DBRS Morningstar Confirms Commonwealth Bank’s Issuer Ratings at AA / R-1 (high); Stable Trend

DBRS Ratings Limited (DBRS Morningstar) confirmed the ratings of Commonwealth Bank of Australia (CBA or the Bank), including the Long-Term Issuer Rating at AA. The Short-Term Issuer Rating was confirmed at R-1 (high). The trend on all ratings is Stable. The Intrinsic Assessment (IA) of the Bank 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 CBA’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 CBA’s extremely strong domestic franchise, particularly in retail banking, as well as the Bank’s conservative risk profile, robust capital levels and very strong earning generation ability. The ratings also incorporate a well-managed funding and liquidity profile, which has seen a reduction in the usage of wholesale funding in recent quarters due to the liquidity injected into the system through the Reserve Bank of Australia’s (RBA) funding programs, and the significant increase in deposits due to extraordinary government support packages and precautionary savings. The confirmation of the ratings also takes into consideration the Bank’s continued progress in addressing risk management issues. DBRS Morningstar also considers that the impact of the coronavirus (COVID-19) pandemic has negatively affected the Bank’s operating environment, and, as a result, expects weaker revenue generation for CBA in 2021, as well as some deterioration in its asset quality profile.

RATING DRIVERS
An upgrade of the IA is unlikely in the near term, given the uncertain economic outlook. Over the longer term, an upgrade of the ratings would require the Bank’s credit profile to remain resilient throughout the COVID-19 crisis, accompanied by sustained lower reliance on wholesale funding while maintaining very strong earnings and capital levels.

The ratings could be downgraded if CBA experiences a prolonged material deterioration of its asset quality profile, combined with lower returns and capital levels. Furthermore, a downgrade of the long-term ratings could occur if, in DBRS Morningstar’s opinion, the likelihood of timely systemic support were reduced.

RATING RATIONALE
Commonwealth Bank of Australia is one of the four leading Australian banks, with very strong positions in the Australian retail banking sector, including market shares of 24.9% in home lending and of 27.1% in household deposits. The Bank also has strong market shares in New Zealand of 21.5% in home lending and 18.2% in household deposits. In recent years, the Bank has divested certain overseas and wealth management assets, which reflects the management's strategy to reducing complexity and risk by focusing on the core banking operations.

CBA continues to demonstrate very strong earnings generation despite the requirement to take higher provisions and the more challenging economic environment. On a statutory basis, the Bank reported net profit of AUD 9,634 million in FY20, up 12.4% on FY19. This was mainly due to a circa AUD 2.1 billion gain on disposal of assets. On a cash basis, which refers to the Bank’s underlying results and excludes non-cash items and unrealised gains and losses related to hedging and IFRS volatility, net profit after tax from continuous operations was AUD 7,296 million, or down 11.3% compared to FY19. CBA’s net interest income increased by 2.1% in FY20, while operating expenses were up 0.7%. However, the FY20 results were marked by substantial COVID-19 related provisions. Overall, the Bank’s ROE was still a strong 10.3% on a continuing operations basis in FY20 or 13.6%, including the discontinued operations (vs. 12% both on a statutory and cash basis in FY19), which compares well with most of the Bank’s international peers. In Q1 2021, CBA’s net profit was about AUD 1.9 billion on a statutory basis or AUD 1.8 billion on a cash basis - down 16% compared to Q1 2020 on flat revenues and increased expenses due to higher staff costs (up 2%). Meanwhile loan loss provisions remained contained at 28 bps of gross loans and acceptances in Q1 2021.

Efficiency levels remain very good. Despite an increase in costs the reported cost-to-income ratio remained below 50% at 45.9% on an underlying basis (flat vs. FY19, and 44.1% in FY18). Remediation costs did continue to weigh on the Bank's operating expenses in FY20, albeit these decreased to AUD 479 million from AUD 996 million in FY19, representing about 4.7% of total operating costs (about 8% in FY19). CBA is committed to achieving a cost-to-income ratio of below 40% - a better level than that reported over the past five years, which will reflect a simplified business model.

