Aussie bank tier 2 credit ratings to rise

Global investors appear to be completely oblivious to the prospect of a very important upgrade to the major banks’ Tier 2 bond credit ratings with Standard & Poor’s and Moody’s into the crucial “A” band. They also seem to be unaware that the regional banks’ senior and Tier 2 bond ratings are also likely to be upgraded.

Based on fundamental research via our 13x analyst and 11x trader/PM team, Coolabah Capital Investments (CCI) judges that there is a strong probability of an upgrade to major bank Tier 2 bond credit ratings with S&P from BBB+ to A- and Bendigo and Bank of Queensland’s senior bond ratings from BBB+ to A- in the near-term. This is based on analysis of recent important changes published by S&P.

CCI further assesses that Moody’s is all but certain to upgrade the major banks’ Tier 2 bond ratings from Baa1 to A3 due to changes it is proposing.

CCI assesses that S&P is likely to upgrade Australia’s Banking Industry Country Risk Assessment (BICRA) score from 3 to 2 (lower is better) in the next 3-6mths.

This BICRA score has been officially on a “positive trend” with S&P since April 2021. The positive trend signals a greater than 1-in-3 likelihood of improvement in the next two years.

In June 2023, S&P very materially adjusted the potential trigger for an upgrade to Australia’s BICRA score. Previously, between April 2021 and June 2023, the upgrade trigger (technically for the “Industry Risk” score subcomponent of the overall BICRA score) had been limited to any improvements in “system wide funding”.

In June 2023, S&P crucially introduced two new potential upgrade triggers:

• “a reduction in the industry’s risk appetite”,
• "or a lower possibility of significant regulatory lapses -- for example, due to the simplification of business models of the larger Australian banks".

These two new upgrade triggers refer to the “competitive dynamics” and “institutional framework” sub-tests within the Industry Risk subcomponent of the BICRA score.

S&P previously downgraded Australia’s Industry Risk score from 2 to 3 as a result of the 2017 to 2019 Royal Commission into banking. This occurred due to the “institutional framework” and “competitive dynamics” sub-tests being downgraded from “very low risk” to “low risk”.

CCI believes that S&P will likely upgrade the “institutional framework” score from “low risk” to “very low risk” due to its judgement that APRA and the banking system have successfully responded to the Royal Commission recommendations, improving the intensity of the regulatory architecture to a “very low risk” level.

This is reinforced by APRA’s demonstration in recent years that it has among the toughest regulatory approach to capital, liquidity, and interest rate risk management in the developed world. Specifically:

• APRA is the only regulator in the world to make IRRBB a Pillar 1 requirement, which was a key issue for US regional banks,
• APRA has removed the Committed Liquidity Facility, requiring Aussie banks to only rely on Level 1 high quality liquid assets (HQLA) in contrast to global peers that use broader Level 2 and Level 3 assets for HQLA,
• APRA has recently proposed banning the non-HQLA liquid assets that are used by smaller MLH banks (eg, bank debt securities), and
• APRA has introduced some of the toughest global CET1 (“unquestionably strong”) and Tier 2 (at 6.5% of RWA) targets on an internationally harmonised basis.

Mechanically, an improvement in the Industry Risk score from 3 to 2 would lift Australia’s BICRA score from 3 to 2. This would in turn automatically upgrade Australia’s banking industry “anchor” score from “bbb+” to “a-” – and this is the foundation of all Aussie bank credit ratings.

The improvement in the Aussie banking anchor score from “bbb+” to “a-” would in turn automatically upgrade all Aussie bank Stand-Alone Credit Profiles (SACPs) by one notch. This would not change major bank senior bond credit ratings (because their Issuer Credit Ratings (ICRs) stay constant at AA-), but would increase by one notch – automatically – their Tier 2 bond and AT1 hybrid ratings from BBB+ to A- and from BBB- to BBB respectively.

It would further lift the BoQ and Bendigo Issuer Credit Ratings from BBB+ to A- (because these ICRs do not receive the benefit of a too-big-to-fail government support increase in the ICR that Macquarie and the majors’ capture), which would automatically increase BoQ and Bendigo’s senior bond ratings from BBB+ to A-.

Macquarie senior bond ratings would stay at A+, but their T2 bond ratings would increase from BBB to BBB+.

Finally, Moody’s has released a ‘Request for Comment’ on proposed changes to update Australia to their Advanced Loss Given Failure (ALGF) methodology. Moody’s expect this to result in “one notch upgrades in most cases for dated subordinated debt ratings and junior subordinated bank debt ratings”. The Request for Comment closed on 15 November. This would upgrade major bank Tier 2 bond ratings from Baa1 to A3, meaning that both S&P and Moody’s put major Tier 2 at A-.