Australian Banks

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NAB's $5.5b raising will hit investor confidence in banking sector


by Tony Boyd
National Australia Bank's $5.5 billion rights issue is not the start of a wave of capital raisings by the big four banks as happened following the collapse of Lehman Bros in 2008.

But NAB's move will put a pall over the banking sector at a time when investors are nervous about the future earnings prospects and worried about increased capital requirements.

The Lehman Bros bankruptcy prompted NAB, ANZ Banking Group, Westpac Banking Corp and Commonwealth Bank of Australia to go to shareholders for cash to bolster their balance sheets and restore confidence in the banking system.

In hindsight those capital raisings in late 2008 and early 2009 presented a once in a decade opportunity to buy stock in the big four very cheaply. The amounts raised by the banks at that time ranged from $1.9 billion to $2.3 billion. The share issues were done at discounts of about 10 per cent to the prevailing share prices.

One lesson from that period of uncertainty was that you should always take up your rights when they are offered to you by a major Australian bank raising capital.

In 2015 there is not a systemic capital problem across the banking sector. That is not to say banks are not raising capital. Westpac is using its dividend reinvestment plan to raise $2 billion but that is organic capital accretion which could be used by any one of the other banks.

ANZ CEO Mike Smith made it clear this week his bank would not raise capital for the sake of it. But he did use a DRP discount to, in effect, raise capital organically.

Smith is on the outer from his colleagues when it comes to capital because of his fundamental belief that capital is not finite and that it will be available when ANZ wants it.


Smith thinks about the ANZ balance sheet in the following way. He looks at the $860 billion in assets and says the $48 billion in capital, which is in excess of the demands of regulators, is adequate. He questions whether another $5 billion in capital will be make much difference in the event of a crisis.

But work down by the European Central Bank in the wake of the crisis found that relatively small amounts of additional capital would have provided protection for taxpayers against government bail-outs.

When it comes to capital NAB's chief executive Andrew Thorburn is in a very different position to his peers. In order to rid himself of the troubled Clydesdale Bank in the United Kingdom he needs to satisfy the tough demands of the local banking regulator, the Prudential Regulation Authority (PRA), which is part of the Bank of England.

The PRA has forced NAB to pay a very high price for exiting the country. It has told NAB no demerger of its UK assets can happen without the bank putting aside a provision to cover "severe conduct scenario support" of about $3.4 billion.



In other words, when Thorburn says NAB is leading the industry with its capital conservatism he is making a virtue out of a necessity.

While the $3.4 billion in contingent capital in the UK may never be used it must be available in cash, which explains at least part of the capital raising. The remainder relates to the potential accounting loss of about $1.5 billion to cover the realisation of the banks foreign currency translation reserve.

To understand how tough the PRA has been on NAB you only need look at the fact that it already has a provision of $700 million to cover untoward conduct in the Clydesdale business. The PRA is saying that this provision must be at least $4 billion.

It would be a very costly financial outcome for NAB shareholders if the losses on its conduct issues in the UK went beyond the $700 million already provided. It would be an absolute gilt edged disaster if it absorbed $4 billion but that cannot be ruled out.



The most likely outcome is that all or most of the $3.4 billion of contingent capital will not be needed and can be returned to NAB after the demerger of Clydesdale. The return of that capital will probably happen progressively over many years.

NAB shareholders are now faced with the decision of whether to participate in the rights issue or decline to do so and have their shareholding diluted.

In making that decision, shareholders need to consider several issues including the soundness of the institution, the quality of its management and the quality of its board of directors.

Unfortunately, the Clydesdale disaster does not reflect well on the board. Outgoing chairman Michael Chaney says the decision to retain Clydesdale following a review in 2004 occurred before he became a director in December 2004.

But many of the problematic issues that have beset the UK business occurred while he was on the board including the conduct issues and a blow out in commercial property loan losses.

The numbers speak for themselves. When Chaney was appointed chairman in September 2005 NAB shares were trading at $33 each. If the stock resumes trading on Tuesday nar the theoretical ex-rights price of $33.79 the bank's stock will have gone nowhere in a decade.

Over the same period CBA shares have doubled while ANZ and Westpac shares are up about 40 per cent.

NAB could be heading into a period of outperformance. Demergers have usually proven to add value to shareholders. The sum of the parts is usually worth more than the whole. But NAB's exit is coming at a time when HSBC is talking of selling its retail branches and the UK government is talking of selling more of Lloyds Banking Group.

The NAB share issue comes against a background of talk that all of the big four banks in Australia will have to raise capital. The discussion usually involves claims that there will be a first mover advantage to the bank that goes to the market first.

However, the flexibility provided by dividend reinvestment plans is likely mean that we will not see a repeat of 2008. DRP capital raisings will remain the favoured tool for building capital unless the Australian Prudential Regulation Authority goes overboard with its use of discretion in changing the risk weight for mortgages.

If the banks do raise capital through rights issues, it is unlikely that NAB's peers will have to endure the heavy price paid by NAB. Its renounceable issue is at a 16.7 per cent discount to the prevailing share price to raise capital.

NAB shareholders are paying a very expensive price for the mistakes of past management and former directors.

Henry replaces Chaney

Ken Henry's appointment as chairman of NAB means he has reached what many regard as the pinnacle of business in Australia.

A big four bank chairmanship is coveted because of the power and influence it brings. The chairman can set the tone for the organisation both in terms of culture and risk appetite.

Henry's experience as treasury secretary will come in handy given that the world is in danger of heading into a period of cyclical economic stagnation.

As Treasury secretary from 2001 to 2011, Henry accompanied the treasurer to many international meetings of finance ministers and senior bankers. That would have given him a first-hand understanding of the workings of the global financial system.

He was also a member of the Reserve Bank of Australia board which would have given him an understanding of the limited power of monetary policy when confidence is lacking among consumers and business.

