Global ratings agency Standard & Poors recently downgraded the credit rating of 23 Australian financial institutions due to the increased risks in our property market.
According to Westpac Banking Corp's (ASX: WBC) announcement yesterday, the ratings agency raised its Banking Industry Country Risk Assessment (BICRA) from a '2' to a '3'. The BICRA ranks a country's economic risks from 1 (low risk) to 10 (high risk). The decision to upgrade Australia's risk rating was a result of:
"In our opinion, economic imbalances in Australia have increased due to strong growth in private sector debt and residential property prices in the past four years, notwithstanding some signs of moderation in growth in recent weeks. Consequently, we believe financial institutions operating in Australia now face an increased risk of a sharp correction in property prices and, if that were to occur, a significant rise in credit losses." (emphasis added).
Although the downside risks have increased, for the moment S&P expects that the recent regulatory actions by the government should lead to a gradual unwinding of pressure in the banking system.
Still, because of the increased BICRA rating, S&P downgraded Westpac's Tier 1 and Tier 2 capital instruments rating by 1 notch. The company's senior debt rating was unchanged at AA-, although it remains on a negative outlook.
Other banks like Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd. (ASX: NAB) were met with similar downgrades. Bendigo and Adelaide Bank Ltd (ASX: BEN) was not even notified by the ratings agency but first discovered its downgrade through media reports yesterday. After the bank contacted S&P it discovered that its long-term credit rating (the most important one) had been dropped by one notch to BBB+.
On their own the downgrades are not a major concern. However, they reflect broader issues in the banking industry that have led to a number of changes to the way that banks will operate their business in the near future. Restrictions on interest-only loans, caps on lending to investors, unilateral rate increases at major banks, the bank levy, and now the downgrade will all combine to affect banking operations in unpredictable ways.
If I had a significant amount of my portfolio in the banks, I would take some time to consider the likely impact on profits and perhaps consider shifting some investments into other industries.
