DBRS Morningstar Confirms SMBC’s LT Issuer Rating at A (high), Stable Trend

DBRS Ratings Limited (DBRS Morningstar) confirmed the ratings of Sumitomo Mitsui Banking Corporation (SMBC or the Bank), including its Long-Term Issuer Rating at A (high) and the Short-Term Issuer Rating at R-1 (middle). The trend on all ratings is Stable. The Intrinsic Assessment (IA) of the Bank, which is based on the financial strength of the consolidated Sumitomo Mitsui Financial Group (SMBC Group or the Group), is A (high).

The Support Assessment is SA2, reflecting DBRS Morningstar’s expectation of timely systemic support in case of need, given the Bank’s systemic importance to the Japanese financial system. However, given that the sovereign rating of Japan is also A (high), Stable trend, there is currently no uplift to SMBC’s Long-Term Issuer Rating. See the full list of ratings at the end of this press release.

KEY RATING CONSIDERATIONS

The confirmation of SMBC’s IA at A (high) reflects the Group’s strong domestic franchise in retail and wholesale banking with strong competitive positions in certain specialised lending areas globally such as aircraft leasing. SMBC’s IA also takes into account the Group’s business diversification and strong asset quality, which are supportive of resilient earnings. SMBC’s profitability levels have been benefiting from higher overseas interest rates and strong loan demand.

While SMBC’s funding and liquidity position is strong, supported by a very large customer deposit base domestically, DBRS Morningstar also notes that the Group’s overseas business operations make strong usage of market funding, particularly short-term wholesale funding. The IA also takes into account a satisfactory capital position considering the sizeable exposure to Japanese Government Bonds and Japanese equities, which have declined but still add volatility to regulatory capital ratios through mark-to-market valuations.

Separately, DBRS Morningstar continues to monitor the Group’s Russian exposure through its aircraft leasing operations and its Russian banking subsidiary. However, DBRS Morningstar expects the potential negative impact on the Group’s P&L to be manageable given the limited size of these operations relative to the Group’s total assets and SMBC’s earnings.

RATING DRIVERS

An upgrade of the Bank’s Long-Term ratings would require that the sovereign rating be upgraded providing room for systemic support to be consequently incorporated into the Long-Term ratings, in line with the SA2 Support Assessment, assuming the IA of the Bank either remains at the current level or improves.

Or an upgrade of the Bank’s Long-Term ratings would require the overseas activities to increase sufficiently so that the proportion and quality of profits and exposures outside of Japan lead to the IA being positioned higher than the sovereign rating.

A downgrade of the sovereign rating would likely lead to a downgrade of the ratings. Absent any change to the sovereign rating or to the Support Assessment, a downgrade of the Bank’s Long-Term Issuer Rating would require a two-notch downgrade of the IA. Downward pressure on the IA would arise from a substantial deterioration of the Group’s profitability, or capital position.

RATING RATIONALE

Franchise Combined Building Block (BB) Assessment: Strong

SMBC is one of three large Japanese mega bank groups with total assets of JPY 264.6 trillion (approximately USD 2,006.4 billion) at end-December 2022 (9M 2022). The Group has a strong retail and wholesale banking franchise in Japan while it has a strong presence in specialised lending areas globally. This includes aircraft leasing through its subsidiary SMBC AC. The Group is also present in Asia, in particular Indonesia, India, Vietnam and the Philippines, with a multi-franchise strategy.

The Group has exposure to Russia. SMBC reported an impairment of its aircraft leasing of JPY 47 billion, representing 52% of the total aircraft leasing net book value in FY21 after net guarantee deposits. The Group guided for an additional impairment of USD 460 million after considering tax and ownership ratio under a worst case scenario. In addition, SMBC has banking exposure to Russia, which includes a local subsidiary. This banking exposure to Russia represented USD 2.6 billion at end-December 2022, down from USD 2.9 billion at end-March 2022, largely related to Russian borrowers and central bank exposure.

Earnings Combined Building Block (BB) Assessment: Good/Moderate

The Group reported profit attributable to owners of the parent of JPY 766 billion (approximately USD 5.9 billion) in 9M 2022, up 23% year-on-year (YOY) from JPY 625 billion in 9M 2021 mainly thanks to higher net interest income supported by solid loan growth both in Japan and overseas, higher rates, and lower credit costs. The Group consequently reported an improved return on equity (ROE) of 10.0% in 9M 2022 up from 8.6% in 9M 2021. The Group’s target ROCET1 is 8.5% at end-March 2023. While Group’s ROCET1 for Q3 was not disclosed, ROCET1 was 11.9% in H1 2022 and the expected ROCET1 for FY22 is 9.0%.

Supported by higher revenue as well as ongoing cost discipline, the Group's efficiency ratio improved to 60.1% in 9M 2022, compared to 61.0% in 9M 2021. Credit costs decreased to JPY 111 billion in 9M 2022, which included reversals of JPY 58 billion, compared to JPY 158 billion in 9M 2021 which was driven by some large corporate borrowers. Nonetheless, the group’s full year (FY22) forecast for credit costs remains unchanged at JPY 210 billion due to the uncertain global economic outlook.