Having a former bureaucrat as chairman should not inhibit Thorburn's ability to be innovative or bold. Westpac's former chairman Ted Evans, who was Treasury secretary from 1993 to 2001, showed with his chairmanship of Westpac that former bureaucrats are not barriers to bold moves by banks.

It was under Evans that Westpac went ahead with the $18.6 billion takeover of St George Bank. But takeovers are unlikely to be on Thorburn's agenda given what happened in the UK.

Disclosure: The author's super fund owns NAB shares.

Tony Boyd

Twitter: @TonyBoydAFR

tony.boyd@afr.com.au


http://www.afr.com/brand/chanticleer/nab...507-ggvwmr

[greengiraffe]

Five challenges face big four
Shaun Drummond
1221 words
9 May 2015
The Australian Financial Review
AFNR
English
Copyright 2015. Fairfax Media Management Pty Limited.

Banking Signs that the best is past are gathering force.

The share prices of the major banks went into free fall after Westpac reported a flat profit result for the first half of 2015 of $3.6 billion. The interim results of ANZ Bank and NAB had better headline improvements, as did a quarterly update from Commonwealth Bank of Australia, but even the coincidence of a second cut in interest rates by the Reserve Bank to 2 per cent didn't stop the rout, with each dropping more than 10 per cent over the week.

But does this mean the banks' record results of recent years are over? Analysts' assessments this week were, by and large, positive on the big four. Thirty-one recommended holding onto the majors' shares, 23 to buy and 15 to sell. But signs that the best is past are gathering force.

The big four accounting firms have all analysed the big banks' first-half performance. It shows cash earnings for the four majors rose 4.7 per cent to $15.5 billion compared with the first half of 2014.

But three other key measures declined. Return on equity fell almost 0.4 per cent, net interest margins were at a record low of 2.03 per cent, down 0.06 percentage points, to the lowest level since March 2008. Bad and doubtful debts ticked up by 8.1 per cent in the six months to March after at least three years of sharp declines. Writing back in provisions held in reserve for bad debts has accounted for 60 per cent of the majors' rise in pre-tax profits in the past year. Volatile trading income contributed a third of the income growth in the first half of 2015.

The head of PwC's banking practice, Hugh Harley, said rock-bottom interest rates should mean bad debts stay low for some time, but a government intent on reversing deficits, a wind-down of the resource sector and shaky employment growth are pushing arrears the other way. Regulators are likely to raise the amount of capital that banks are required to hold on mortgages, and put a break on investor loan growth, meaning revenue growth is going to be hard to come by. Borrowers maintaining their repayment amounts as interest rates fall is also cutting into loan growth and the interest banks are earning.

With a bunch of new online competitors offering unsecured loans to small business now, it is notable that all the major banks and the Bank of Queensland passed the rate cut on, in full, to their business customers, while keeping back some from households.

Apart from competing harder in other sectors, that all points to limited ability to grow revenue, according to most experts. The one thing the banks can do, however, argues EY's financial services partner, Tim Dring, is become more efficient, and there's still a lot of fat to trim to maintain profits.

Expense growth, however, is proving hard to keep a lid on. Cost to income ratios were flat in the half year. Mr Dring believes there'll be short-term pain for bank shareholders as banks will need to continue to spend on technology to attract new customers and defend against the threat of digital upstarts nibbling at their big profits. But the payoff will come later.

"I still think there is upside to the banks, but maybe not the top line," he says. "Where there are opportunities is in becoming even more efficient. Whilst they look digitised at the front end, there are still a lot of manual processes that occur in middle and back office."

In the half-year results, only Commonwealth Bank delivered "positive jaws", meaning growth in income beat growth in costs. The other three were negative.

KPMG notes the "amortised" cost of technology investment in the first half of 2015 was $816 million across the big banks. But it expects they will have to increase their investment to remain competitive, as well as to reduce costs in the long run.

Regulators locally and globally are intent on making banks prudent capital allocators to the economy, not cheap debt pushers looking for a quick buck. Since investor loans in Sydney and Melbourne got above 50 per cent of all new loans written in the past 18 months, all of our financial regulators - APRA, ASIC and the Reserve Bank - have pressured the banks to rein it in, for fear a correction in our biggest cities would reverberate in the wider economy and kill off private and business confidence.

Simultaneously the Murray financial system inquiry has called for a banking system that relies on the confidence of offshore investors to maintain unquestionably strong levels of capital. While equity capital is being raised by Westpac and NAB, most don't see it as a sign of a wave of capital raisings to get ahead of the new requirements. Westpac is raising $2 billion organically via a dividend reinvestment program. NAB is making a $5.5 billion capital placement, most of which will be kept on reserve to cover any problems in Clydesdale Bank after it is spun off.

One way or another, however, capital is going up, reducing bank leverage - especially on mortgages, cutting profits and the ability to distribute these to customers in lower interest rates or to shareholders in dividends.

The failure by most of the majors and the two independent listed regional banks to pass on Tuesday's full rate cut of 0.25 per cent is a sign of margin pressures finally leading to a choice being made to keep something for shareholders. As one fund manager put it: "Who's going to lock up money for 2 per cent?" Several observers called the selective rises in a couple of the short-term deposit rates of Commonwealth Bank and Westpac "marketing".

Big bank bashing is a national sport, but the big four have more than 80 per cent of loans and deposits, in large part because people trust the four pillars. Australia's banks only have to look at Europe and the US to see what happens when trust is lost. Helped by government policy and technology, new online players and supermarkets there are cutting much more heavily into market share.

For most analysts, technology disrupters are still just a blip on the radar, but Martin North from Digital Finance Analytics and JP Morgan bank analyst Scott Manning have noted in annual surveys of attitudes towards banks that younger generations are just as comfortable getting financial services from Apple or Google as CBA or Westpac.

More immediate hits to customer loyalty are the scandals in the big banks' wealth divisions. Even there, the cost of compensation is barely noticeable compared to multibillion-dollar profits. Mr Dring, however, says the damage to reputation is still a worry. "Australian banks have been insulated from the scale of overseas scandals," he says in EY's assessment of the big four's half-year results.

