Fitch Ratings has affirmed Bank of Queensland Limited's (BOQ) Long-Term Issuer Default Rating (IDR) of 'A-' with a Stable Outlook.

BOQ's Short-Term IDR, Viability Rating (VR), Government Support Rating (GSR) and debt ratings have been affirmed at the same time.

Key Rating Drivers

Robust Risk Controls: BOQ's Long-Term IDR and senior debt ratings are driven by the VR, which is supported by a robust risk profile that underpins good asset quality. The assigned VR is in line with the implied VR. The Short-Term IDR of 'F2' is at the lower of the two options available at a Long-Term IDR of 'A-', as the funding and liquidity score of 'bbb+' is not sufficiently high enough to support an 'F1' rating.

Economic Growth to Slow: We expect high inflation and rising interest rates to result in slower economic growth and an increase in unemployment in 2023 in Australia. However, we expect the weakening to be manageable for banks in Australia and do not expect a sharp deterioration in the banks' asset quality. We factor in high household leverage into our assessment of the operating environment to reflect households' susceptibility to sharp interest-rate hikes, resulting in a score at the lower end of the 'aa' category.

Modest Australia-Focused Franchise: BOQ maintains a simple business model focusing on traditional commercial banking activities with operations primarily in Australia. This is offset, however, by its modest market share, which limits pricing power.

Credit Risk Drives Risk Profile: BOQ's main risk is credit risk, which stems from its loan portfolio, and this appears to be well managed by the bank. Market risk and non-financial risk also seem to be manageable, although the bank has identified areas for improvement in risk culture and governance, and raised a provision to account for the associated costs. We expect this to remain one of the bank's focus areas as it continues to increase reliance on digital channels and strengthen operational resilience.

Moderate Weakening in Asset Quality: We expect some decline in BOQ's asset quality and a moderate weakening of its stage 3 loan ratio over the next two years as sharply higher interest rates and inflation put pressure on borrowers' ability to repay loans. However, the low unemployment rate in Australia should limit the deterioration in asset quality.

Pressure on Earnings Ahead: Slower loan growth and higher funding costs should offset a rise in net interest margin in the financial year ending 31 August 2023 (FY23), resulting in BOQ's earnings facing some pressure in the next two years. Higher operating expenses, ongoing investment costs and a rise in impairment charges will also squeeze earnings.

Improved Capitalisation: The implementation of the final Basel III rules is the main driver for our forecast increase in BOQ's common equity Tier 1 (CET1) ratio in FY23. BOQ reported a CET1 ratio of 10.7% at end-1HFY23, with a 120bp uplift under the new rules, and we expect the ratio to rise above 11% by FYE23.

Deposit-Focused Funding Base: We expect BOQ's funding profile to improve slightly in FY23, adding to enhancements in the loan/deposit ratio over the last two years, and to remain stable in FY24. This underpins our revision of the outlook on the 'bbb+' factor score to positive from stable. Refinancing of the Reserve Bank of Australia's term funding facility is underway, and is likely to be manageable, with slower loan growth assisting the process. We expect liquidity metrics to remain well above the 100% regulatory minimums.

Rating Sensitivities

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

The VR and Long-Term IDR may be downgraded if one or more of the following were to occur:

The four-year average of stage 3 loans/gross loans increases to above 2.5% for a sustained period;

The four-year average of operating profit/risk-weighted assets declines below 1% on a sustained basis; and

CET1 ratio falls below 9% without a credible plan to raise it back above this level.

The VR, Long-Term IDR and senior unsecured debt ratings are sensitive to an increase in BOQ's risk profile, such as a loosening of underwriting standards or risk controls in the pursuit of growth, although that appears unlikely in the current environment.

A downgrade of the Short-Term IDR appears unlikely in the near term. It would require the Long-Term IDR to be downgraded by at least two notches to 'BBB', and the funding and liquidity score to be lowered by at least one notch to 'bbb'.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

An upgrade of BOQ's Long-Term IDR, VR and senior debt ratings appears unlikely over the next two years, as it would require both a significant improvement in its market position so that the business profile would be consistent with a factor score of 'a-' (current score of bbb+), and a significant and sustained improvement in BOQ's financial profile.

BOQ's Short-Term IDR may be upgraded without an upgrade in the Long-Term IDR if its funding and liquidity score were upgraded by two notches to 'a'. This does not seem probable in light of the bank's reliance on wholesale funding.

OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS

Senior Unsecured: BOQ's long-term senior unsecured debt ratings are aligned with the Long-Term IDR, consistent with Fitch's Bank Rating Criteria.

Subordinated: BOQ's subordinated Tier 2 debt is rated two notches below its anchor rating, the VR, which is consistent with the base case in Fitch's Bank Rating Criteria. The two notches below the anchor rating are for loss severity, with non-performance risk captured adequately by the VR. None of the reasons for alternative notching from the anchor rating as described in the criteria is present.

GSR: The GSR of 'bb' reflects a moderate potential of support coming from the authorities, if needed, in light of BOQ's modest market share and role in the banking system.

OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES

Senior Unsecured: The long-term senior unsecured debt ratings will move in line with BOQ's Long-Term IDR.

Subordinated: The subordinated debt ratings will move in line with BOQ's VR.

GSR: A downgrade of Australia's sovereign rating of 'AAA'/Stable or a weakening in propensity for the authorities to provide support may result in Fitch lowering BOQ's GSR of 'bb'. Conversely, an increase in the probability of support from the authorities as a result of, for example, increased systemic importance, may lead to a higher GSR for BOQ.

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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