Tag: Capital Ratios

Still Higher Aussie Bank Capital Expected From New Rules – Fitch

A further increase in capital by Australia’s four largest banks is likely over the medium term as regulatory changes stemming from the December 2014 Financial Services Inquiry (FSI) and Basel framework are implemented, says Fitch Ratings. The increase in capital will be supportive of the big banks’ current ratings, though upgrades are not likely given their already high ratings and weaker funding profiles relative to their international peers.

Two of Australia’s “Big 4” banks have announced multi-billion dollar capital raises thus far in August in response to increased regulatory capital requirements. Commonwealth Bank of Australia (CBA) said that it would raise approximately AUD5bn on 12 August while Australia and New Zealand Banking Group (ANZ) declared its own AUD3bn capital raise on 6 August. The additional capital will add 135bp to common equity Tier 1 capital (CET1) for CBA, bringing its CET1 ratio to 10.4% on a pro-forma basis as of end-June. ANZ’s move will add between 65-78bp to CET1 capital, bringing its pro-forma CET1 ratio to 9.2%-9.3%.

The CBA and ANZ announcements come after the Australian Prudential Regulation Authority (APRA) said on 20 July that minimum average mortgage risk-weights for Australian residential portfolios would increase to at least 25% from around 16% currently. Banks have been given until 1 July 2016 to address any capital shortfalls from the higher risk-weights.

Australian banks could have met the increased capital requirement from the APRA decision through internal capital generation given robust profitability. However, Fitch believes that the higher risk-weights are likely to be only the first of a series of new measures to be implemented. In addition to the FSI, the Basel committee is also expected to finalise their proposals for an update to the global framework by end-2015/early-2016. Together, global and domestic regulatory changes are likely to result in yet higher capital requirements.

Fitch believes that the banks’ recent efforts to raise capital in part reflect positioning for a broader range of regulatory changes – in addition to the higher risk-weights announced by APRA – and in anticipation of future growth. National Australia Bank (NAB) had announced plans to raise AUD5.5bn of capital in May, ahead of any regulatory changes. Westpac, too, said in the same month that it would raise an additional AUD2bn in capital through its dividend reinvestment plan (DRP).

The Australian banks are likely to use a combination of retained earnings, discounts on their DRPs, underwritten DRPs, and equity issuance to increase their capital positions.

The Bank Event Horizon

Thanks to the banks fixation on housing lending, we have a situation where ever larger banks require more and more capital to lend to ever inflating house prices.  It has become the Banks “Event Horizon”. The economic cost to Australia is potentially significant and possibly irreversible. Its also part of a global trend.

swirling gas, stars in space Photo nasa

According to Wikipedia, an event horizon is a boundary in spacetime beyond which events cannot affect an outside observer. In layman’s terms, it is defined as “the point of no return”, i.e., the point at which the gravitational pull becomes so great as to make escape impossible.

As Philip Lowe said in a speech yesterday, households borrowing is higher and more risky, lower income growth means households are less likely to spend more, and value is being shifted inter-generationally speaking.

In the past few years, we have seen house prices surge to new heights, housing debt rise to all-time records, and regulators struggling to adjust capital ratio controls to more reasonable levels, having let those lenders with advance IRB calculations off the hook for year, and with a focus only on financial stability.

We have consistently questioned the wisdom of ever more lending pouring into the housing sector, at the expense of productive lending to business, the former simply inflating house prices, household debt and bank balance sheets, but not contributing to productive growth at all. Bigger banks are not necessarily better.

Now the upcoming changes to capital have made the banks suck in even more capital – circa $13bn so far this year in one-off activities, and more to come. But this capital, and the current loan repricing is all about positioning for more mortgage lending, though with greater focus on refinancing, and owner occupied loans.

But, consider the circular and reinforcing forces in play, more lending allows household debt to rise, which allows house prices to rise, which grows the banks balance sheet, which demands more capital, which allows the banks to lend more, which allows debt to rise…… etc, etc. A never-ending cycle.

