8/30/2017 [ Press Release ] Fitch Affirms Seven New Zealand Financial Institutions

Fitch Affirms Seven New Zealand Financial Institutions

Fitch Ratings-Sydney-30 August 2017: Fitch Ratings has affirmed the ratings of the following seven New Zealand financial institutions: - Kiwibank Limited; - TSB Bank Limited; - Southland Building Society (SBS); - The Co-operative Bank Limited (Co-op); - Nelson Building Society (NBS); - Credit Union Baywide (CUB); and - Wairarapa Building Society (WBS).

At the same time, the agency has assigned Local-Currency Issuer Default Ratings (IDR) to TSB, Co-op and CUB. A full list of rating action is at the end of this commentary.

The affirmation of the IDRs, Viability Ratings and instrument ratings for the seven institutions reflects our view that they are likely to continue performing solidly over the next year or two. However, we maintain a negative sector outlook for New Zealand, reflecting rising household indebtedness and high property prices, which could lead to asset quality deterioration if unemployment or interest rates rise. Conversely, dairy exposures, for the institutions that have them, are likely to see improved asset quality if higher global dairy prices are sustained into 2018.

Many of these entities are planning for strong loan growth. However, we believe market conditions and regulatory action, including already-implemented macro-prudential tools, may make it increasingly difficult for the banks to sustain such growth levels.

KEY RATING DRIVERS

IDRs Kiwibank's IDRs reflect Fitch's view that there is an extremely high capacity and likelihood of support from the bank's ultimate owner, the New Zealand sovereign (AA/Stable), if required. Kiwibank is directly owned by New Zealand Post, New Zealand Superannuation Fund and Accident Compensation Corporation, which are all sovereign-owned entities.

The IDRs of TSB, SBS, Co-op, NBS, CUB and WBS are aligned with their respective Viability Ratings. See below for details of the key rating drivers.

VIABILITY RATINGS Kiwibank Kiwibank's Viability Rating reflects its robust asset quality, controlled risk appetite and funding profile. Kiwibank operates a simple business model focusing on the retail segment. The bank is significantly larger by total assets than its regional bank peers, but its low market share of around 4% means it has similarly limited pricing power. Kiwibank's growth over recent years has been moderate relative to peers. Fitch does not expect the bank's asset quality and funding profile to significantly change over the next two years in the absence of an external shock.

The bank's capitalisation has historically been a weakness relative to peers. However, the gap has closed following strong growth from other regional banks and capital injections from Kiwibank's shareholders, if retained. Fitch expects the bank's capitalisation to gradually improve over the long term due to its moderate growth levels and willingness of shareholders to reinvest dividends. Fitch considers the bank's access to capital as stronger than peers.

TSB TSB's Viability Rating reflects its conservative risk appetite, simple business model and financial metrics that on the whole are stronger than that of peers, while also capturing its small domestic franchise, geographic concentration and limited access to new capital. The bank has experienced strong loan growth through 2016 and into 2017, although this does not appear to have been at the expense of underwriting standards or risk controls. However, TSB expects to maintain strong loan growth levels, which may negatively affect its capitalisation and funding profile.

The loan growth follows TSB's five-year strategy to replace less-liquid securities with customer loans. The loan book remains fully deposit funded despite the strong loan growth, although the level of on-balance-sheet liquidity has declined. Profitability is likely to decline in the short- to medium-term as the bank continues to invest in systems and processes to accommodate customer growth, https://www.fitchratings.com/site/pr/1028432 1/7 8/30/2017 [ Press Release ] Fitch Affirms Seven New Zealand Financial Institutions

although this should ultimately support higher profitability in the longer term.

TSB's credit profile should not be significantly affected by the funding and special dividend it has provided to its parent to assist with the purchase of a further stake in Fisher Funds Management Limited. However, Fitch continues to monitor the growth and nature of the non-bank operations of TSB's parent to determine what, if any, risk they pose to TSB's profile.

SBS SBS's Viability Rating reflects its conservative risk appetite, improving asset quality and earnings, and sound capital ratios. It is offset by a modest domestic franchise and limited pricing power. The bank's growth strategy has given rise to strong loan growth, particularly for residential mortgages and consumer lending. The August 2017 announcement of the acquisition of the Warehouse Financial Services Group is consistent with this strategy.

