Treasure Chest: CBA To Choose To Raise Capital?

This story features NATIONAL AUSTRALIA BANK LIMITED, and other companies. For more info SHARE ANALYSIS: NAB

By Greg Peel

Yesterday FNArena published Australian Banks: Capital Requirements Not Onerous, which noted broker assumptions that anticipated increases in bank capital ratios as required by the regulator would not impact significantly, and indeed direct equity raisings may not be needed.

Aside from organic generation of capital in the period from when APRA benchmarked its preliminary recommendations, the banks have already taken varying steps towards increasing their tier one capital ratios.

The most obvious of these is National Bank ((NAB)), which recently put away the biggest raising in Australian history without any adverse impact on its share price. The raising is to be primarily used to fund the listing of NAB’s Clydesdale Bank in the UK, but a proportion of the new funds was also raised in anticipation of new APRA requirements.

ANZ Bank ((ANZ)) and Westpac ((WBC)) both implemented dividend reinvestment plans at their interim result releases, which lead to increased tier one capital, and ANZ also sold its Esanda finance business. The only bank not to have yet made any extant move to build capital is Commonwealth Bank ((CBA)).

Prior to these actions from the other three banks, CBA boasted the strongest capital position amongst the Big Four, and CBA management has always stated, over the long period of APRA increase anticipation, that the bank’s capital position is “strong”. To that end, most brokers have assumed CBA would be able to satisfy stricter capital requirements without having to resort to a raising. But Morgan Stanley is one broker that has never been so sure.

A weaker than expected third quarter means CBA did not generate as much capital organically as was expected, and now that the other three banks have undertaken their individual actions, CBA’s capital position is now below the average of the four. Morgan Stanley forecasts a tier one ratio of 9.1% at end-FY15. This compares to a current 8.8% ratio for ANZ, 9.5% for Westpac and 10.0% for NAB.

The broker is assuming CBA will follow Westpac’s lead and announce a partially underwritten dividend reinvestment plan when it releases its FY15 result next month, which would provide for around $2.5bn in additional capital and take the bank’s ratio to 9.8%. But Morgan Stanley “sees merit” in a capital raising of $4-5bn.

APRA has suggested that banks should “take sensible opportunities to accumulate capital” and “there is little to be lost from starting early”. A pre-emptive capital raising from CBA would comply with advice. The downside is a pre-emptive raising would initially dilute the bank’s forecast return on equity, but this may not be a negative for investors.

The threat of increased capital requirements has been hanging over Australia’s banks now at least since late last year, when the Financial System Inquiry findings were delivered, but realistically for many years global banking regulators have been debating how best to prevent the need for governments to again have to bail out “too big to fail” banks with taxpayer funds, as was the case in the GFC (in Australia’s case, the government provided deposit guarantees).

Morgan Stanley argues that shareholders may well prefer to cop return on equity dilution up front and thus nip uncertainty in the bud, rather than carry an investment that is forever at risk of a necessary capital raising.

There may nevertheless be a need for CBA to raise new capital, the broker notes, once APRA has separately settled on its new mortgage risk weight requirements, which it will do so shortly. Were that ratio to be lifted from a current 10% to 25%, CBA would need to raise $4bn anyway to cover its market-leading mortgage book. And while broker expectations for the new weighting range from 20-30%, Morgan Stanley has previously suggested it would not be surprised in a ratio in excess of 30%.

It is not clear whether APRA’s new weighting requirements will be known by the time CBA’s result release is due, given the regulator has promised “soon” but not committed to any specific timing. Clearly, Morgan Stanley believes it would be in CBA’s best interests to appease shareholders with a pre-emptive raising to a level of capital comfort rather than wait through a period of uncertainty until such a capital increase is simply necessary.

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