This is the Bank Event Horizon.

ANZ Announces Capital Raising, and Glimpse Of Trading Update

ANZ today announced a fully underwritten institutional share placement to raise $2.5 billion.

The Placement will be followed by an offer to ANZ’s eligible Australian and New Zealand shareholders who will have the opportunity to participate in a Share Purchase Plan (SPP) to raise around $500 million. The SPP is not underwritten.

The Institutional Placement and SPP will allow ANZ to more quickly and efficiently accommodate additional capital requirements recently announced by the Australian Prudential Regulation Authority (APRA), in particular the increase in average credit risk weights for major bank Australian mortgage portfolios to 25% taking effect from 1 July 2016.

ANZ’s shares have been placed in a trading halt with trading expected to resume at 10.00am on 7 August 2015.

On a 30 June 2015 pro-forma basis, the placement would add approximately 65 basis points (bps) to ANZ’s CET1 Capital Ratio increasing it to 9.2%. If $500 million is raised under the SPP, on the same pro-forma basis this would add a further 13 bps increasing the CET1 Capital Ratio to 9.3%. This capital raising should position ANZ Capital Ratio in the top quartile of international banks on an internationally harmonised basis, the bank said.

ANZ will release a scheduled Trading Update on 18 August. Ahead of that and to accompany today’s capital raising announcement ANZ advises the following financial results on an unaudited basis:

  • For the nine month period to 30 June 2015, Cash Profit was $5.4 billion, an increase of 4.3% on the same period in 2014 ($5.18 billion). Profit before Provisions over the same period grew 5.1% (+3.4% on a constant Foreign Exchange (FX) basis).
  • On a constant FX basis for the nine month period to 30 June 2015, revenue expense jaws were broadly neutral. Revenue for the three months to 30 June 2015 grew at a slightly faster rate than in the first half, while expense growth for the three month period slowed.
  • The total provision charge for the nine month period to 30 June 2015 was 13% higher at $877 million. While the Individual Provision charge reduced 12.5%, the Collective Provision charge increased due to balance sheet growth coupled with some risk grade migration related to the resources and agriculture sectors. For the Full Year 2015, while loss rates are expected to remain well under the long term average, ANZ estimates that the total loss rate will be around 21 bps equating to a total provision charge of circa $1.2 billion given increased collective provisioning.
  • Customer Deposits for the nine month period to 30 June 2015 grew 9.5% (+5% FX adjusted) with net loans and advances increasing 7.7% (+5.4% FX adjusted).
  • During the third quarter (period 1 April to 30 June 2015) the Group Net Interest margin remained broadly stable assisted somewhat by slower growth in lower margin liquid asset holdings.
  • The CET1 Capital Ratio was 8.6% at 30 June 2015.

Higher Mortgage Risk-Weights First Step to Strengthen Australian Bank Capital – Fitch

Fitch Ratings states that an increase in the minimum average Australian residential mortgage risk-weight for banks accredited to use the internal ratings-based (IRB) approach for regulatory capital calculations was expected, and is only the first step in higher capital requirements for these banks. Greater levels of capital are likely to be required over the next 18-24 months as further measures from Australia’s 2014 Financial Services Inquiry (FSI) are implemented and adjustments to the global Basel framework are finalised.

The announced increase in minimum mortgage risk-weights is the first response to the final FSI report, published December 2014, which also recommended Australian banks’ capital positions be ‘unquestionably strong’. The latter recommendation is aimed at improving the resilience of the banking system given its reliance on offshore funding markets, its highly concentrated nature, and the similarity in the business models of most Australian banks. The change in mortgage risk-weights should provide a modest boost to the competitiveness of smaller Australian deposit takers that currently use the standardised approach for regulatory capital calculations.