"But recent inquiries have again raised the spectre of damage to the local sector's social licence to operate. We view this trust deficit as particularly significant in light of changing consumer preferences, digital disruption and the possibility of alternative market competitors."


Fairfax Media Management Pty Limited

Document AFNR000020150508eb5900005

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Bank stocks go out of favour as lenders face headwinds
THE AUSTRALIAN JULY 01, 2015 12:00AM

Michael Bennet

Reporter
Sydney
Bank stocks go out of favour

The S&P/ASX 200 Bank Index lost 0.3 per cent for 2015. Source: News Limited
After two financial years of stellar double-digit returns, bank stocks weren’t the place to be for investors in the past 12 months.

Battling several headwinds, most notably new proposed rules to increase capital levels, the S&P/ASX 200 Bank Index lost 0.3 per cent in the 2015 financial year compared with the broader market’s 1.2 per cent gain, albeit not factoring in dividends.

This paled in comparison with the 31 per cent and 16 per cent gains in the previous two financial years as the “chase for yield” and falling losses from soured loans pumped up share prices.

Much of the pain occurred in recent months after the Bank Index, which features the big four banks, Bank of Queensland, Bendigo and Genworth, hit a record high of 10,412 in late March. Since then, a perfect storm of soft bank earnings results, rising bond yields and impending capital rules have resulted in heavy selling. The fear of a housing bubble in Sydney and Melbourne hasn’t helped.

Commonwealth Bank, the nation’s biggest lender, had fallen from a record high of $96.32 in March to $85.13. But it was still the best performing of the big four, up 5.3 per cent ahead of National Australia Bank’s $1.6 per cent rise, while ANZ and Westpac went backwards.

“The capital headwinds for the banks have only just started,” said Brad Potter, head of equities at Nikko Asset Management Australia. “We see earnings per share and dividends per share risks over the next few years due to the capital raisings required that will adversely affect return on equity and ultimately the market multiple of the banks.”

Mr Potter said that while a new bad debt cycle wasn’t on the near-term horizon, the favourable trends of recent years were fading and would be a “further headwinds to profits”.

“Although further credit growth may help alleviate the issue, the real lever is banks clawing back some margin from mortgages,” he said.

Ahead of looming capital requirements, the banks have already begun propping up margins by “repricing” mortgages. In May, Westpac, CBA and NAB held back some of the Reserve Bank’s rate cut in a move expected to be the start of several repricing initiatives.

“We believe the banks could contribute to dampening some of the RBA’s ‘low rate financial stability’ concerns by repricing mortgages,” Macquarie analysts said last week. “This would help margins, slow loan growth and allow the RBA to take rates lower, helping bank share prices too.”

White Funds Management managing director Angus Gluskie said the pullback in share prices was mostly driven by the banks’ lofty valuations and market uncertainty, while loan growth remained healthy, expenses were being controlled and bad debts benign. “I think the underlying story is still reasonably firm, but the slight negative adding to the short-term bear case is the requirements for banks to enhance their capital positions,” he said. “But it’s not a huge impost and not necessarily a bad thing in the longer term. Overall, it doesn’t really affect our medium and longer-term view on the sector still being a reasonable place to invest.”

While the banks’ earnings per share are tipped to rise just 2-3 per cent, according to Credit Suisse, the sector was recently given a boost when legendary investor Warren Buffett flagged his interest in the space through his company Berkshire Hathaway.

Bell Potter said NAB was likely to top Mr Buffett’s “wish list”, followed by CBA when it falls back below $83 and Westpac at less than $32. “There is a strong case for Berkshire to invest in the Australian banks — a sentiment that is entirely consistent with our positive sector view as a whole,” said Bell Potter’s T.S. Lim.

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Australia's big four most profitable in developed world: BIS

Clancy Yeates
566 words
29 Jun 2015
Sydney Morning Herald
SMHH
English
© 2015 Copyright John Fairfax Holdings Limited. Factiva.Gateway.Messages.Archive.V1_0.ELink
Banking

Investors may have fallen out of love with Australian banks, but they remain among the most profitable lenders in the developed world.

The big four had the highest return on assets when compared with major banks from 10 other wealthy economies and some emerging markets, new figures from the Bank for International Settlements show.

The big four's pre-tax profits as a percentage of their assets was 1.28 per cent in 2014, putting them ahead of banks from other developed countries included in the BIS annual report, released on Sunday night. Australian banks were not as profitable as those from emerging markets Brazil and China, which notched up profits that were 1.66 per cent and 1.83 per cent of assets, respectively.

The figures highlight the strong state of the Australian banking sector, and it is the fifth year in a row that the big four banks' profitability has been ranked higher than other developed nations.

The next most profitable developed-world banks were in the US, where earnings were 1.11 per cent of assets, and Canada, where the figure was 1.06 per cent.

However, it comes after investors sold off bank shares sharply in recent months on fears the big four will find it harder to deliver the strong dividend growth of recent years.

Shares in all the major banks have fallen significantly from their peaks earlier this year - with Westpac shares posting the sharpest drop of 17 per cent from their April high of $40.07 to $33.01 on Friday.

The sell-off has come amid a looming threat of tougher capital rules, a rise in bond yields, against which some investors had valued bank shares, and softer-than-expected profit results.

The BIS described the revenue environment in banking as "subdued", noting a decline in income from interest in North America and Europe.

Australian banks' average net interest margins - a measure of bank funding costs compared with what they are charging for loans - fell to 1.75 per cent, the report said. This was lower than all the emerging markets banks, the US and Spain.

Bell Potter analyst TS Lim said one reason Australian banks had been more profitable was interest rates here were higher than overseas - and this tends to support wider lending margins. The local banks' business mix is also heavily skewed towards retail banking, rather than overseas banks' investment banking businesses that have become much less profitable since the global financial crisis.

Low levels of bad debts have also boosted the profitability of the Australian lenders, though analysts say this will no longer act as a tailwind to bank profits.