Credit quality remains strong. The Stage 3 loans ratio remains below 1%, meanwhile total troublesome and impaired loans decreased on an absolute basis down to AUD 8.4 billion at end Q1 2021 from AUD 8.7 billion at end-FY20, reflecting the ongoing support provided by the Australian government. The overall quality of the Australian home loans portfolio remained strong and was supported by COVID-19 related payment deferrals in FY20, with impaired loans totaling AUD 1.67 billion at end-FY20, down from AUD 1.81 billion at end-FY19. With regards to the Bank's exposures to sectors mostly affected by COVID-19 (Commercial Property, Agriculture & Forestry, Accommodation, Cafes & Restaurants, and Retail Trade), DBRS Morningstar notes that about AUD 14 billion of lending, or 15% of the book, were under payment deferrals at end-July 2020. Regarding conduct issues over the past years, DBRS Morningstar views CBA as having made significant progress in rectifying identified operational risk shortcomings.

CBA has a well-managed funding profile, supported by a good access to the markets, good diversification and no significant wholesale funding refinancing concentrations. The Bank’s net loan-to-deposit ratio, as calculated by DBRS Morningstar, decreased to 120% at end-FY20 from 131% at end-FY19 on the back of a significant increase in deposits, which increased by about AUD 66 billion, or 10.3% YoY. Similar to its major Australian peers though, the Bank has been relying to a higher degree than most of its global peers on overseas wholesale market funding. Wholesale funding accounted for 26% of total funding at end-FY20 albeit down from 31% of total funding at end-FY19. The Reserve Bank of Australia (RBA), through the establishment of the Term Funding Facility (TFF) in March 2020, injected liquidity in the system so that banks would be able to extend credit and support customers affected by the COVID-19 outbreak. The Bank has relatively good diversification in its wholesale funding profile in terms of product and currency. In addition, the Bank has a solid liquidity position with a Liquidity Coverage Ratio of 155% at end-FY20 or 146% at end-Q1 2021 (up from 132% at end-FY19). The Bank’s Net Stable Funding Ratio was 120% at end-FY20 or 125% at end-Q1 2021 (vs. 112% at end-FY19).

DBRS Morningstar views CBA as having a robust capital position and being well-placed to address the challenging environment. The Bank reported an APRA Common Equity Tier 1 (CET1) ratio of 11.6% at end-FY20 (up from 10.7% at end-FY19), with the increase reflecting organic capital generation and the gains from the divestments of assets. At end-Q1 2021, CET1 was 11.8%. This is above the minimum requirement of 8% and APRA’s requested benchmark of 10.5%. On an internationally comparable basis, CBA’s CET1 ratio was 17.4% and its leverage ratio was 6.7% at end-FY20, which is above many similarly rated peers.

ESG CONSIDERATIONS
DBRS Morningstar views the Business Ethics and Corporate Governance ESG subfactors as significant to the credit rating. These are included in the Governance categories. In recent years operating risk and control deficiencies have been identified, however, CBA appears to be working towards improving controls and resolving these issues by strengthening its compliance function, and simplifying its business model.

Since 2017, CBA has encountered regulatory scrutiny over conduct issues that have tarnished its otherwise strong performance. In June 2018, CBA entered into an agreement with AUSTRAC to resolve court proceedings, relating to serious breaches of anti-money laundering and counter-terrorism financing (AML/CTF) laws, by agreeing to pay an AUD 700 million civil penalty along with AUSTRAC’s legal costs. This was followed by a Prudential Inquiry by the Australian Prudential Regulation Authority (APRA), which revealed a number of shortcomings in CBA’s governance, culture and accountability frameworks, particularly with regards to non-financial risks. DBRS Morningstar recognises that CBA, as part of the Enforceable Undertaking (EU) agreed with APRA on April 30, 2018, has taken action to address these issues, including the appointment of an Independent Reviewer. As such, we foresee that the Bank will successfully respond to the outstanding issues. Since February 2019, CBA has been in the process of actioning recommendations by the industry-wide Royal Commission.

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 CBA are as follows: Franchise Strength – Very Strong/Strong; Earnings Power – Very Strong/Strong; Risk Profile – Strong; 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 (8 June, 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 FY20 Annual Report, FY20 Pillar 3 Disclosure, FY20 Results Highlights, FY20 Investor Presentation, FY20 Results Transcript, Reserve Bank of Australia’s Financial Review, Australian Prudential Regulation Authority, 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/369918

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 24, 2005
Last Rating Date: November 19, 2019

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