The change announced by the Australian Prudential Regulation Authority (APRA) on 20 July 2015 is likely to be the first of a number of changes made to strengthen the capital positions of Australian banks. APRA referred to the higher risk-weights as an interim measure, with final calibration between IRB and standardised models expected once the Basel committee’s review of the framework is completed – this is unlikely to be before the end of 2015.

The move will result in minimum average risk-weights for Australian residential mortgage portfolios increasing to at least 25% from around 16% at the moment. APRA estimates this would increase minimum common equity tier 1 (CET1) requirements by about 80bps for Australia’s four major banks – Australia and New Zealand Banking Group Limited (ANZ; AA-/ Stable), Commonwealth Bank of Australia (CBA; AA-/ Stable), National Australia Bank Limited (NAB; AA-/ Stable), and Westpac Banking Corporation (Westpac; AA-/ Stable). This is equivalent to nearly AUD12bn for the four banks based on regulatory capital disclosures at 31 March 2015. The only other bank to be impacted is Macquarie Bank Limited (A/ Stable) which has estimated a CET1 impact of about 20bps, or AUD150m.

The higher risk weights will be implemented on 1 July 2016, giving the affected banks nearly 12 months to address capital shortfalls. Sound profitability means that shortfalls could be met through internal means – the AUD12bn is equivalent to about 40% of annualised 1H15 net profit after tax for the four major banks. Fitch expects the banks will look at increasing the discount on dividend reinvestment plans, and/or underwriting participation in these schemes to meet shortfalls. However, raising capital in equity markets is also an option to address both the requirement early and in anticipation of future increases in regulatory capital requirements. Banks have already begun increasing capital positions, with a number of the major banks announcing capital management activity at their 1H15 results.

The size of the increased capital requirement will vary across the banks based upon their loan portfolio compositions – CBA and Westpac have the largest Australian mortgage portfolios and therefore their minimum capital requirements are expected to be the most impacted.

FED Announces Further Capital Uplifts For GSIB’s

The Federal Reserve Board approved a final rule requiring the largest, most systemically important U.S. bank holding companies to further strengthen their capital positions. Under the rule, a firm that is identified as a global systemically important bank holding company, or GSIB, will have to hold additional capital ranging from 1.0 to 4.5 percent of each firm’s total risk-weighted assets to increase its resiliency in light of the greater threat it poses to the financial stability of the United States.

The final rule establishes the criteria for identifying a GSIB and the methods that those firms will use to calculate a risk-based capital surcharge, which is calibrated to each firm’s overall systemic risk. Eight U.S. firms are currently expected to be identified as GSIBs under the final rule: Bank of America Corporation; The Bank of New York Mellon Corporation; Citigroup, Inc.; The Goldman Sachs Group, Inc.; JPMorgan Chase & Co.; Morgan Stanley; State Street Corporation; and Wells Fargo & Company.

“A key purpose of the capital surcharge is to require the firms themselves to bear the costs that their failure would impose on others,” Chair Janet L. Yellen said. “In practice, this final rule will confront these firms with a choice: they must either hold substantially more capital, reducing the likelihood that they will fail, or else they must shrink their systemic footprint, reducing the harm that their failure would do to our financial system. Either outcome would enhance financial stability.”

Like the proposal issued in December 2014, the final rule requires GSIBs to calculate their surcharges under two methods and use the higher of the two surcharges. The first method is based on the framework agreed to by the Basel Committee on Banking Supervision and considers a GSIB’s size, interconnectedness, cross-jurisdictional activity, substitutability, and complexity.

The second method uses similar inputs, but is calibrated to result in significantly higher surcharges and replaces substitutability with a measure of the firm’s reliance on short-term wholesale funding. As seen during the crisis, reliance on this type of funding left firms vulnerable to runs and fire sales, which may impose additional costs on the broader financial system and economy.

Under the final rule and using the most recent available data, estimated surcharges for the eight GSIBs range from 1.0 to 4.5 percent of each firm’s total risk-weighted assets. Because the final rule relies on individual GSIB data that will change over time, the currently estimated surcharges may not reflect the surcharges that would apply to a GSIB when the rule becomes effective.