Despite the tougher environment for Australian lenders, Mr Lim said they were likely to respond by using technological advances such as mobile banking to lower their expenses.

The question of whether Australia's banks can retain their leadership position in the next few years is likely to depend on how and when the Australian Prudential Regulation Authority implements Murray inquiry recommendations to increase capital level. (More capital reduces return on equity).

Analysts expect APRA chief Wayne Byres could move on the issue of risk weightings on mortgages as soon as next month, although there is still some uncertainty about what the new rules will look like.


Fairfax Media Management Pty Limited

Document SMHH000020150628eb6t0002c

[greengiraffe]

Jul 9 2015 at 12:15 AM Updated Jul 9 2015 at 12:15 AM

The big banks' investor loan dilemma

As the banking regulator tries to temper booming housing markets, new rules will mainly affect new home buyers.


The upshot of all this regulatory change is that it will be harder to get a loan to buy an investment property than it has been before.
The upshot of all this regulatory change is that it will be harder to get a loan to buy an investment property than it has been before. Reuters


by Michael Smith
After spending most of their careers trying to grow loan books, big bank executives are now in the bizarre position of coming up with ways to reduce the amount of money home buyers can borrow.

The way major lenders are thinking about the investor loan space is the biggest challenge facing the banks as they seek to meet the banking regulator's edict to curb the growth in investment property loans.

Just how far banks are willing to go to actively manage this down became clearer this week when Westpac significantly changed the rules for its customers.

Property buyers seeking to borrow money from the bank for an investment property will now have to pay Westpac a deposit of at least 20 per cent instead of as little as 5 per cent previously.

Take Sydney's median house price of almost $1 million as an example, and this equates to a whopping $250,000 per investor once you throw in another $50,000 or so in stamp duty.

This locks out of the market a huge number of potential investors, particularly first-time buyers who cannot afford to live in the first place they buy.

MOVE RAISED EYEBROWS

The move raised eyebrows amongst the other major lenders, who are now wondering if they need to take more drastic measures to meet the Australian Prudential Regulation Authority's (APRA) 10 per cent benchmark for investment property loan growth. Some are asking if it will get to the point where they stop writing investor loans completely in order to meet the target.


It was not a move Westpac took lightly. About 51.6 per cent of the bank's mortgages written in the first half of the current financial year were for investment housing, according to figures from the company's last results presentation.

Loan-to-valuation ratios (LVRs) are a measure for the way banks assess risk by weighing up the amount borrowed against the value of the property. Westpac's 80 per cent LVR cap announced this week compares with a 90 per cent limit ANZ and National Australia Bank are putting in place.

While Commonwealth Bank of Australia's investor loan growth is within the APRA target, it is also looking at ways to manage the issue. As the country's largest lender with high volumes, it could easily breach those targets.

The new rules creeping in are the culmination of months of pressure behind closed doors by the banking regulator to temper booming housing markets.

APRA first started writing to the banks in December, warning them they had to start watching their investor loans. The discussions have been more active in recent months and APRA staff are said to be regular visitors to the headquarters of the major banks in Melbourne and Sydney. APRA wants the banks to have the issue under control by September rather than in March next year as previously expected.

RANGE OF RESPONSES

Banks and other lenders have been gradually introducing a range of responses over the past three months, tweaking pricing to remove discounts and tightening discretionary credit decisions. But it is the bigger policy decisions such as tightening LVRs that will have the biggest impact.

Working out what APRA chairman Wayne Byers wants can be like reading tea leaves for the banks at times but the regulator's approach appears to be working, and the lenders prefer the approach to the restrictions imposed in New Zealand.

No one wants to get on the wrong side of the regulator, but is has not spelt out what the penalties would be for lenders that do not meet the benchmark.

While it has not been discussed much in public, the big question bank executives are asking at the moment is: 'what happens next?'

There are a number of scenarios. The number of loans written will fall, excess investor loans will flow through to other institutions and owner-occupier loans will become more attractive.

While there will inevitably be a decline in investor loans, a lot of money is still going to flow through to tier-2 and non-banking lenders.

'LIKE SQUEEZING A BALLOON'

"It is like squeezing a balloon, isn't it? The market goes elsewhere. It gives those other institutions an opportunity," says John Flavell, the chief executive of one of the country's biggest mortgage brokers, Mortgage Choice.

Mortgage Choice data shows investment loan approvals fell from 33 per cent to 29 per cent in June but overall lending did not come off. Flavell says there is already evidence of investor loans shifting to other players not governed by the APRA requirements. These are the so-called non-Authorised Deposit-taking Institutions, which are regulated by the Australian Securities and Investments Commission (ASIC) rather than APRA.

Analysts also say it could open up the opportunity for non-banker and regional lenders to compete on price and get a foothold.

The major banks are also looking at ways to make owner-occupier loans more attractive to help cushion the slowdown in investor loan growth. They will be trying to find ways to be more competitive by doing things such as improving the package benefits currently on offer with things such as discounts to new credit cards.

Westpac's limit on owner-occupier loans is 95 per cent, but it also has an option to capitalise lender's mortgage insurance, to get up to 97 per cent for a new loan.

SAVVY BUYERS WILL LOOK FOR LOOPHOLES

Making investor loans harder to obtain will also encourage savvy home buyers to try and find loopholes to access a owner-occupier loan.

The upshot of all this regulatory change, spurred on by concerns about an overheating property market in a low interest rate environment, is that it will be harder to get a loan to buy an investment property than it has been before.

Mortgage brokers argue that raising the bar for investor loans is the wrong approach at a time when the government is under pressure to address the housing affordability crisis. "I reckon you are taking out the least risky part of the market. Fishing in the wrong pond," Flavell says. "I would back your ability to find a tenant in any Australian capital. There is greater risk in people relying on their own income."

The changes add to a host of headwinds for the major banks facing tough new capital requirements. It is safe to assume, though, that the major banks will not be passing on an interest rate cut if there is one, as expected in the second half.