The strength of SBS's balance-sheet growth has pressured its capitalisation and funding profiles, although we expect these to remain in line with those of peers and the bank's ratings. Its strategy is likely to assist earnings and profitability in the medium term, which should ultimately support capitalisation, although growth in non-mortgage consumer loans may increase impaired assets and charge-offs over the cycle.

Co-op Co-op's Viability Rating reflects its modest risk appetite, sound asset quality and stable funding profile. This is offset by the bank's moderate franchise and resulting limited pricing power.

Fitch expects Co-op's strong expansion - which does not appear to have been achieved at the expense of higher risk appetite or weakening underwriting - to continue. Residential mortgages comprise the bank's core business segment, although we expect it to develop other retail lending. The bank's expansion is likely to continue pressuring its Fitch Core Capital ratio in the short-term, but it has kept its total capital ratio stable by raising Tier 2 capital.

NBS The society's ratings are constrained by its modest franchise, small absolute size and capitalisation, as reflected in its low pricing power and higher concentration risk than that of peers. This is offset by NBS's conservative risk appetite, robust asset quality and stable funding position.

NBS continues to deliver double-digit asset growth and high deposit growth, with strong community support in its home region. Competition may challenge profitability growth, but robust loan volume should provide a buffer. NBS has limited access to new common equity and its capitalisation ratios remain pressured by strong growth.

CUB CUB's Viability Rating reflects its greater risk appetite against that of most domestic peers, with a focus on higher loan/value mortgages and consumer lending. This increases the susceptibility of its loan performance to a weaker operating environment through the cycle. CUB's risk controls are adequate for its size and consistent with regional peers, but are not as developed as those of larger banks.

CUB's risk-weighted and unrisk-weighted capitalisation ratios have historically been above those of peers. However, Fitch expects ongoing growth, which exceeds internal capital generation, to pressure capitalisation over the next two years. The credit union has a small absolute capital base and limited ability to generate fresh common equity outside of internal capital generation.

WBS The society's Viability Rating reflects its modest franchise and product offering, weaker earnings profile and higher concentration risk relative to peers. WBS's property investment portfolio has historically provided stable rental returns, but adds potential volatility through fair-value market adjustments. These issues are offset by the society's asset quality and conservative risk appetite.

The society's conservative risk appetite is reflected in its minimal historical losses and low loan/value mortgages across its loan book, which supports asset quality. The society has reduced its property investment holdings and says it is comfortable with its current portfolio, but continues to monitor opportunities as they arise. WBS's capital ratios are adequate, but it has a small absolute capital base, limited access to new common equity and concentration risk.

SUPPORT RATINGS AND SUPPORT RATING FLOORS

Kiwibank Kiwibank's Support Rating reflects Fitch's view that there is an extremely high capacity and likelihood of support from the bank's ultimate owner, the New Zealand sovereign, if required. https://www.fitchratings.com/site/pr/1028432 2/7 8/30/2017 [ Press Release ] Fitch Affirms Seven New Zealand Financial Institutions

TSB, SBS, Co-op, NBS, CUB, WBS The Support Rating and Support Rating Floor of these six institutions reflect our view that while support from the New Zealand sovereign is possible, it cannot be relied on. We believe the existence of the open bank resolution scheme (OBR) lowers the propensity of the sovereign to support its banks. The OBR allows for the imposition of losses on depositors and senior debt holders to recapitalise a failed institution. NBS, CUB and WBS are not covered by the OBR due to their status as non-bank deposit-taking institutions; however, the existence of the framework indicates authorities are unlikely to provide support to these entities.

SENIOR DEBT Kiwibank Kiwibank's guaranteed senior debt ratings remain aligned with the sovereign rating, as the guarantee covers existing liabilities, including deposits, until final maturity. Ratings of new senior debt issuances, which do not benefit of a guarantee, are likely to be aligned with the relevant IDR.

TSB The rating of the registered certificates of deposit programme is aligned with the bank's Short-Term IDR, in line with Fitch's criteria.

