How To Rate A Bank In Australia

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1 Page 1 of 5 Fitch Upgrades NZ's Heartland Bank, Affirms Five Other FIs Ratings Endorsement Policy 28 Oct :56 AM (EDT) Fitch Ratings-Sydney-28 October 2014: Fitch Ratings has upgraded Heartland Bank Limited's (HBL) Long-Term and Short-Term Issuer Default Ratings (IDR) and Viability Rating (VR) to 'BBB'/'F2'/'bbb' from 'BBB-'/'F3'/'bbb-'. The Outlook on the Long-term IDR is Stable. Fitch has also affirmed: TSB Bank Limited (TSB) at 'A-' Southland Building Society (SBS-Bank, SBS) at 'BBB' The Co-Operative Bank Limited (Co-op) at 'BBB-' Nelson Building Society (NBS) at 'BB+' Wairarapa Building Society (WBS) at 'BB+' The Outlooks on all IDRs are Stable. The Support Ratings and Support Rating Floors of all these entities have been affirmed at '5' and 'No Floor', respectively. A full list of rating actions is at the end of this rating action commentary. Operating in New Zealand, all six entities are small financial institutions with simple and transparent business models. Their main focus is on residential mortgages, with the exception of HBL which targets niche markets such as motor vehicle finance, invoice and equipment finance and more recently home-equity-release mortgages. This gives HBL relatively greater pricing power in its target markets. The other banks have relatively small national franchises and are price-takers, although most enjoy a level of community support in their home regions. All entities have strong capital ratios relative to international peers. Nevertheless, most have limited access to capital given their ownership structures - either mutual or owned by community trusts. HBL is owned by a holding company which is publicly listed in New Zealand and could allow it access to equity capital from the market if needed. Fitch expects New Zealand's economy to continue its strong performance with real GDP growth at 3.5% in 2014 and 2.9% in 2015, as both consumption and business investment continue to be strong. Hence, the agency expects the labour market to improve with a further reduction in the unemployment rate to 5.5% in 2015 (2013: 6.2%). The Reserve Bank of New Zealand (RBNZ) has increased the official cash rate (OCR) by 100bp to 3.5% since March 2014 to prevent a rise in inflation expectations. With inflation currently at moderate levels, the RBNZ has indicated it is undertaking a period of monitoring and assessment before considering further policy adjustment. These economic conditions should be beneficial for the entities' asset quality and operating performance. Nevertheless, high household leverage and New Zealand's high property prices remain risks to the financial system, but higher interest rates and macro-prudential measures taken by the authorities appear to be keeping these risks in check given the underlying strength of the economy. There are risks building in the agricultural sector where low dairy prices, should they persist, may contribute to asset quality issues in this sector. However, most of the entities of this peer review have limited exposure to the agricultural sector. The operating environment does not constrain the entities' IDRs and VRs. TSB Bank Limited TSB's conservative risk appetite has led to its consistently sound asset quality and profitability, which have been above industry average over the past decade. TSB's conservative risk appetite combined with its simple business model has resulted in a strong balance sheet structure and sustainable operating performance. TSB's liquidity, funding and capital positions are good for an institution of its size and are strong relative to international and domestic peers. The ratings also take into account TSB's small domestic franchise, geographic concentration and limited access to new capital. TSB's business model has been strongly influenced by the bank's conservative risk appetite which reflects the bank's tight underwriting standards, careful expansion outside its home region as well as holding a sizeable securities portfolio which supports the bank's exceptional liquidity position. TSB's IDRs and VR are sensitive to a change in the bank's risk appetite. An increased risk profile, reflected in weaker