Managing rate cuts is another key strategy dilemma for the banks ahead of the next round of earnings results. CBA lifted some deposit rates as a trade-off for not passing on the last cut in May. But CBA and Westpac's decision not to renew those promotional discounts, a move that became public this week, are a reflection of the shifting banking landscape.

Michael.smith@fairfaxmedia.com.au

[greengiraffe]

OPINION Jul 14 2015 at 10:42 AM Updated Jul 14 2015 at 1:18 PM
Big banks still short $40b on APRA's terms

APRA backs the financial system inquiry's (FSI) finding that while the major banks might be "well capitalised" they are not "unquestionably strong".



by Christopher Joye
There are several important take-aways from the Australian Prudential Regulation Authority's excellent new study on the major banks' capital. Winners are depositors, senior and subordinated bond holders, and the regional banks. Losers will likely be shareholders and investors in the majors' hybrid securities.

The first learning is that APRA backs the financial system inquiry's (FSI) finding that while the majors might be "well capitalised" they are not "unquestionably strong". The latter characterisation is a key FSI principle that APRA has embraced.

APRA finds that on an internationally comparable basis, Australia's major banks crucial "common equity tier one" (CET1) capital ratios are "are above the median, but not in the top (fourth) quartile [or above the 75th percentile]". Specifically, they are situated in the middle of the 50th and 75th percentiles or the third quartile.

APRA revealed it will start using the FSI's recommended benchmark of keeping the majors' CET1 ratio in the 75th percentile (top quartile) of internationally active banks as a "sense check" or sanity test of their capital adequacy and will republish comparison studies from "time to time".


Understandably, it will not use the 75th percentile benchmark to calibrate the majors' specific capital levels, which avoids the need to adjust capital simply because the 75th percentile has shifted, which can happen for reasons unrelated to the prudential supervision of local deposit-takers.

To lift the majors' CET1 ratio towards the 75th percentile, APRA concludes they would only have to expand equity by about 70 basis points over their June 2014 levels.

Capital ratios need to rise 200 basis points: APRA

But APRA warns that because the report makes several assumptions that are unrealistically favourable to the majors, and the majors' CET1 ratios have fallen behind global peers since June 2014, it believes they "are likely to need to increase their capital ratios by at least 200 basis points … to be comfortably positioned in the fourth quartile".

In dollar terms, UBS' No. 1 ranked analyst Jonathon Mott estimates that this represents a CET1 shortfall of about $24 billion today, accounting for the extra equity the majors have started sourcing since June 2014 (the short-fall would otherwise have been $30 billion). That's consistent with the lower bound of estimates I previously canvassed here.

Yet this number may be a low-ball for two reasons. First, APRA has yet to respond to the FSI's recommendation of introducing a minimum average residential mortgage "risk-weighting" of between 25 per cent and 30 per cent. Second, the majors are likely to be slugged with higher risk-weights on their non-residential assets as a consequence of the new Basel 4 rules.

UBS' research implies that the combined impact of this will be another $16 billion in CET1 on top of the $24 billion shortfall, which gives a total CET1 capital deficiency of $40 billion.

The Australian Financial Review's Chanticleer column says the majors will only be given 12 months to boost CET1 in response to APRA's looming decision on residential mortgage risk-weights, which the regulator says it will make "shortly".

Bank share prices tipped to decline

From a shareholders' perspective, higher equity means lower leverage and associated returns. Whether that translates into a fall in the majors' valuations is an open question and depends on whether reduced returns on equity are offset by repricing of deposits and loans and cheaper overall funding costs. As I have explained before, there are arguments for and against. My base-case is that we see a 200 basis point dilution in returns on equity from current world-beating marks that results in a circa 18.5 per cent reduction in major bank valuations.

What is undeniable is that bigger equity buffers are ostensibly news for all higher ranking securities, including additional tier one capital (AT1) hybrids, subordinated bonds, senior bonds and depositors.

Here, however, APRA says that when examining the majors' Tier 1 capital ratios, which include AT1 hybrids, and their Total Capital ratios, which include Tier 2 subordinated bonds, they look even further behind global peers. Yet, APRA carefully explains, this is mainly because it has deliberately chosen not to impose a so-called "statutory" bail-in of the banks' old-style AT1 hybrids and their subordinated bonds and is instead allowing them to be replaced over time with new Basel 3 compliant securities.

"The exclusion of legacy [hybrids and subordinated bonds] results in approximately half of these capital instruments issued by the Australian major banks being excluded from their [tier one and total capital ratios]," APRA points out. It cautions that "the effect of this issue will diminish over time as legacy instruments are replaced…[and means] there is less comparability in non-CET1 ratios at the present time".

APRA's analysis does not, therefore, necessarily portend a surge in non-equity capital security supply. It is certainly clear APRA's focus is on the majors' CET1 and Tier 1 capital ratios, rather than Total Capital, which is a less useful conception that has limited relevance to investors. "Market participants generally focus on the CET1 ratio as the prime measure of capital adequacy for banks, as it comprises the highest quality capital," APRA says.

In this context, APRA stresses that "Tier 1 [capital] includes AT1 [hybrids], which [are] capable of absorbing losses on a 'going-concern' basis" while the Tier 2 bonds included in Total Capital ratios only absorb losses "when a non-viability event is triggered or in liquidation".

Reiterating the primacy of the CET1 and Tier 1 capital ratios, APRA quantifies how the major banks rank relative to peers on the basis of their "leverage ratios". This increasingly important metric divides equity capital by the dollar value of a bank's assets rather than their "risk-weighted" assets.

Capital ratios less important in a crisis

APRA's chairman, Wayne Byres, maintains that markets tend to discount risk-weighted capital ratios during crises, probably because they are artificial constructs that may not be accurate proxies for the real likelihood of loss. "At the height of the financial crisis, investors turned away from the risk-based ratios as a measure of financial health, and quickly reverted to a basic leverage ratio," Byres remarked.

