Australia | Dec 09 2019
After a year's consultation, the RBNZ has released additional capital requirements for Australian banks that are not as onerous as feared.
-Lower than feared CET1 requirement
-Longer compliance period
-Capital raising not likely
-Dividend cuts cannot be ruled out
By Greg Peel
If the GFC brought one thing, it was the realisation global "big" banks were not carrying enough capital against the risk they were holding on their balance sheets. So began a lengthy process of tightening regulations while awaiting the outcome of a globally coordinated review that would result in a set of "Basel IV" regulations.
The Australian Prudential Regulation Authority told the big Australian banks it would take on board the Basel recommendations and then add an additional capital buffer to compensate for the fact Australia's "too big to fail" banks operated in a relatively small economy. APRA would require our banks to be "unquestionably strong".
No one knew what that meant.
As it was, the Basel negotiations went on and on and eventually ended in stalemate, so APRA decided it better go ahead with "unquestionably strong" anyway, which turned out to be a requirement that 10.5% of bank capital must be common equity tier one (CET1).
APRA has also since tightened other capital measures with regard to risk-weighted assets and offshore subsidiaries but at the time analysts suggested the Big Four could reach their required capital levels in a dawdle by the January 1, 2020 deadline.
Of course we've since seen the Royal Commission put bank balance sheets under tremendous pressure which, at the recent earnings season, forced changes to dividend policy and a capital raising. But even then, it appeared the CET1 requirement would still be readily achievable.
Except that, in between, the Reserve Bank of New Zealand decided it wanted an even bigger buffer for its own "too big to fail banks" than APRA's 10.5%, which itself was always planned to be greater than whatever Basel came up with. Indeed, as much as 16%.
This was the initial proposal, before the RBNZ began a year-long consultation. The problem for Australia's TBTF banks is that they are also New Zealand's TBTF banks. The Big Four here are the Big Four there, ahead of smaller domestic players.
All the Big Four needed at this difficult time was yet another capital requirement increase, further risking dividends and perhaps forcing more capital raisings.
The hope was the RBNZ would not find it necessary to go all the way to 16%.
But it did.
Not So Bad
However, last week's announcement was not as bad as feared. Yes, the total capital requirement would be 16% but this would be made up of 13.5% CET1 and 2.5% additional tier one (AT1) capital, which means hybrid debt/equity issuance. The initially proposed split here was 14.5% and 1.5%.
And instead of having five years to comply from the 2018 date, implying 2023, the RBNZ is allowing seven years from 2020, to July 2027. Plenty of time, analysts suggest, for the banks to work towards achieving their requirements.
Furthermore, the definition of AT1 has been widened to include redeemable, perpetual preference shares rather than just non-redeemable preference shares as was initially proposed. The reason for this is not because the RBNZ caved in but because the central bank agreed there simply may not be enough demand in the market for the latter hybrid to satisfy requirements.
It is not a given there will be overwhelming demand for redeemable, perpetual preference shares either, but a much better chance, analysts suggest, than the alternative, and plenty of time to get there.
The end result is the banks won't need to come up with as much new capital as feared. On the initial proposal, analysts assumed the NZ subsidiaries of the Big Four would need to cut the level of dividends they pay back to their parents in Australia, forcing the parents to carry the burden at a time they were struggling with RC-related remediation, increased costs, a historically low cash rate and a lack of loan demand.
Whereas analysts feared those dividends might have to be cut to as little as a 35% payout, it looks like 50-60% will now be more likely.
Which in turn implies the level of additional capital the banks will need to accumulate will not be as great as feared. And they have more time to reach the target.
Of the four, ANZ Bank ((ANZ)) is the most exposed to New Zealand with Commonwealth Bank ((CBA)), the least. Westpac ((WBC)) and National Bank ((NAB)) are roughly even in the middle. To date, ANZ is the only bank to officially respond to the RBNZ's decision.
"We are confident that we can meet the higher requirements without the need to raise additional capital," said management. Given ANZ is the most exposed, and can divest of some of its NZ assets if necessary, analysts assume the other banks won't need to raise either. Indeed Westpac already has, and on the sale of its Life business, CBA might even be able to return funds to shareholders.
That's the view of Macquarie, at least, while other brokers are not so sure based on CBA's now elevated payout ratio. And despite the RBNZ factor not being as big an impost as feared, given everything else going on for the Big Four, further dividend cuts cannot be ruled out.
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