2 Page 2 of 5 underwriting standards and/ or risk controls, or a substantial increase in asset growth could lead to deterioration in asset quality, operating performance and capitalisation which may result in negative rating actions. Positive rating momentum would require significant improvements in the bank's franchise while maintaining its current business model and risk appetite which is unlikely in the short- to medium-term. Heartland Bank Limited The upgrade of HBL's Long- and Short-Term IDRs and VR reflect the bank's consistent reduction in non-core assets resulting in improved asset quality and stronger earnings. At the financial year end 30 June 2014 (FY14) HBL's noncore asset portfolio stood at NZD41m. HBL expects to reduce the portfolio to NZD26m by end-2014, while maintaining current provisioning levels. At this point the portfolio would be unlikely to present a material risk to the bank's capitalisation and profitability. HBL's funding and liquidity profile is adequate for its rating level. It makes greater use of wholesale funding relative to most of its domestic peers, with a loan/ deposit ratio of 116% at FYE14, leaving it somewhat susceptible to investor confidence. In addition, HBL's on-balance sheet liquidity is lower than domestic peers. This risk is partly offset by HBL's shorter duration loan portfolio. Around 53% of HBL's liabilities maturing within 12 months are covered by maturing assets at FYE14. HBL's business model focuses on lending niche markets in which it has a leading market share. As a result, HBL generates a stronger net interest margin than peers despite the riskier lending profile. Fitch expects HBL's core asset quality to remain sound, benefiting from strengthened underwriting standards and good economic conditions. In addition, HBL's capital ratios are adequate relative to its risks. HBL's IDRs and VR are sensitive to changes in its company profile and risk appetite. A weaker company profile - mainly reflected in its business model and franchise, could impact the bank's earnings performance and could lead to a change in risk appetite, placing negative pressure on HBL's asset quality and/or capital, funding and liquidity positions. Positive rating action is unlikely in the short- to medium-term. Southland Building Society SBS's IDRs, VR, senior debt ratings, and Outlook reflect its improving asset quality and operating performance and solid capital ratios. Offsetting these attributes is the bank's modest domestic franchise and limited pricing-power, although strategic initiatives are targeting a larger national presence. Asset quality has improved with the work out of problem loans and tighter underwriting standards over the last four years, and supported stronger earnings and profitability. Capital ratios include solid buffers over regulatory minimums. Fitch's Core Capital (FCC) ratio was 13.35% at FYE14 (FYE13: 12.95%) and SBS was stronger than international peers, measured by the tangible common equity to tangible assets ratio. An upgrade to SBS's IDRs, VR and senior debt ratings would require the bank to improve the value of its franchise through the successful execution of its growth strategy, demonstrate asset quality towards the high end of its peer group and maintain strong balance sheet metrics. SBS's senior unsecured debt 'deposit notes' have priority over the bank's redeemable shares and could be equalised with the IDR should the level of subordination decrease. The IDRs, VR and senior unsecured debt ratings allow for some deterioration in the operating environment as well as SBS's balance sheet composition, but potential negative rating pressure could occur if asset quality deteriorated and resulted in a negative impact to earnings, capital ratios and the reputation of the organisation. The Co-operative Bank Limited Co-op's IDRs and VR are limited by the bank's low, but improving profitability relative to domestic peers, an area which management seeks to address through a five year strategic plan. Continued strengthening in profitability is likely as the bank progresses its strategic plan, although a more significant sustainable improvement may take some time. Profitability is therefore likely to lag domestic peers in the financial year ended 31 March 2015 (FY15). The bank's medium term strategic objectives are clearly articulated by management. Although it has performed well against the objectives to date, the brand and strategic goals are still relatively new and a longer term track record has not been established. Expansion, particularly into the Auckland market has been approached cautiously, reflective of the banks modest risk appetite. The VR is supported by strong capitalisation relative to peers and solid asset quality which has continued to remain stable. The FCC ratio was 15.8% at FYE14 and is unlikely to deteriorate materially despite the bank's growth ambitions. The impaired loan ratio of 0.2% also compares favourably against local and international peers.