APRA did not historically require the majors to meet a minimum leverage ratio, but will do so in the future. Irrespective of whether APRA measures the majors' leverage ratios using CET1 or Tier 1 capital, it finds they rank just below the 50th percentile of global peers. This equates to a leverage ratio of about 4.5 per cent versus the 6.0 per cent held by 75th percentile global banks as at June 2014.

Across the majors' capital structure the regulatory pressure will be demonstrably to boost loss-absorbing "going concern" equity and (potentially) hybrid AT1 capital to improve the banks' CET1, Tier 1 and leverage ratios.

The FSI and APRA have been more sceptical about the efficacy of converting investment-grade bonds into "gone concern" loss-absorbing capital, which is only helpful when banks have become non-viable or are in liquidation (ie, they don't do anything to prevent banks going bust in the first place). This contrasts with perpetual AT1 hybrids that are required by APRA to automatically convert into equity if the banks' CET1 ratio falls below 5.125 per cent. In APRA's stress-tests last year it found that several AT1 hybrids would have been forced into ordinary shares as a result of this trigger.

In summary, the majors' depositors and bond holders will benefit from much stronger equity buffers that mitigate the probability of loss and moral hazard related risks. Smaller banks, which have carried less than half the leverage of the majors when lending against housing, will also win as the playing field in capital terms is levelled. The biggest losers will be equity and hybrid investors who suffer from a surge in supply.

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OPINION Jul 13 2015 at 5:00 PM Updated Jul 14 2015 at 5:45 AM

Why banks shares are still a good buy

The major banks as a whole are slightly on the cheap side, according to Deutsche Bank's analyst Andrew Triggs. Jesse Marlow


by Philip Baker
Bank shares have been under the pump since April, but investors snapped them up after news that although they will still have to raise billions to fall in line with global standards, they have been given breathing space compared with other banks around the world.

So does that mean the worst is over for the banks?

Well, it did fpr most of Monday when gains in the major banks helped spark a rally in the sharemarket, turning a 35 point loss in the major S&P ASX 200 index in early morning trading, into a 40-odd point gain by the afternoon session, before closing down 18 points.

Indeed, for a time traders' pulses raced faster as the sharemarket extended its recent recovery despite the Greece issue that is still unresolved.

But smart investors should be asking if it is merely another rush from "risk off" to "risk on" by short-term traders.

These short-term flurries may be good for a 5 to 10 per cent move in the market, but there is no guarantee they necessarily signal the solution to the really big investment questions.

The bank index is still down 13.5 per cent since the high point in April compared with an 8 per cent fall in the major index.

Deutsche Bank's analyst Andrew Triggs has released a series of charts that value the major banks on all sorts of different measures.

Not surprisingly, they throw off all sorts of different signals.

First up, he has ANZ and Westpac as his best picks along with the Bank of Queensland, while he's not as keen on the Commonwealth Bank and National Australia Bank.

He says the major banks as a whole are slightly on the cheap side when investors compare their average price earnings ratio with the PE of the industrial sector over the past five years, but some are cheaper than others.

As one of the accompanying graphs show, ANZ and Westpac are trading at much larger discounts to their average PEs of the past five years while CBA is pretty much in line with its average PE, and NAB with just a small discount of about 2 per cent.

Triggs notes that from an absolute perspective, the majors are trading about 12 per cent above the five-year average on a one-year forward PE valuation, but there is decent support for them when looking at their relative yields.

Although the average one-year forward dividend yield of 5.7 per cent for the major banks is below the five-year average of 6.3 per cent and below the 10-year average of 6.1 per cent, it looks good when compared with the 90-day bank bill over the past five and 10 years.

But the banks are trading on a forward PE of about 13.2 times earnings and that compares with an average PE over the past five years of 11.8 times and over the past decade of 12.1 times. When the golden run of the banks started back in 2011 the PE was closer to 9 times so they are still looking expensive.

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APRA orders rise in home loan capital
THE AUSTRALIAN JULY 20, 2015 10:20AM

Michael Bennet

Reporter
Sydney
The banking regulator has ordered the major banks to pump billions of dollars into their mortgage books to further safeguard the financial system, likely shaking up the competitive landscape in the $1.3 trillion home loan market.

In a win for small banks and credit unions, The Australian Prudential Regulation Authority today revealed lenders using advanced “internal ratings-based” models to determine credit risk would have to increase the average “risk weight” on mortgages from about 16 per cent to at least 25 per cent.

Commonwealth Bank, Westpac, National Australia Bank, ANZ and Macquarie use IRB models and will have to meet the new ruling by July 1 next year.

A 25 per cent mortgage risk weight floor would increase the majors’ capital requirements by about $12.5bn, according to Morgan Stanley.

The banks have warned more onerous capital rules will likely be passed on to customers through less attractive prices or shareholders via lower dividends.

The Commonwealth bank said it expects the move to have the effect of increasing the amount of common equity tier 1 required for residential mortgages by approximately 95 basis points.

“To the extent that there is any increase of actual capital levels as a result of this change, this will further improve our position relative to international peers,” it said, adding the bank had been “working on a number of options for managing our capital over the coming year”.

The change comes after the Murray financial system inquiry called on APRA to raise the majors’ risk weights to increase competition, given other lenders are forced to set aside more capital to write mortgages and thus have less pricing power or receive lower returns.

Global regulatory body, The Basel Committee on Banking Supervision, is also reviewing risk weights amid fears banks are generating different credit risks for the same assets, potentially to “game” the system.

APRA’s changes today will thus be an “interim” measure so it can respond to the Basel review when completed.

“The residential mortgage portfolio is the largest credit portfolio for authorised deposit-taking institutions (ADIs) and, in aggregate, IRB accredited ADIs hold the material share of these exposures,” APRA said.

“Therefore, strengthening the capital adequacy requirement for residential mortgage exposures under the IRB approach will enhance the resilience of IRB-accredited ADIs and the broader financial system.”

