ASX bank shares have still not recovered from the earnings dilution from last year’s multi-billion dollar equity raisings and one main reason is fears of more after the Basel Committee on Banking Supervision delivers its next policy statement at the end of the year. Several influential sell-side analysts have large, dilutive rights issues in their valuations and it would not be an overstatement to say the buy side has hated banks for most of this year.
We think this is about to change with the result banks will find more support in the sharemarket. We also had a second round of large, dilutive rights issues in our valuations but removed them a month ago because we expect Basel IV, as the current round of the committee’s process is known, will not trigger large, upfront equity raisings by banks next year at the subsequent behest of Australia’s regulator APRA. If there are higher capital requirements at all, banks will be allowed to reach them gradually over several years.
Led by Bank of England chief Mark Carney, who said “there is no Basel IV”, European banking regulators have called more for adjustments to the existing Basel III rules than a wholesale new round of equity raisings. The reason is they perceive Europe’s economy as too fragile for the price of more risk mitigation (more capital) to be worth it. Higher regulatory capital levels reduce a bank’s ability to lend, and European banks are hardly enthusiastic about lending now given the poor profitability caused by ultra-low interest rates.
If there is no broad push coming for higher capital ratios at European banks, then Australian banks can hardly be expected to hold more capital given they already have some of the world’s highest capital ratios. The Financial System Enquiry recommended banks be “unquestionably strong” and APRA interpreted this to mean domestically systemically important banks should have common equity tier 1 capital ratios in the top quartile of banks globally. Today this is the case, presented in the chart below from Commonwealth Bank.
International Peer Basel III CET1
Further, it is not the case regulators desire banks to raise more capital forever. In stronger economies like Australia’s, higher capital levels could encourage banks to take imprudent risks to sustain earnings growth and meet management remuneration thresholds. Having succeeded at slowing the rate of growth in bank lending to investors to 4.6 per cent over the year to August from a peak of 10.8 per cent in June last year, APRA will not want to create incentives to undo its work.
If higher capital ratios are required by, say, 2019 banks could reach them gradually by managing dividend payout ratios, dividend reinvestment plans and their mix of business. Business loans, being riskier, require more capital to be held against them than for less risky housing loans, so reducing the proportion of business loans in total loans reduces the amount of capital which has to be held. Lower payout ratios and discounted dividend reinvestment plans reduce the amount paid out in dividends and increase retained earnings.
There has already been a modest rerating of some banks. Since the end of July ANZ and NAB have found a bid, which has rewarded the positions in our model portfolio. Our largest bank weighting is to ANZ, currently outperforming the sector.
This article was originally published in The Australian Tuesday 4th October.
David Walker is Senior Analyst at StocksInValue. StocksInValue provides model portfolios, stock valuations and research covering Australian and international markets. Start making better investment decisions by registering for a trial at StocksInValue.com.au or call 1300 136 225.