3 Page 3 of 5 Positive rating action would require a sustainable and significant improvement in profitability whilst maintaining current strong levels of capitalisation, sound funding and modest risk appetite. Negative rating action may result should the bank weaken its risk appetite and the FCC ratio significantly decline as part of its growth strategy. A material deterioration in Co-op's operating environment, placing pressure on asset quality and potentially eroding the bank's capital base would also place downward pressure on the bank's ratings. Nelson Building Society NBS's IDR, VR and Stable Outlook reflect the society's consistently strong operating performance, solid asset quality, and stable funding and liquidity profiles. The main constraints on the ratings are the society's moderate franchise which can limit pricing power and competitive advantages, its small absolute size which increases concentration risks, and below peer capitalisation and leverage. NBS's performance in the face of intense competition has been very strong with higher operating profits from good loan growth and wider net interest margins. However, as a mutual institution, NBS has limited capital raising options and rapid loan growth has pressured capital ratios. Capital ratios are lower than domestic peers but stronger than more highly rated international peers. An upgrade to NBS's IDR and VR would require the society to improve the value of its franchise, decrease its concentrations and strengthen its capital position. A negative rating action could occur if asset quality unexpectedly deteriorated due to its large single-name or geographic concentrations, or because of poorly managed expansion and loan growth. Wairarapa Building Society WBS's IDR, VR and Stable Outlook reflect the society's moderate franchise, good asset performance and adequate capital ratios containing satisfactory buffers over regulatory minimums, offset by large loan and investment property exposures for an institution of its size. WBS's conservative underwriting approach is reflected in the performance of its loan book despite significant single name concentration. Capital ratios are high relative to peers but Fitch views this as appropriate given WBS's small absolute capital base, limited capital raising options and large loan concentrations. WBS's IDR and VR are unlikely to be upgraded due to the society's small absolute capital base, small domestic franchise, and geographic and large-loan concentrations. A negative rating action could occur if asset quality unexpectedly declined leading to capital erosion. KEY RATING DRIVERS & RATING SENSITVITIES - SUPPORT RATING AND SUPPORT RATING FLOOR The Support Ratings and Support Rating Floors of all six banks and building societies reflect that while support from the New Zealand sovereign is possible, it cannot be relied upon. In Fitch's view, the introduction of the Open Bank Resolution Scheme (OBR) from 1 July 2013 reduces the propensity of the sovereign to support its banks. The OBR allows for the imposition of losses on depositors and senior debt holders to make up capital shortfalls if a deposittaking institution has failed. The Support Ratings and Support Rating Floors are sensitive to any change in assumptions around the propensity or ability of the New Zealand government to provide timely support to each institution. The rating actions are as follows: TSB Bank Limited Long-Term IDR affirmed at 'A-'; Outlook Stable Short-Term IDR affirmed at 'F2' Viability Rating affirmed at 'a-' Support Rating affirmed at '5' Support Rating Floor affirmed at 'No Floor' Heartland Bank Limited: Long-Term IDR upgraded to 'BBB' from 'BBB-'; Outlook Stable; Short-Term IDR upgraded to 'F2' from 'F3'; Viability Rating upgraded to 'bbb' from 'bbb-'; Southland Building Society (SBS Bank) Long-term IDR affirmed at 'BBB'; Outlook Stable;

4 Page 4 of 5 Short-term IDR affirmed at 'F2'; Local Currency Long-term IDR affirmed at 'BBB'; Outlook Stable; Local Currency Short-term IDR affirmed at 'F2'; Viability Rating affirmed at 'bbb'; Support Rating affirmed at '5'; Support Rating Floor affirmed at 'No Floor'; Commercial Paper affirmed at 'F2'; and Long-Term senior unsecured debt (deposit notes) affirmed at 'BBB+'. The Co-operative Bank Limited Long-Term IDR affirmed at 'BBB-'; Outlook Stable; Short-Term IDR affirmed at 'F3'; Viability Rating affirmed at 'bbb-'; Nelson Building Society: Long-Term IDR affirmed at 'BB+'; Outlook Stable; Short-Term IDR affirmed at 'B'; Local Currency Long-Term IDR affirmed at 'BB+'; Outlook Stable; Local Currency Short-Term IDR affirmed at 'B'; Viability Rating affirmed at 'bb+'; Wairarapa Building Society: Long-Term IDR affirmed at 'BB+'; Outlook Stable; Short-Term IDR affirmed at 'B'; Local Currency Long-Term IDR affirmed at 'BB+'; Outlook Stable; Local Currency Short-Term IDR affirmed at 'B'; Viability Rating affirmed at 'bb+'; Contact: Primary Analyst Andrea Jaehne (TSB, HBL) Fitch Australia Pty. Ltd., Level 15, 77 King Street, Sydney NSW 2000 Tim Roche (Co-op) Senior John Birch (SBS, NBS, WBS) Secondary Analyst Tim Roche (TSB, HBL, SBS, WBS, NBS) Senior John Birch (Co-op) Committee Chairperson Mark Young Managing Media Relations: Leni Vu, Sydney, Tel: , Leni.Vu@fitchratings.com.

5 Page 5 of 5 Additional information is available on Applicable criteria, "Global Financial Institutions Rating Criteria", dated 31 January 2014 is available at Applicable Criteria and Related Research: Global Financial Institutions Rating Criteria Additional Disclosure Solicitation Status ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S FREE WEB SITE AT PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE. Fitch Australia Pty Ltd holds an Australian financial services licence (AFS licence no ) which authorises it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act Copyright 2014 by Fitch Ratings, Inc., Fitch Ratings Ltd. and its subsidiaries.