Of the big four, CBA could be most exposed as it has the lowest average mortgage risk weight of 15 per cent, versus Westpac at 16 per cent, ANZ at 17 per cent and NAB at 18 per cent, according to Morgan Stanley.

In contrast, Bank of Queensland’s is far higher at 44 per cent and Bendigo and Adelaide Bank is around 39 per cent, as they must use the “standardised” approach to modelling credit risk, where risk weights for mortgages cannot fall below 35 per cent.

The regionals lobbied the Murray inquiry for relief, pointing out in their submission that almost a third of CBA’s housing book was risk-weighted at just 2.9 per cent, or 26c of equity against every $100 in loans.

It stems from the Basel II reforms, where banks could invest to receive “advanced accreditation” and lower their risk weighted assets, which APRA granted to the big four and Macquarie in late 2007, just before the global financial crisis.

The rules result in the major banks’ $3.5 trillion of assets falling to just $1.5 trillion of “risk weighted assets”, or RWA. But in November, APRA chairman Wayne Byres noted that “much of the strengthening of capital ratios relative to a decade ago is less the product of substantial growth in capital and more the product of the increasing proportion of housing loans within loan portfolios”.

“In short, banks have de-risked rather than deleveraged,” he said at the time.

Today’s risk weight changes come after APRA last week released a study that said the big four would need to increase “capital adequacy ratios” by 200 basis points from June last year to be “comfortably positioned” in the top quartile of banks globally.

APRA today said increasing the big four’s average risk weights to 25 per cent “is the equivalent of increasing minimum capital requirements for the major banks by approximately 80 basis points”.

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Bank of Tokyo-Mitsubishi wants to lend more in Australia
Date
August 4, 2015 - 8:18PM

James Eyers
Senior Reporter

Go Watanabe, and Nobuyuki Hirano from the Bank of Tokyo-Mitsubishi, in Sydney. Photo: Louie Douvis

The Bank of Tokyo-Mitsubishi UFJ, Japan's largest bank, held a grand dinner at the Museum of Contemporary Art in Sydney on Tuesday night to celebrate 30 years since it was awarded a banking licence in Australia.

Each of the 200-plus guests received a bottle of Australian-made sake, from the Go-Shu Australian Sake Brewery in the Blue Mountains, which the bank described as a symbol of "taking the best from two countries and customising it without losing the essence of the original taste and flavour".

In the traditionally conservative and relatively staid world of Japanese banking, the shindig by Bank of Tokyo-Mitsubishi is also symbolic of a growing confidence among the country's financial institutions and reflects the quiet, structural revolution in Japanese finance alongside the reforms of Prime Minister Shinzo Abe.

These dynamic policies known as Abenomics are encouraging Japanese companies and investors to look outwards in order to improve their returns after more than 20 years of deflation. BTMU, with assets of $3 trillion and a market capitalisation about the size of Commonwealth Bank of Australia, has been the most aggressive of Japan's banks in forging a regional footprint.

In its early days in Australia, most of BTMU's lending was to expanding Japanese companies, but it now earns more revenue in Australia from banking non-Japanese corporates – often through loan syndicates alongside the major Australian banks.

It has $13 billion of loans in Australia to non-financial companies, including to mega-infrastructure projects such as the Port of Brisbane, toll roads Peninsula Link and Connect East, and energy deals including the Dampier Bunbury Natural Gas Pipeline. It is also funding large mining and energy projects, including Pilbara iron ore mine Roy Hill, and the Ichthys LNG project off the north-west coast.

More lending
Nobuyuki Hirano, the president and chief executive of BTMU and of Mitsubishi UFJ Financial Group, BTMU's parent company, told Fairfax Media on Tuesday the bank wants to do more lending in Australia and to diversify its portfolio into healthcare, food and value-added services, while also bolstering its advisory work.

He also said Japanese companies were increasingly keen on doing deals in Australia. "Investment in Australia is attracting more interest," he said, pointing to the $6.5 billion acquisition of Toll Holdings by Japan Post in February and the arrival of retailer Uniqlo, attracted to Australia because the population is growing and incomes are relatively high.

"The current bilateral relationship between Australia and Japan is symbolised by the excellent relationship between prime ministers Abbott and Abe. That steady government-to-government relationship lays the ground for business leaders to pursue work."

Go Watanabe, BTMU's CEO for Asia and Oceania, said interest from Japanese companies in Australia was a function of the ageing and decline of Japan's population.

"Most of Japan's big and mid-sized companies, in order to grow, have to look for opportunities outside Japan," he said. "Despite the devaluation of the yen, they are getting more aggressive looking for more opportunities to buy and invest into foreign assets and companies. That's a trend we will see continue. And many companies are looking for those opportunities in Australia."

With iron ore prices tumbling this year, putting heavy dents in various equity prices and a hole in the commonwealth budget, BTMU remains comfortable with its exposures from a credit perspective and says the projects it has backed are all cost competitive compared with others in the region.

"Natural resources will keep its importance, not only for Australia but also for Japan," Mr Hirano said. "We are the second-largest trade partner with Australia and that won't change, no matter how the price might fluctuate. So Australia will keep its position as a steady exporter and provider of natural resources and energy to Japan."

Corporate deposits
While it has more deposits in Japan than it makes in loans globally, in Australia BTMU plans to lift its corporate deposits as part of its liquidity management. Deposits in Australia are about $5 billion, but BTMU will target more by offering a cash management service to iron ore and gas projects as they come on line and start generating cash. With a quarter century of low interest rates in Japan shrinking loan margins, high levels of cash in Japanese companies, and anaemic housing markets keeping a lid on credit growth, BTMU has been forced to diversify its operations by targeting services for which it can charge fees, including asset management.

Mitsubishi UFJ Financial Group's trust banking unit owns 15 per cent of AMP Capital and BTMU has sold hundreds of millions of dollars worth of AMP products to Japanese households, an arrangement Mr Hirano said had boosted fee income and is providing an opportunity for Japanese households to diversify financial assets. "We are encouraging retail and institutional clients to diversify their portfolios."

