Analysts warn market singling out Australian and New Zealand banks for potential Standard and Poor's downgrade

By Gareth Vaughan

Australian and New Zealand banks have been singled out for possible one to two notch credit ratings downgrades as a result of Standard & Poor's review of the way it rates banks, say Royal Bank of Scotland (RBS) banking analysts.

In a research report Sydney-based RBS analysts Andrew Lyons, Ashley Dalziell and John Buonaccorsi say as S&P's review of its global banks rating methodology comes towards a conclusion, the market has singled out Australian and New Zealand banks as candidates for a one to two notch downgrade. This comes after S&P said in January it was going to revamp the way it rates banks in a move that could, potentially, see its credit ratings on New Zealand banks lowered.

"The key issue for Australia and New Zealand is the possible revision to S&P’s Banking Industry Country Risk Assessment (BICRA) methodology, which it uses to reflect its view of the relative riskiness of a country’s banking industry," the RBS analysts say.

"Based on high reliance on offshore wholesale funding and also economic imbalances (persistent current account deficits), Australia and New Zealand will potentially be moved to Group 2 (from Group 1) under the new methodology (which will then feed through into bank sector ratings). While this situation will take some time to unfold, the negative sentiment could see spreads widen slightly in the interim."

"The consensus view is that a one notch downgrade could add 15-30 basis points to term funding costs. However this is all relative to what occurs in other banking regions and how closely debt investors follow any new methodology," the RBS analysts added.

An S&P spokesman said the credit ratings agency expects to publish its final criteria first, and then take any rating actions soon after, in the fourth quarter of 2011.  

S&P currently has AA ratings on the big four banks, ANZ NZ, ASB, BNZ and Westpac NZ, AA- on Kiwibank, and rates TSB Bank BBB+. SBS Bank has a BBB rating from Fitch Ratings. See S&P's most recent comments on the big four banks here.

S&P also rates the Australian parents of New Zealand's big four, ANZ Banking Group, Commonwealth Bank of Australia, National Australia Bank, and Westpac, AA.

The threat of an S&P downgrade to the big four banks' credit ratings comes after rival Moody's Investors Service downgraded its ratings on ANZ NZ, ASB, BNZ and Westpac NZ, by one notch to Aa3 from Aa2 in May, citing New Zealand's subdued economy and the banks' exposure to wholesale financial markets for funding. The downgrades bought the Moody's ratings in line with S&P's.

"Investors had long looked through the generous Moody's 'Aa1' long term ratings for the four Australian major banks and their New Zealand branches and focused largely on the S&P 'AA' rating," the RBS analysts say. "As such this (Moody's downgrade) has had little effect on CDS (credit default swaps) and cash market spreads."

Meanwhile, in this month's edition of its bi-annual Banking Perspectives report, auditing firm PricewaterhouseCoopers (PwC) said ANZ NZ, ASB, BNZ, Westpac NZ and Kiwibank - combined - sourced 36% of their funding in the first-half of their financial years from overseas. PwC noted that the banks issued NZ$39.9 billion in money market deposits, bonds and notes, consisting of 27% of their funding books.

"So any market adjustment with respect of this - for example if there was a two-notch downgrade by S&P - could put pressure on interest margins, especially when historical funding rolls are repriced at higher rates."

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