SBS Deposits from customers are rated one notch above the bank's IDRs, at 'BBB+', to reflect the substantial subordination provided by other instruments to the deposits. Customer deposits rank equally with wholesale funding and ahead of redeemable shares (SBS's main senior funding source), subordinated instruments and equity. Redeemable shares, subordinated instruments and equity equated to over 75% of total assets at end-March 2017.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES Co-op The bank's subordinated notes are rated one notch below its Viability Rating of 'bbb' to reflect the notes' below-average recovery prospects compared with senior unsecured notes. The notes would be written down in part or in full should the Reserve Bank of New Zealand appoint a statutory manager or deem that Co-op was non-viable without the write down. We have not applied any additional notching from the Viability Rating for non-performance, as the Viability Rating already captures the point of non-viability.

RATING SENSITIVITIES

IDRs Kiwibank's IDRs are sensitive to the same factors that affect its Support Rating. The IDRs of TSB, SBS, Co-op, NBS, CUB and WBS are likely to move in line with their respective Viability Ratings.

Viability Ratings Kiwibank A weakening in the bank's capitalisation, earnings or profitability, possibly due to deterioration in risk appetite, could place downward pressure on its Viability Rating. Positive rating action would require a sustained increase in capital ratios or significant improvement in the bank's franchise.

TSB The bank's IDRs and Viability Rating may face downward pressure if its strong loan growth is maintained, even if it is not at the expense of the bank's conservative risk appetite, as it is likely to pressure TSB's financial metrics. This would shrink the buffers it enjoys over the metrics of peers. Negative rating action could also follow deterioration in the bank's risk appetite, which would be reflected in softer underwriting standards or weaker risk controls, as this could hurt its asset quality, operating performance and capitalisation. We do not believe an upgrade is probable.

SBS The bank's IDRs and Viability Ratings may be downgraded if macroeconomic risks continue to rise and SBS quickly increases its balance-sheet size at the expense of its conservative risk appetite or its sound funding and capital positions. The IDRs and Viability Rating may be upgraded if New Zealand's macroeconomic risks decline and the bank maintains its risk appetite, capital and funding positions while executing its growth strategy.

Co-op Co-op's IDRs and Viability Rating may be downgraded if there is deterioration in its risk appetite or a higher-than-Fitch-expected decline in capital ratios. A heightened risk profile, possibly through weaker underwriting criteria or unsustainable growth, could weaken asset quality, operating performance and capitalisation. An upgrade is not probable in the short to medium term. Positive rating momentum would require significant improvements in Co-op's franchise while maintaining or improving its financial profile and risk appetite. https://www.fitchratings.com/site/pr/1028432 3/7 8/30/2017 [ Press Release ] Fitch Affirms Seven New Zealand Financial Institutions

NBS The society's IDRs and Viability Rating are sensitive to an increase in risk appetite, possibly from weakening underwriting criteria or aggressive growth resulting in a deterioration of its asset quality, profitability or further erosion in its already-modest capitalisation. An upgrade to NBS's ratings would require sustained and significant improvement in its company profile and capital position.

CUB An upgrade of CUB's IDRs and Viability Rating would require an improved risk appetite, possibly through lower risk underwriting or a stronger risk-control framework, evidenced by performance through the cycle. Conversely, a downgrade may result if risk appetite increases substantially.

WBS The society's IDRs and Viability Rating are sensitive to an increase in its risk appetite, which could result in a deterioration of its asset quality or erosion of its capitalisation. An upgrade is not probable due to WBS's small absolute capital base, modest franchise and higher concentration risk relative to peers.

SUPPORT RATING AND SUPPORT RATING FLOOR Kiwibank Kiwibank's Support Rating is sensitive to the shareholders', and ultimately, the sovereign's ability and propensity to provide timely support to the bank.

TSB, SBS, Co-op, NBS, CUB, WBS 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.

SENIOR DEBT Kiwibank The legacy guaranteed debt ratings will move in line with the New Zealand sovereign ratings.

TSB The rating on TSB's registered certificates of deposit programme is subject to the same factors that influence the IDRs.

SBS The rating on SBS's customer deposits is subject to the same factors that influence the IDRs. In addition, a downgrade could result from a substantial increase in the proportion of senior unsecured debt (customer deposits and wholesale funding) in the funding structure, as this would lower the subordination provided by other instruments. Such a downgrade would align the rating with SBS's IDRs, although we do not believe a downgrade is probable due to the high level of subordination.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES Co-op Co-op's subordinated debt ratings are sensitive to the same considerations that might affect its Viability Rating.

