Moody’s Investors Service has upgraded the long-term debt ratings of Sumitomo Mitsui Banking Corporation (SMBC) to A1 from A3 and its subsidiaries – including Sumitomo Mitsui Banking Corporation Europe Plc -also to A1 from A3. SMBC’s bank financial strength rating (BFSR) has been raised to E+ from E. Rating outlooks are positive, while outlooks for debt ratings are stable. The rating agency comments that the upgrade in BFSR reflects the bank’s progress in reducing the balance sheet risk represented by its large non-performing loans and equity portfolio, and Moody’s expectation that its non-performing loans will further decrease. The upgrade also incorporates SMBC’s position as the second-largest banking group in Japan and Moody’s positive evaluation of the long-term value of its diversified franchises, comprising strong retail and middle-market banking and wholesale banking.
Moody’s notes that the profile of and future selections for SMBC’s business portfolio, combined with disciplined management, may allow the bank to maintain its pre-provision profit. SMBC’s pre-provision performance is consistently better than peers’, characterized by better expense management and larger fixed-income gains. The bank has increased efforts to manage down the rate risk of its JGB portfolio, and has strengthened its business portfolio – in areas such as risk-adjusted priced loans to small- and middle-market segments – so that it could respond positively to a rising-rate environment.
However, SMBC’s lag relative to peers in decreasing its non-performing loans continues to position its credit expense/pre-provision profit ratio at a comparatively high level, resulting in a less rapid pace of retaining internal earnings. Consequently, SMBC’s capitalization (adjusted for deferred tax assets) is still weaker than peers’. The upgrade of SMBC’s credit rating to A1 strongly incorporates Moody’s positive evaluation of the strong safety net in place for large Japanese banks. The rating agency views SMBC’s large scale as a factor that ensures that support from the safety net if necessary. The positive rating outlook for BFSR reflects Moody’s expectation that SMBC’s financial fundamentals will continue to show improvement, particularly in capitalization. The key driver that could lead to positive BFSR actions will be improvement in the bank’s capitalization measures relative to non-performing loans. Moody’s preferred measurement for capitalization is non-performing loans minus loan loss reserve, as a percentage of adjusted Tier I capital (after adjusting for deferred tax assets). If the bank can achieve its targeted non-performing loan reduction, improve credit expenses relative to pre-provision profit and show resulting improvement of its Tier I capital structure, its current BFSR may be reviewed for upgrade. A further increase in risk appetite without conservative attention to capitalization, or deterioration in the bank’s credit expense/pre-provision profit relationship may put downward pressure on its BFSR.