DBRS Morningstar Confirms Westpac’s Long-Term Issuer Rating at AA; Maintains Negative Trend

DBRS Ratings Limited (DBRS Morningstar) confirmed the ratings of Westpac Banking Corporation (Westpac or the Group), including the Long-Term Issuer Rating at AA and the Short-Term Issuer Rating at R-1 (high). The trend on the Group’s ratings remains Negative. The Intrinsic Assessment (IA) of the Group is AA (low) and the Support Assessment is SA2, which reflects the generally supportive regulatory framework and DBRS Morningstar’s expectation of timely systemic support, given Westpac’s importance to the financial system in Australia. This results in a one notch uplift to the Issuer Rating from the IA. See a full list of ratings at the end of this press release.

KEY RATING CONSIDERATIONS
The confirmation of the ratings reflects the strength of Westpac’s franchise in its core markets of Australia and New Zealand, the robust capital levels, and the Group’s strong earnings generation ability. The ratings also take into consideration the well-managed funding and liquidity profile, despite a higher reliance on wholesale funding than most similarly rated global peers. Positively, DBRS Morningstar notes a reduction in the usage of wholesale funding in recent months, which is due to the liquidity injected into the system through the Reserve Bank of Australia’s (RBA) funding programs, and also the significant increase in deposits due to extraordinary government support packages and precautionary savings.

The Negative Trend continues to incorporate the identified serious shortcomings in operational risk management, which have resulted in a penalty of AUD 1.3 billion, following the proceedings by the Australian Transaction Reports and Analysis Centre (AUSTRAC) in light of contraventions to the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (AML/CFT Act). Although Westpac's sound earnings generation ability means that the Bank has been able to cushion this sizeable penalty, DBRS Morningstar continues to monitor the progress made in addressing risk management issues and the Group's progress in restoring its reputation and financial performance. The Negative Trend also considers that the impact of the coronavirus (COVID-19) pandemic has negatively affected the Group’s operating environment, and, as a result, DBRS Morningstar expects weaker revenue generation for Westpac in 2021, as well as some deterioration in its asset quality profile.

RATING DRIVERS
An upgrade of the ratings is unlikely in the near term, given the Negative trend and the uncertain economic outlook. A return to a Stable trend would require the Bank to continue to demonstrate limited impact from the operational risk issues while maintaining a resilient credit profile throughout the COVID-19 crisis, strong earnings and capital levels.

The ratings would be downgraded if Westpac experiences a material deterioration in its franchise, a prolonged material weakening of its earnings, or a significant deterioration in asset quality and lower capital levels. Furthermore, a downgrade of the Long-Term Issuer Rating could occur if, in DBRS Morningstar’s opinion, the likelihood of timely systemic support were reduced.

RATING RATIONALE
Westpac enjoys strong market shares in retail banking in Australia (including 22% in household mortgages), and this is complemented by a strong retail market position in New Zealand. During FY20, the Group consolidated its international presence into the three branches in Singapore, London and New York. DBRS Morningstar notes that Westpac's franchise has remained relatively intact despite the negative press coverage related to AUSTRAC’s findings in relation to serious shortcomings in risk management, which has resulted in significant executive management and Board composition changes.

The Group has consistently generated strong profits, however in FY20 earnings were weaker, impacted mainly by COVID-19 related collective provisions, the AUD 1.3 billion AUSTRAC-related penalty, other remediation costs, and write-downs of goodwill on its life insurance and auto finance businesses. The Group reported statutory net profit attributable to owners of AUD 2.3 billion in FY20, down 66% on FY19. Despite margin pressure from the lower interest rate environment in Australia, net interest income was largely resilient, down only 1% year on year (YoY). Non-interest income in FY20 was down 7% compared to the prior year, mainly as a result of lower net wealth management and insurance income. As a result, statutory total revenues were down 2% YoY to AUD 20.2 billion. However, on a cash basis, total revenues were flat YoY. In FY20, the Group's cost-to-income ratio was materially affected by notable items, and subsequently weakened to 63.1% in FY20 from 48.9% in FY19.

Credit quality remains strong, in spite of some deterioration in FY20. The Group’s gross impaired loans plus loans over 90+ days past due (DPD) to total loans increased to 1.62% at end-FY20, from 0.95% at the end of the prior year, reflecting the more challenging environment in Australia. This remains manageable but is at the higher end of its domestic peer group, and DBRS Morningstar expects that the economic impact of the COVID-19 crisis on Westpac's overall credit profile will become more apparent over time. Westpac has communicated that about AUD 19.2 billion of Australian home loans are under payment deferrals as of October 19, 2020, which represented about 4.4% of Westpac’s total Australian home loans portfolio. In addition, DBRS Morningstar notes that addressing non-financial risks remains an important priority for Westpac as the AUD 1.0 billion capital add-on imposed by the Australian Prudential Regulation Authority (APRA) will remain in place until APRA is satisfied that Westpac has completed governance, culture and accountability framework changes.