“A set of graduated capital surcharges for the nation’s most systemically important financial institutions will be an especially important part of the strengthened regulatory framework we have constructed since the financial crisis,” Governor Daniel K. Tarullo said. “Like the higher leverage ratio requirements we will apply to these firms, they reflect the relatively new, but very significant, principle that the stringency of prudential standards should vary with the systemic importance of regulated firms.”

In response to comments, the Board modified several aspects of the proposal’s second method to more accurately reflect a GSIB’s systemic importance. Additionally, the Board released a white paper on Monday describing how the surcharges were calibrated. The paper details the methodology used to set a GSIB’s surcharge at a level that would reduce the impact of its failure to near the impact of the failure of a large bank holding company that is not a GSIB.

The surcharges will be phased in beginning on January 1, 2016, becoming fully effective on January 1, 2019.

APRA Increases IRB Capital Adequacy Requirements for Residential Mortgages

APRA has announced that capital risk weight for banks using the internal risk-based model will increase from 16% to at least 25% from 1 July 2016. These changes, which chime with the recommendations from the FSI, will apply mainly to the big four and Macquarie and will tilt the playing field slightly back towards a more neutral balance with the smaller players who use the unchanged standard approach. That said the regional’s still have to hold more capital, at around 35%, and still have to pay more for that capital, so it will not create a level playing field.

The changes will require the banks to raise more capital (we think about ~$11bn to meet these revised ratios), throttle back mortgage lending growth or lift interest rates charged to borrowers or cut rates to savers. Further changes will probably follow in the light of evolving international developments, including the upcoming Basel IV. The changes as announced were expected, and it is unlikely overall banking profitability will impacted much at all, though the banks will squeal.

The Australian Prudential Regulation Authority (APRA) has today announced an increase in the amount of capital required for Australian residential mortgage exposures by authorised deposit-taking institutions (ADIs) accredited to use the internal ratings-based (IRB) approach to credit risk.

This change will mean that, for ADIs accredited to use the IRB approach, the average risk weight on Australian residential mortgage exposures will increase from approximately 16 per cent to at least 25 per cent.

The increase in IRB mortgage risk weights addresses a recommendation of the Financial System Inquiry (FSI) that APRA ‘raise the average IRB mortgage risk weight to narrow the difference between average mortgage risk weights for ADIs using IRB risk weight models and those using standardised risk weights’. The increase is also consistent with the direction of work being undertaken by the Basel Committee on Banking Supervision (Basel Committee) on changes to the global capital adequacy framework for banks.

The increased IRB risk weights will apply to all Australian residential mortgages, other than lending to small businesses secured by residential mortgage. The increase is being implemented through an adjustment to the correlation factor used in the IRB mortgage risk weight function for each affected ADI. In order to provide these ADIs sufficient time to prepare for the change, the higher risk weights will come into effect from 1 July 2016.

The residential mortgage portfolio is the largest credit portfolio for ADIs and, in aggregate, IRB accredited ADIs hold the material share of these exposures. 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.

The increase in IRB mortgage risk weights announced today is an interim measure. It is not possible to settle on the final calibration between the IRB and standardised mortgage risk weights until changes arising from the Basel Committee’s broader review of this framework are complete. Further changes to IRB mortgage risk weights will be considered over the medium term in the context of these broader international developments.

You can listen to my comments on ABC Radio National today on the APRA move.

FED to Modify its Capital Planning and Stress Testing Regulations

The Federal Reserve Board has proposed a rule to modify its capital planning and stress testing regulations.  The proposed changes would take effect for the 2016 capital plan and stress testing cycles.

The proposed rule would modify the timing for several requirements that have yet to be integrated into the stress testing framework.  Banking organizations subject to the supplementary leverage ratio would begin to incorporate that ratio into their stress testing in the 2017 cycle.  The use of advanced approaches risk-weighted assets–which is applicable to banking organizations with more than $250 billion in total consolidated assets or $10 billion in on-balance sheet foreign exposures–in stress testing would be delayed indefinitely, and all banking organizations would continue to use standardized risk-weighted assets.

