sikora.

'Pincer' movement

That said, Sikora said there would probably be a "slight pincering of the universe."

"The universe of banking systems (ratings) is somewhere between A and B-. So that would then tell you that probably the AA and higher banks may potentially come under significant review," said Sikora.

S&P currently has AA ratings on all of ANZ, ASB, BNZ and Westpac.

S&P says it has tested the proposed new rating criteria on 138 banks it rates with the results indicating the ratings impact of the changes would probably be modest.

"The results suggest that 85% of the long-term issuer credit ratings (ICRs) on the banks in the sample would remain the same or move one notch up or down," S&P says. "Of the remaining 15% of the ICRs, we found that about half moved up by more than one notch - especially on smaller institutions or niche players - and about half moved down by more than one notch."

The potential for downgrades stemming from S&P's new ratings methodology comes as rival credit rater Moody's Investors Service has the big four New Zealand banks on review for a possible ratings downgrade from their Aa2 ratings.

These four banks currently have a Moody's rating of Aa2.  Moody's review, due for completion by mid-May, comes as it also reviews the local banks Australian parents. Moody's says it will also look at the New Zealand banks structural sensitivity to wholesale funding market conditions given, on average, they source about 40% of their total funding from wholesale sources.

A fall in the credit ratings of New Zealand's banks is likely to increase the cost of funding over time and be passed on in the form of higher lending rates than would otherwise have been the case.

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