The “relief rally” that followed the Australian Prudential Regulation Authority’s announcement of its new capital rules last Wednesday had run out of steam by the end of the week.
This won’t have surprised leading banking analysts, whose commentaries focused on the banks’ longer-term challenges, which include lower demand for finance and pressure from regulators to limit certain types of lending.
The rally, which saw ANZ stock up by more than four per cent over the week, was in response to new capital requirements being much less than expected.
APRA’s announcement marked the completion of its assessment of the amount of additional capital banks would need to be considered “exceptionally strong”.
It was a key recommendation of the Financial System Inquiry that Australian banks be exceptionally strong and the Government accepted the recommendation.
The FSI’s final report was released in November 2014 and last week’s announcement was the first time since the financial crisis that the banks have had clarity on their capital requirements.
The major banks need common equity their one (CET1) ratios of at least 10.5 per cent. The inclusion of a buffer will take that to 10.75 per cent or 11 per cent. At the moment the regulatory requirement is for a minimum CET1 ratio of eight per cent, with a 1.5 per cent buffer.
APRA said: “APRA expects that any changes to the capital framework that may eventuate from the finalization of international reforms will be able to be accommodated within the calibration set out in this paper and will not necessitate further increases to requirements at a later date.”
This implies that potentially higher risk-weighted assets will not be additive to the new CET1 ratio.
The amount of capital the major banks require to reach “unquestionably strong” benchmarks is now estimated at around $7.9 billion, rather than $17.7 billion if higher mortgage RWA had been additive.
According to estimates: ANZ will need to come up with an additional $493 million of capital, Commonwealth Bank $4.2 billion, National Australia Bank $1.7 billion and Westpac $1.5 billion.
“If anything, APRA appears to have gone light on the banks,” UBS said in a note on the APRA announcement.
“We believe the major banks should be able to achieve their targets organically, potentially with the help of DRP discounts at CBA. Active capital management and associated repricing is unlikely unless the credit cycle or housing market deteriorates,” UBS said.
“We expect a near-term relief rally but the medium term outlook remains challenging. The revenue environment is difficult, with credit growth subdued following APRA’s macroprudential measures to reduce household leverage. Bad debt charges are at near-record lows and could easily move back to higher levels if the economy softens.”
According to UBS, banks are trading on an average price-earnings multiple of 13.7 times (based on estimated 2017/18 earnings), which is above their long-term average.
“We do not believe the banks are cheap given the medium-term headwinds they face,” It says
UBS is maintaining an underweight position on the Australian banks. Its recommendations are ‘neutral’ ANZ, ‘neutral’ CBA, ‘sell’ NAB and ‘neutral’ Westpac.
Macquarie Securities says it expects the increased capital requirement to dilute bank earnings by two or three per cent.
It says ANZ is well placed to meet capital requirements and may start to do small buybacks, as divestments continues.
CBA has the biggest shortfall due to its slightly lower capital position relative to peers and lowest current mortgage risk weights. CBA may do a partially underwritten dividend reinvestment plan.
NAB’s elevated dividend payout ratio is not conducive to capital accumulation. NAB can cut its dividend or rely on discounted DRPs.
It expects Westpac to meet its requirements with a series of discounted DRPs.
Macquarie’s recommendations are ‘outperform’ ANZ, ‘underperform’ CBA, ‘neutral’ NAB and ‘neutral’ Westpac.