At the end of 2008 South Canterbury Finance was rated BBB- by Standard and Poors. Earlier that year, it has issued three year bonds (themselves rated BBB-) in the US private placement market. BBB- wasn’t such a bad credit rating for a small, not overly diversified unregulated domestic lender. But a year or two later, SCF failed spectacularly, at considerable cost to the taxpayer.
Today, S&P has come out downgrading the standalone ratings of three of the four big banks to BBB+. Of course, that is still two notches above SCF’s rating, but if it is really justified the news would have to be quite concerning. Note that the overall issuer credit ratings remain at AA-, reflecting the combination of probable parental support and the possibility of government support (for these systemically significant banks) in the event that they get into trouble. Their assessment of the risk of investors losing money hasn’t changed.
But it is the standalone rating that is meant to reflect the quality of each bank’s loan book.
Recall that the RBNZ and APRA stress-tested the large banks only last year. The stress scenarios were very demanding – a 50 per cent fall in house prices and an increase in the unemployment rate larger than any seen in floating exchange rate countries in the post-war decades. And the banks’ loan books came through with flying colours, and the actual capital of each of the banks was not impaired at all (capital ratios fell because risk weights on the remaining loans rose).
Here is a chart of capital ratios from the stress test scenarios from the November FSR
If Standard and Poor’s are right there must be something very wrong with the Reserve Bank stress test results. Not that much has changed in the make-up of banks’ portfolios in the last 12-18 months for the difference to be about new, much riskier, loans being made. My bias is to run with the stress test results – perhaps they are a little optimistic, but probably not too much. But the Governor doesn’t seem to believe them, and neither apparently does one of the leading rating agencies. If the Bank is really sceptical then it is really past time for it to lay out any reasoning, and evidence, it has as to why the stress test results are not now a good guide to the standalone health of the major banks.