Last week Standard and Poor's (S&P) revised the outlook on the Australian sovereign rating (AAA) to negative. The local currency rating (AAA) has also been revised to negative outlook.
The revision to the sovereign outlook impacts the level of government support in the Australian major bank parent ratings, with the result that they too have also been revised to negative outlook.
We expect the supported ratings of the New Zealand bank subsidiaries to also be impacted, and at risk of moving to A+ from AA- in 6 to 12 months’ time should the Australian sovereign lose the AAA rating.
S&P have cited ongoing budget slippage and a lack of sufficiently “forceful fiscal policy decisions” as a reason for the sovereign move to negative outlook.
A downgrade in the Australian sovereign rating would cap the extent of government support afforded to the major banks at a lower level. For banks with an 'A' standalone rating (unchanged) a sovereign rating move to AA+ would suggest the bank rating could
move from AA- to A+.
Source: AMP Capital
What does 'negative outlook' mean?
'Negative outlook' does not necessarily mean the Australian sovereign rating will be downgraded, merely that there is some likelihood of that happening unless more budget savings measures are legislated or there are improvements in the revenue outlook for Australia over the next 6 to 12 months. So we are essentially relying on Australian politicians to act!
Has the credit quality of our banks actually changed?
No. The credit quality of our banks is reflected in the 'stand alone' rating (SACP in the table above). This is BBB+ and remains unchanged.
Why does this matter for New Zealand?
There’s a domino effect. The mechanics of 'parent bank support' in S&P New Zealand bank ratings suggest that a local currency downgrade in Australia would lower the level of support the Australian banks can provide to their New Zealand subsidiaries in a crisis. 'Support' currently takes Westpac, BNZ and ANZ’s ratings from BBB+ up to AA- and ASB’s rating from A- up to AA-. A downgrade in the Australian parent banks would cap New Zealand issuer ratings at A+ (see matrix above).
Would a downgrade lead to higher funding costs and therefore higher mortgage rates in NZ?
Maybe, but we don’t anticipate a large cost increase and competition could mean that this impacts bank margins more than mortgage rates.
Many New Zealand investment mandates are constrained by issuer credit ratings. Although we’d expect a one notch downgrade to A+ to add 0.15% to bank bond coupons domestically, domestic bond issuance is a smaller proportion of total bank funding relative to offshore bonds and NZ based deposits.
Moody's ratings for New Zealand banks would not be impacted as they assume Australian government support is not available to New Zealand subsidiaries in a crisis.
There is evidence that offshore investors already demand a higher coupon based on the BBB+ stand-alone rating, not the supported rating of AA-, so offshore costs may not change substantially based on this move alone.
The deposit rate may rise relative to the cash rate as banks fund credit growth and 2017 maturities, but what the RBNZ does will be important for the overall deposit cost.
Hybrid ratings would be unchanged.
Should investors be concerned?
No. Should the banks be downgraded we would anticipate them being stable at A+.
Bank regulators globally are demanding banks hold more capital and not rely on tax payer funds.
We had anticipated support would ultimately be removed in Australia. A change in the sovereign rating gets us to the same result, but via a different route when you consider the rating methodology.
Indeed, banks in Australia and ultimately in New Zealand will be under pressure to hold more capital to remain in the top quartile of banks globally which ultimately will be positive for debt investors.
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