Reflecting on the "third arrow" of Abenomics – regulatory reform – Mr Hirano said more needs to be done on reform of labour markets, agriculture and industry deregulation while addressing government spending on healthcare was becoming more urgent. Abenomics was dealt a blow by the failure of the Trans Pacific Partnership to reach an agreement last week, which would have provided momentum for Japanese exporters. But he said: "I am quite hopeful they will reach the agreement within the foreseeable future – that would have big benefits for all countries involved. This is a very strategic agreement."

As for the risks in capital markets, Mr Hirano says rising US interest rates looms large, especially for the "Fragile5" developing markets of Brazil, Turkey, South Africa, Indonesia and India, whose currencies fell sharply when the taper was initially announced by former US Federal Reserve chairman Ben Bernanke.

"The US will manage the exit of their QE policy reasonably well – within their border," he said. "However, the impact will probably be more severe and visible in peripheral countries, particularly emerging market countries, because of the reversal of capital flow out of those emerging countries into the US."

He also points to the "liquidity illusion" as another headwind markets will need to face up to. "There is a lack of liquidity in the marketplace because of the lower ability of investment banks to act as intermediaries or market makers as a result of tightening capital and liquidity requirement from the Basel 3 committee. That could further increase the volatility."

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$27 billion wiped off banks
Date
August 7, 2015

James Eyers and Clancy Yeates

ANZ lead the falls for the Big Four, closing 7.5 per cent lower on Friday alone. Photo: Jesse Marlow

The Australian sharemarket suffered its worst day in three years on Friday as the spectre of rising bad loans and capital raisings to satisfy nervous regulators saw investors wipe $27 billion off the value of the big four banks over the past two days.

Shares in ANZ Bank slumped the most, plunging by as much as 8.5 per cent in early trade on Friday as the bank emerged from a trading halt after raising $2.5 billion from institutions on Thursday.

The sell-off in bank stocks drove a broader dive in the ASX 200, which tumbled 2.4 per cent, and came as investors fretted about ANZ's trading update on Thursday which revealed higher provisions for bad debts on loans to the resources and agriculture sectors.

ANZ Bank chief executive Mike Smith rejected claims the bank's retail shareholders received a raw deal.
ANZ Bank chief executive Mike Smith rejected claims the bank's retail shareholders received a raw deal. Photo: Simon Dawson
ANZ chief executive Mike Smith defended the move to raise capital on Friday and told staff the rise in provisions was not because more individual customers were falling behind, but because of "collective provisions," which can indicate a general decline in loan quality.

"Although we need to work closely with our customers in this environment, our sense is we are bumping along the bottom of the credit cycle rather than seeing any fundamental shift," he said in an email to staff.

Mr Smith also rejected claims the bank's retail shareholders received a raw deal because many will have their investments diluted through the institutional placement.

"60 per cent of ANZ shares are held by institutional shareholders and the share purchase plan gives all our individual shareholders the opportunity to purchase stock at a discount to the market," he wrote.

Stalwarts of the equity market for many years, the big banks are under growing pressure as regulators force them to raise more equity to protect the financial system from the risk that a house price bubble in Sydney and Melbourne will burst.

Compounding investor nerves, over the past week banking analysts and mortgage insurers have pointed to additional risks in Brisbane and Perth housing, which is looking increasingly vulnerable to the mining downturn and falling capital expenditure by companies.

"We might just be starting to see some chinks in their armour," Morningstar analyst David Ellis said of the banks.

After initially expressing confidence that additional capital could be generated over time, banks bosses had also been caught by surprise by the speed that regulators want to see bigger buffers, Mr Smith said on Thursday.

Analysts are expecting Commonwealth Bank will announce a multi-billion dollar capital raising when it reports its full-year results next Wednesday after this week's move by ANZ and National Australia Bank's $5.5 billion rights issue in May.

Westpac shares were also under pressure on Friday as analysts suggested it might also have to raise more capital given the upward trajectory of its competitors.

For investors, these higher levels of capital may restrict dividend growth. Morgan Stanley analyst Richard Wiles said ANZ's dividends were likely to be flat for the next three years because of more stringent capital requirements.

"In our view, ANZ's trading update and equity raising highlight downside risk to consensus earnings per share estimates from revenue headwinds, higher loan losses and more onerous capital requirements," he said.

The outlook for the banks is also being clouded by the softer outlook for the economy. In its August statement of monetary policy published on Friday, the Reserve Bank of Australia downgraded in economic growth forecasts, saying GDP growth for the year to June 2016 would be 0.5 per cent lower at 2.5 per cent, while growth for the year to December 2016 would be 3 per cent, 0.25 per cent lower than previously forecast.

The central bank said that while housing investment and the positive impact of the falling Australia dollar would support growth, it would be below average due to falling mining investment.

ANZ, which has a higher exposure to the resource sector than the other big banks, said on Thursday it would raise its collective provisions for resource and agriculture exposures. Impairments were $366 million for the third quarter and are expected to be $1.2 billion for the year, the banks said, higher than the market's expectations of $1.05 billion.

"Weak performance in the third quarter combined with a deteriorating credit quality outlook we believe rightfully left the market concerned," CBA analyst Victor German said.

"Although at this stage it's not clear whether credit quality deterioration is a sectorial issue or ANZ specific, we expect it to weigh on sentiment and the sector's performance in the near term."

Other banking analysts are also pointing to the prospects of bad debts rising as lower capital expenditure by companies puts pressure on GDP and the unemployment rate.

"We continue to be concerned with the economic impact from the dramatic slowdown in capex Australia is likely to face over the next two years," said UBS analyst Jonathan Mott.

"If the sharp reduction in non-mining capex and GDP flows to higher levels of unemployment and non-performing loans, the banks' bad debt charges may begin to rise sharply."

ANZ shares closed 7.5 per cent lower on Friday at $30.14.