Westpac’s funding profile has improved in recent years as growth in customer deposits has outpaced loan growth. The Group’s net loan-to deposit ratio improved to 125% as of end-FY20 (end-FY19: 136%), largely due to a AUD 31 billion rise in deposits, a 6% increase YoY. The Group has relatively good diversification in its wholesale funding profile in terms of product and currency as well as no significant refinancing concentration. Liquidity has been ample and Westpac’s Liquidity Coverage Ratio was 150% at end-FY20 (vs. 127% at end-FY19) while the Group’s Net Stable Funding Ratio was 122% at end-FY20 (vs. 112% at end-FY19).

Westpac’s capitalisation levels have been supported by very good earnings generation ability, large cushions over regulatory minimums, and continued access to capital markets. In FY20, the Bank’s capital cushions improved despite the civil penalty. Westpac’s APRA CET 1 ratio improved to 11.1% at end-FY20, implying a capital cushion of 310 bps over the regulatory minimum, mainly due to organic capital generation and the AUD 2.8 billion capital raising completed in December 2019. These outweighed the impact of the H2 2019 dividend payment and the impact from some of the notable items (such as estimated customer refunds, payments, associated costs and litigation). On an internationally comparable basis, Westpac reported a CET1 ratio of 16.5% and a leverage ratio of 6.5% according to the Group’s calculations as at September 30, 2020.

ESG CONSIDERATIONS
DBRS Morningstar views the Business Ethics and Corporate Governance ESG subfactors as significant to the credit rating, and these are included in the Governance factor. In recent years operational risk and control deficiencies have been identified at Westpac.

On September 24, 2020, the Group announced an agreement with AUSTRAC to resolve the civil proceedings commenced in the Federal Court of Australia on November 20, 2019. Under the agreement, Westpac agreed to pay a penalty of AUD 1.3 billion in relation to admitted contraventions of the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (AML/CTF Act). Westpac had failed to report to AUSTRAC in a timely manner over 19.5 million International Funds Transfer Instructions (IFTIs) over the period November 2013 to September 2018 of transfers both into and out of Australia, while also failing to keep records on the origin of some of the fund transfers, pass information on the source of funds to other banks in the transfer chain and carry out appropriate customer due diligence on transactions to countries that have known financial indicators relating to potential child exploitation risks.
In addition, Westpac continues to address operational risk shortcomings that were identified as part of various reviews, such as the Royal Commission on misconduct in the banking, superannuation and financial services industry (an industry-wide review with the final report released in February 2019), and as part of the Governance, Culture and Accountability (GCA) Self-Assessment that was completed in November 2018 (APRA requested all APRA-regulated institutions to conduct a self-assessment). The latter resulted in a capital add-on of AUD 500 million due to shortcomings in Westpac’s governance, culture and accountability frameworks, particularly with regards to non-financial risks, and was raised to AUD 1.0 billion in December 2019, following the release of AUSTRAC’s statement of claim. Following that, Westpac completed a GCA reassessment, which was released in July 2020.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792

The Grid Summary Grades for Westpac are as follows: Franchise Strength – Strong; Earnings Power – Very Strong/Strong; Risk Profile – Strong/Good; Funding & Liquidity – Strong/Good; Capitalisation – Very Strong/Strong.

DBRS Morningstar notes that this Press Release was amended on 1 December 2020 to incorporate the disclosure regarding rating methodologies and Coronavirus Disease.

Notes:
All figures are in AUD unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 8, 2020) - https://www.dbrsmorningstar.com/research/362170/global-methodology-for-rating-banks-and-banking-organisations

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883

The sources of information used for this rating include, Westpac FY20 Annual Report, Westpac FY20 Results Highlights, Westpac FY20 Pillar 3 Disclosure, Westpac FY20 Investor Presentation, Westpac FY20 Results Transcript, AUSTRAC Agreement 24/09/20, Australian Prudential Regulation Authority, Reserve Bank of Australia’s Financial Review, Reserve Bank of New Zealand, and S&P Global Market Intelligence. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

With Rated Entity or Related Third-Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

DBRS Morningstar does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar's outlooks and ratings are under regular surveillance.
For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/370521

Ratings assigned by DBRS Ratings Limited are subject to EU and U.S. regulations only.

Lead Analyst: Vitaline Yeterian, Senior Vice President, Global FIG
Rating Committee Chair: Ross Abercromby, Managing Director, Global FIG
Initial Rating Date: January 25, 2005
Last Rating Date: November 29, 2019

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