Banks feel the pressure on capital levels
The Australian 12:00am June 20, 2016
Michael Bennet
A lull in the regulatory capital storm engulfing the major banks is set to end, refocusing attention on potential equity raisings as their surcharge for being a risk to the economy may be doubled and global rules are set in stone.
Ahead of a range of regulatory headwinds in the second half of the year, National Australia Bank’s own credit analysts last week told clients the banking regulator would probably double the capital charge on domestic systemically important banks, known as D-SIBs, to 2 per cent.
Analyst Simon Fletcher added the global push for so-called “total loss absorbing capital” (TLAC) on big banks could lead to the ¬creation of a new “tier three” debt class for the domestic major ¬lenders. “An increase to the D-SIB surcharge to 2 per cent (from the current 1 per cent) is also likely,” he said.
“The push from The Australian Prudential Regulatory Authority for more capital to be held by the big four banks is unavoidable.”
Higher capital requirements make banks safer but dent profitability, with the majors’ return on equity falling by 153 basis points to an average 13.8 per cent in the first half, according to KPMG, after they raised about $17 billion from shareholders to meet revised mortgage rules.
NAB’s research follows similar concerns earlier this month raised by Commonwealth Bank’s credit analysts, which found the major banks were up to $30bn short of the most expensive and highest ranking form of tier-one capital, known as common equity tier one (CET1).
Like CBA’s analysis, Mr Fletcher concluded the big four banks — CBA, NAB, ANZ and Westpac — would end up operating with CET1 ratios of at least 10 per cent in the “foreseeable future”, well above the 8 per cent requirement.
The forecast was based on the D-SIB charge being doubled to 2 per cent, lifting the big four’s new minimum CET1 ratio to 9 per cent. The initial D-SIB charge came into effect in January, as part of a global push from the G20 to reduce the “too-big-to-fail” risks to taxpayers posed by major banks.
“Global banks have been (for various reasons) increasing capital levels,” Mr Fletcher said.
“The financial system inquiry recommendation for Australian (banks) to have ‘unquestionably strong’ capital measures from being placed in the top quartile of internationally active banks will likely drive Australian banks to continue to raise additional equity capital.”
Despite the banks’ management dismissing talk that they will need to increase their CET1 ¬capital as a proportion of risk-weighted assets to 10 per cent, -investors remain concerned about further capital raisings and reductions to dividends.
On Friday, Morgan Stanley analyst Richard Wiles told clients the banks’ “capital build” was not over and was instead on “hold” while APRA awaits the final “Basel IV” rules on changes to the “risk weighting” of assets.
“However, there should be more clarity by early 2017, and we believe ‘unquestionably strong’ capital will be set above current levels,” he said. “What’s more, we think the timing of the capital build could be determined more by market forces than by APRA’s transition period.”
According to APRA, the big four have increased their CET1 capital 15 per cent to $150.5bn in the past year, boosting their capital ratios because “risk-weighted” assets stayed flat at about $1.5 trillion.
However, once the benefit of risk weighting is stripped away, the big four’s assets are a much larger $3.5 trillion — one of the reasons why regulators are focusing on other indicators, such as leverage ratios, rather than just CET1 capital ratios.
In its response to the Murray inquiry in October, the government tasked APRA to “take additional steps to ensure our banks have unquestionably strong capital ratios” by the end of the year. APRA then must work on ensuring the banks have “appropriate total loss-absorbing capacity and leverage ratios in place”.
The timing coincides with the Basel Committee’s unveiling of the next suite of major reforms around the end of this year, dubbed Basel IV.
APRA wants to assess the Basel Committee’s proposed changes, particularly new rules on how banks risk weight assets, before locking in its response to the Murray inquiry’s “unquestionably strong” recommendation.
NAB’s Mr Fletcher said APRA would begin consulting on a total loss-absorbing capital regime before the end of the year, potentially resulting in the new “tier three” debt for the major banks.
TLAC was designed by global policymakers for global systemically important banks (G-SIBs) to allow for an orderly resolution and end the too-big-to-fail problem so taxpayers don’t have to step in, with “bail-in” bonds a key feature. While the Australia banks are not so-called G-SIBs, the government has tasked APRA to put a regime in place. “France and Spain have chosen the tier three route and we suspect that APRA is examining the implications and market reactions closely,” Mr Fletcher said.
“We expect that APRA will also choose this option. On balance, this is likely to deliver all of the sought benefits of a TLAC regime and at the lowest cost to the banks themselves.
On NAB’s calculations, the big four banks will have to collectively issue $153bn in TLAC debt, which could reduce their issuance of senior unsecured debt.
“TLAC compliance is readily achievable by the big four banks and, under reasonably expected market conditions, initial tier three issuance should offer good value opportunities to investors,” Mr Fletcher said.