Risk Combined Building Block (BB) Assessment: Strong

SMBC Group's asset quality remains strong. The Group's NPLs, as per the Financial Reconstruction Act, decreased to JPY 1,032.9 billion at end-9M 2022 from JPY 1,157.6 billion at end-FY22, or – 11% YOY. The NPL ratio decreased to a 0.88% at end-December 2022 down from 1.08% at end-March 2022 and from 0.98% at end-March 2021. The NPL coverage ratio was a strong 74.5% at end-September 2022 compared to 67.0% at end-FY22.

However, similar to domestic megabank peers, the Group has a relatively high concentration of Japanese equities and Japanese government bonds, which in our view presents risk management challenges and exposes the Group to market risk fluctuations. In terms of Japanese government bonds (JGB), the Group's JGB holdings significantly decreased to JPY 9.9 trillion at end-September 2022 compared to JPY 15.8 trillion at end-March 2022 and JPY 14.3 trillion at end-March 2021. These represented 87% of the Group’s Tier 1 Capital at end-September 2022, down from 141% at end-March 2022 and 128% at end-March 2021. In terms of Japanese equities, The Group’s domestic equity holdings to its Common Equity Tier 1 (CET1) capital stood at 10.2% at end-September 2022 down from 10.7% at end-March 2022 and 11.3% at end-March 2021 as calculated by DBRS Morningstar.

Funding and Liquidity Combined Building Block (BB) Assessment: Strong

The Group has a strong funding and liquidity profile, supported by a strong domestic deposit base and good liquidity reserves. The Group’s net loan-to-deposit ratio (excluding negotiable certificates of deposit (NCDs)) stood at 64% at end-December 2022 (56% including NCDs) up from 61% at end-FY21 and 60% at end-FY20. Total deposits increased to JPY 156 trillion at end-December 2022, up 5% from end-March 2022, or up JPY 7.1 trillion in absolute terms, mainly driven by overseas domestic deposits.

However, the usage of non-JPY wholesale funding (including medium to long-term funding in the form of corporate bonds and currency swaps) remains important although reduced slightly, representing 55% of total non-JPY funding at end-December 2022 down from 58% at end-March 2022. We consider the usage of wholesale funding in the Group’s overseas operations as significant, particularly in terms of short-term funding (interbank funding including repos and CD/CP) which represent about a third of total non-JPY wholesale funding (31% at end-December 2022, vs 34% at end-March 2022, and 31% at end-March 2021) as calculated by DBRS Morningstar.

Capitalisation Combined Building Block (BB) Assessment: Good

SMBC has a sound capital position, supported by organic capital generation thanks to a moderate dividend payout ratio policy, and good access to capital markets. Including the impact of net unrealised gains on available-for-sale-securities, the Group’s fully-loaded Common Equity Tier 1 (CET1) ratio was 13.7% at end-September 2022, down from 14.5% at end-FY21, while the Basel III leverage ratio was 4.8%. This is well above the minimum regulatory requirement of 8%, even when including the G-SIB surcharge of 1%.

Excluding the impact of net unrealised gains on available-for-sale securities, the Basel III fully-loaded CET1 ratio was 12.4% at end-September 2022, up from 12.1% at end-March 2022, but below prior years.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/410615.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Social (S) Factors
The Social factor does not affect the ratings or trend assigned to SMBC, however, the ‘Product Governance’ subfactor is viewed as ‘Relevant’. This is largely related to the recent market manipulation charges at the Group’s brokerage arm, SMBC Nikko Securities, and this is reflected in the Franchise building block given the tarnished reputation, changes in management and regulatory fines.
There were no Environmental/Governance factors that had a significant or relevant effect on the credit analysis

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (17 May 2022)

Notes:

DBRS Morningstar notes that this Press Release was amended on 9 March 2023 to include the full title of the principal methodology.

All figures are in JPY unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations https://www.dbrsmorningstar.com/research/398692/global-methodology-for-rating-banks-and-banking-organisations (23 June 2022). In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (17 May 2022) in its consideration of ESG factors.

The sources of information used for this rating include Morningstar Inc. and Company Documents, Sumitomo Mitsui Financial Group Inc. Consolidated Financial Results for the six months ended September 30, 2022 and the nine months ended December 31, 2022, SMBC Overview of Q3 FY3/2023, SMBC Overview of H1 FY3/2023, SMBC Data Book H1 FY3/2023, and SMBC Group TCFD Report 2022. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

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.

The conditions that lead to the assignment of a Negative or Positive trend are generally 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: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/410616.

This rating is endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Vitaline Yeterian, Senior Vice President, Global FIG
Rating Committee Chair: William Schwartz, Senior Vice President, Credit Practices Group
Initial Rating Date: 26 September 2001
Last Rating Date: 21 June 2022

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