The rating actions are as follows:

Kiwibank Limited Long-Term Foreign-Currency IDR affirmed at 'AA-'; Outlook Stable Short-Term Foreign-Currency IDR affirmed at 'F1+' Long-Term Local-Currency IDR affirmed 'AA'; Outlook Stable Short-Term Local-Currency IDR affirmed at 'F1+' Viability Rating affirmed at 'bbb' Support Rating affirmed at '1' Guaranteed foreign-currency senior debt affirmed at 'AA' Guaranteed local-currency senior debt affirmed at 'AA+' Commercial paper programme affirmed at 'F1+'

TSB Bank Limited Long-Term IDR affirmed at 'A-'; Outlook Stable Short-Term IDR affirmed at 'F2' Long-Term Local-Currency IDR assigned at 'A-'; Outlook Stable https://www.fitchratings.com/site/pr/1028432 4/7 8/30/2017 [ Press Release ] Fitch Affirms Seven New Zealand Financial Institutions Short-Term Local-Currency IDR assigned at 'F2' Viability Rating affirmed at 'a-' Support Rating affirmed at '5' Support Rating Floor affirmed at 'No Floor' Registered certificates of deposit affirmed at 'F2'

Southland Building Society Long-Term Foreign-Currency IDR affirmed at 'BBB'; Outlook Stable Short-Term Foreign-Currency IDR affirmed at 'F2' Long-Term Local-Currency IDR affirmed at 'BBB'; Outlook Stable Short-Term Local-Currency 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' Long-term senior unsecured debt (deposits from customers) affirmed at 'BBB+'

The Co-operative Bank Limited Long-Term Foreign-Currency IDR affirmed at 'BBB'; Outlook Stable Short-Term Foreign-Currency IDR affirmed at 'F2' Long-Term Local-Currency IDR assigned at 'BBB'; Outlook Stable Short-Term Local-Currency IDR assigned at 'F2' Viability Rating affirmed at 'bbb' Support Rating affirmed at '5' Support Rating Floor affirmed at 'No Floor' Subordinated debt affirmed at 'BBB-'

Nelson Building Society Long-Term Foreign-Currency IDR affirmed at 'BB+'; Outlook Stable Short-Term Foreign-Currency IDR affirmed at 'B' Long-Term Local-Currency IDR affirmed at 'BB+'; Outlook Stable Short-Term Local-Currency IDR affirmed at 'B' Viability Rating affirmed at 'bb+' Support Rating affirmed at '5' Support Rating Floor affirmed at 'No Floor'

Credit Union Baywide Long-Term Foreign-Currency IDR affirmed at 'BB'; Outlook Stable Short-Term Foreign-Currency IDR affirmed at 'B' Long-Term Local-Currency IDR assigned at 'BB'; Outlook Stable Short-Term Local-Currency IDR assigned at 'B' Viability Rating affirmed at 'bb' Support Rating affirmed at '5' Support Rating Floor affirmed at 'No Floor'

Wairarapa Building Society Long-Term Foreign-Currency IDR affirmed at 'BB+'; Outlook Stable Short-Term Foreign-Currency IDR affirmed at 'B' Long-Term Local-Currency IDR affirmed at 'BB+'; Outlook Stable Short-Term Local-Currency IDR affirmed at 'B' Viability Rating affirmed at 'bb+' Support Rating affirmed at '5' Support Rating Floor affirmed at 'No Floor'

Contact:

Primary Analyst Jack Do (Kiwibank, Co-op, NBS, CUB and WBS) Director +61 2 8256 0355 https://www.fitchratings.com/site/pr/1028432 5/7 8/30/2017 [ Press Release ] Fitch Affirms Seven New Zealand Financial Institutions

Fitch Australia Pty Ltd Level 15, 77 King Street, Sydney NSW 2000

Tim Roche (TSB, SBS) Senior Director +61 2 8256 0310

Secondary Analyst Tim Roche (Kiwibank, Co-op, NBS, CUB and WBS) Senior Director +61 2 8256 0310

Jack Do (TSB, SBS) Director +61 2 8256 0355

Committee Chairperson Grace Wu Senior Director +852 2263 9919

Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: [email protected].

Additional information is available on www.fitchratings.com

Applicable Criteria Global Bank Rating Criteria (pub. 25 Nov 2016) (https://www.fitchratings.com/site/re/891051)

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