Banking organizations are currently required to project post-stress regulatory capital ratios in their stress tests.  As the common equity tier 1 capital ratio becomes fully phased in under the Board’s regulatory capital rule, it would generally require more capital than the tier 1 common ratio.  The proposal would remove the requirement that banking organizations calculate a tier 1 common ratio.

The Board is also currently considering a broad range of issues related to its capital plan and stress testing rules.  Any modifications will be undertaken through a separate rulemaking and would take effect no earlier than the 2017 cycle.

Comments on the proposal will be accepted through September 24, 2015.

APRA Confirms Banks Will Need More Capital To Achieve FSI Recommendations

APRA released their comparative capital study today. Overall, whilst it shows that on an international comparison basis Australian banks are well placed, they are not placed in the top quartile of their international peers, so confirms the observation made  by the FSI Inquiry. For the purpose of this analysis, APRA has used the 75th percentile (i.e. the bottom of the fourth quartile) as a benchmark. This provides an estimate of the minimum adjustment needed if the FSI’s suggestion is to be achieved. However, it is clearly a moving target, as Banks around the world are lifting capital, and further changes to the Basel framework are in the works.

APRA says positioning CET1 capital ratios at the bottom of the fourth quartile would require an increase of around 70 basis points in CET1 capital ratios; and to simultaneously achieve a position in the fourth quartile for all four measures of capital adequacy, the increase in the capital ratios of the major banks would need to be significantly larger, albeit that there are more substantial caveats on the ability to accurately measure the relative positioning of Australian banks using measures other than CET1.

However APRA also says the conclusions of this analysis are, on balance, likely to provide a conservative scenario for Australia’s major banks, given:

  • limitations on data availability have meant that certain adjustments that might otherwise have unfavourably impacted the relative position of the Australian major banks have not been possible. These relate to (i) the exclusion of upward adjustments to the capital ratios of some foreign banks, and (ii) the exclusion of the impact of the capital floor on the capital ratios of the Australian major banks;
  • anticipated changes arising from the Basel Committee on Banking Supervision’s (Basel Committee) review of variability in RWAs will possibly lead to a relatively lower position for the Australian major banks; and
  • international peer banks are continuing to build their capital levels – over the past couple of years, the major banks have seen a deterioration in their relative position, despite an increasing trend in their reported capital ratios.

We note that while APRA is fully supportive of the FSI’s recommendation that Australian ADIs should be unquestionably strong, it does not intend to tightly tie that definition to a benchmark based on the capital ratios of foreign banks. APRA sees fourth quartile positioning as a useful ‘sense check’ of the strength of the Australian capital framework against those used elsewhere, but does not intend to directly link Australian requirements to a continually moving benchmark such that frequent recalibration would be necessary.

APRA will be responding to the recommendations of the FSI, bearing in mind the need for a coordinated approach that factors in international initiatives that are still in the pipeline. This will mean that, whilst APRA will seek to act promptly on matters that are relatively straight-forward to address, any final response to the determination of unquestionably strong will inevitably require further consideration. In practice, this will be a two-stage process as:

  • APRA intends to announce its response to the FSI’s recommendation regarding mortgage risk weights shortly. To the extent this involves an increase in required capital for residential mortgage exposures of the major banks, and the banks respond by increasing their actual capital levels to maintain their existing reported capital ratios, it will have the effect of shifting these banks towards a stronger relative positioning against their global peers; and
  • other changes are likely to require greater clarity on the deliberations of the Basel Committee (unlikely to be before end-2015) before additional domestic proposals are initiated.

