OREANDA-NEWS. Fitch Ratings has assigned Australia and New Zealand Banking Group Limited's (ANZ, AA-/Stable) USD1bn fixed-rate resetting perpetual subordinated contingent convertible securities a final rating of 'BBB'. The notes qualify as Additional Tier 1 securities for regulatory capital purposes.

ANZ can redeem all the notes on each interest reset date with the approval of the Australian Prudential Regulation Authority (APRA). The first reset date will be 15 June 2026 - 10 years after issuance - with additional reset dates every five years thereafter.

The final rating follows final documentation conforming to information previously received and is the same level as the expected rating assigned to the notes on 29 May 2016.

KEY RATING DRIVERS

The notes are rated five notches below ANZ's Viability Rating of aa-, with two notches for loss severity and three notches for incremental non-performance risk, in line with Fitch's approach to rating hybrid capital securities.

The two notches for loss severity reflect the notes' deep subordination - only ordinary equity ranks below the notes in a winding-up.

The notching for incremental non-performance risk reflects the notes' fully discretionary coupons, which Fitch views as the most easily activated form of loss absorption. In addition to management discretion, coupon payments are subject to ANZ not breaching its regulatory capital requirements (common equity Tier 1, Tier 1 or Total) at Level 1, Level 2 and, if implemented, Level 3; or the bank not becoming insolvent as defined in the Corporations Act 2001; or APRA not objecting to the payment.

The coupon payments are non-cumulative. Level 1 capital requirements are set at a standalone level, while Level 2 captures the consolidated entity, excluding some businesses such as insurance, trustee, non-financial and securitisation operations. Level 3 capital requirements encompass the entire group, but APRA is yet to determine the full implementation date and framework's final form.

Fitch's criteria allows for wider notching for incremental non-performance if Fitch has particular concerns around the probability of coupon omission. Fitch does not have this concern for ANZ, as the bank has strong and proven capital-flexibility, a solid buffer above regulatory minimum capital requirements and Additional Tier 1 coupon payments are small as a portion of ANZ's profit.

ANZ's profitability is strong, relative to many international peers, and internal capital generation can be increased quickly by placing a discount on the dividend reinvestment plan. Alternatively, the bank could issue ordinary shares to the market, cut its dividend payout, restrict risk-weighted asset growth or undertake asset sales to improve capitalisation if needed.

ANZ reported a Level 1 common equity Tier 1 ratio of 10.2% at 31 March 2016 and a 9.8% CET1 ratio at Level 2, 220bp and 180bp respectively above the bank's Pillar 1 minimum of 8%. Tier 1 and total capital buffers at Level 1 and Level 2 were higher. ANZ targets a common equity Tier 1 ratio of around 9%, so Fitch expects the bank to maintain a buffer of at least 100bp, even after the minimum average risk-weight for Australian mortgages under the internal ratings-based approach rises to 25% on 1 July 2016. The regulatory minimum includes 2.5pp for the capital conservation buffer and 1pp for being a domestically systemically important bank.

If a coupon on the notes is cancelled, ANZ cannot pay an ordinary dividend until the next coupon is paid. Fitch believes this, combined with the small size of the coupon payments for Additional Tier 1 instruments relative to ordinary dividends, creates a strong incentive for ANZ to pay the coupons, even if it enters the capital conservation buffer. ANZ paid about AUD275m in Tier 1 coupon payments in the financial year to 30 September 2015 (equivalent to 3.7% of net-profit after-tax), while its dividend on ordinary shares totalled AUD4.9bn.

The notes have additional loss absorption features in the form of a capital trigger and a point of non-viability trigger. The capital trigger requires the notes to convert, in part or in full, to ordinary equity of ANZ if the bank's common equity Tier 1 ratio falls to, or below, 5.125% at Level 1, Level 2 and, if implemented, Level 3. The non-viability trigger requires the notes to convert, in part or in full, to ordinary equity of ANZ if the bank receives written notice from APRA that without conversion of capital securities or a public-sector capital injection, the bank would be nonviable in the regulator's opinion.

RATING SENSITIVITIES

The notes' ratings are sensitive to movements in ANZ's Viability Rating. The notching for incremental non-performance risk could also be widened and the rating downgraded if Fitch developed concerns over ANZ's ability to remain above its capital-buffer zone at either Level 1, Level 2 and, if implemented, Level 3. This could arise due to a change in Fitch's assessment of ANZ's conservative approach to capital management or an unexpected shift in regulatory buffer requirements.

For more details on ANZ's ratings and credit profile, see the rating action commentary, Fitch Affirms Australia's Four Major Banks, dated 11 May 2016.