As a result of these factors, and the broader caveats contained in this study, an accurate measure of the increase in capital ratios that would be necessary in order to achieve fourth quartile positioning is difficult to ascertain at this time. A better picture is likely to become available over time as, in particular, international policy changes are settled. Based on the best information currently available, APRA’s view is that the Australian major banks are likely to need to increase their capital ratios by at least 200 basis points, relative to their position in June 2014, to be comfortably positioned in the fourth quartile over the medium- to long-term. This judgement is driven by a range of considerations, including:

  • the findings of this study;
  • the potential impact of future policy changes emerging from the Basel Committee; and
  • the trend for peer banks to continue to strengthen their capital ratios.

In instituting any changes to its policy framework, APRA is committed to ensuring any strengthening of capital requirements is done in an orderly manner, such that Australian ADIs can manage the impact of any changes without undue disruption to their business plans. Furthermore, this study has focussed on the Australian major banks; the impact of any future policy adjustments, if any, is likely to be less material for smaller ADIs.

The benefits of having an unquestionably strong banking sector are clear, both for the financial system itself and the Australian community that it serves. Furthermore, Australian ADIs should, provided they take sensible opportunities to accumulate capital, be well-placed to accommodate any strengthening of capital adequacy requirements that APRA implements over the next few years.

So no clarity yet on the amount of additional capital banks will need to hold, nor timing of changes. Here is DFA’s view of how these outcomes will translate in the Australian context:

  1. Banks need to raise $20-40 bn over next couple of years, – that is doable – assuming they will be able to access functioning global markets. It will be ratings positive.
  2. Smaller banks will be helped by the FSI changes to advanced IRB, if they translate, but will still be at a funding disadvantage
  3. Deposit rates will be cut again
  4. Mortgage rates will lift a little, and discounting will be even more selective – Murray’s estimates on the costs are about right
  5. Lending rates for small business will rise further
  6. Competition won’t be that impacted, and the four big banks will remain super profitable
  7. We will still have four banks too big to fail, and the tax payer would have to bail them out in the event of a failure (highly unlikely but not impossible given the slowing economic environment here, and uncertainly overseas). The implicit government guarantee is the real issue.

APRA is concerned about financial stability, not about effective competition, or balancing the interests of shareholders and banks customers.

Basel III Stable Funding Disclosure Standards Will Improve Bank Transparency – Moody’s

According to Moody’s, the Basel III disclosure standards which were finalised recently, are positive for creditors of internationally active banks because they will improve transparency into bank funding, allowing investors to assess the adequacy and reliability of funding for a bank’s least-liquid assets, including loans.

Detailed NSFR disclosure is positive for bank investors evaluating a bank’s liquidity and stable funding position since the ratio is distinct from the LCR, measuring a different type of funding risk. The LCR measures whether banks hold enough high-quality liquid assets (HQLA) that could be liquidated to cover stressed cash outflows (e.g., deposit outflows and maturing liabilities that cannot be rolled over) over a 30-day period. The NSFR measures whether funding of longer duration adequately supports less liquid longerterm assets such as loans.

The NSFR template aligns with the LCR disclosure template, which for investors provides some consistency in evaluating short- and long-term liquidity risks. Both, for example, require disclosure of stable and less stable retail deposits, and wholesale deposits used for operational purposes. These disclosures are used to calculate stressed cash outflows in the LCR, and in the NSFR are categories of available stable funding. The Basel Committee noted that in formulating the template, it balanced usability of disclosure with “undesirable dynamics during stress.” Although the Basel Committee did not specify exactly how it achieved the trade-off in the disclosure framework, this has likely restricted funding transparency to some degree.

In addition to a standardized reporting template, the NSFR disclosure standards require qualitative disclosures that are important in evaluating a bank’s stable funding position. The disclosure of interdependent assets and liabilities, which are assigned 0% required stable funding and available stable funding factors in the NSFR calculation, is key because the interdependency is judged by national discretion and could drive significant differences in ratios across banks. The disclosures also will describe drivers of changes in the NSFR categories across reporting periods, which should help investors understand how a bank’s NSFR has changed over time.