Published in The Australian 17 October 2015
The four major banks — ANZ, CBA, NAB and Westpac — must juggle the demands of many interested parties, a balancing act that sometimes requires them to issue capital, as shown by Westpac’s $3.5 billion share rights issue this week, offered to retail investors at a 13 per cent discount
Westpac’s rights issue is just one of a number of capital building initiatives that will raise $6bn in new equity by year’s end.
Westpac has also stirred controversy by lifting its homeowner mortgage rate by 0.2 per cent, although official rates are unchanged.
This came about because one of the most important stakeholders for banks is the regulator, the Australian Prudential Regulation Authority (APRA). It has extensive and prescriptive powers and late last year required major banks to increase capital so they would be ranked in the top quartile of banks on a global scale.
Mid-year there was a further announcement demanding the major banks hold more risk weighted capital against home loans starting mid-2016. This was a significant, costly shift, and will make residential lending more expensive for the majors.
To help cover the additional capital requirements, Westpac announced a share rights issue of $3.5 billion. This will have a direct impact on shareholders, diluting their holdings if they fail to take up additional shares. The rights issue is just one part of other capital building initiatives that will raise $6 billion in new equity by year end.
The bank also put up home loan rates transferring higher risk weight costs onto consumers. By passing on costs, Westpac demonstrated one of its key strengths, but conversely and especially if the other banks follow, it could dampen the economy.
The purpose of having more capital is to make the banks safer, so that they can withstand another GFC type event without the need for government support.
But making banks ‘safer’ has consequences. They will be required to hold even more funds on their balance sheets absorbing capital that might otherwise be invested to grow the economy. Westpac has disclosed that the extra capital it needs to hold to meet housing risk weights amounts to A$42 billion, or an additional 12 per cent over that which is already held.
Globally, the capital needed to meet new regulatory requirements runs into hundreds of billions of dollars.
The question becomes what is safe? Having been an international bank analyst and watching British banks RBS and Lloyds throughout the GFC, I consider safety and survivability inextricably linked. The more common equity a bank has the more capital it has to absorb losses and protect bond holders that sit higher up in the capital structure. Remember bond investors must be paid interest and principal when due whereas there is no legal obligation to pay dividends or return capital with shares.
So, how have Westpac’s senior bonds performed as it transitions to a ‘safer’ bank? One simple assessment would be to consider the bank’s credit rating as it is an indicator of perceived risk and safety. Westpac’s senior debt rating has not changed in the last 12 months, which would imply there has been no perceived change in safety.
The way the institutional market would assess performance is through credit default swaps, an indicator of what it would cost Westpac to raise senior five year bonds in the US, over the benchmark. As at 1 April 2015, the cost was 58 basis points (100 basis points = 1 per cent). By 1 October, it rose to 101 basis points. As at 14 October the rate was 87.3 basis points. Over the last quarter there has been a material increase in the cost to issue five year debt.
This could be seen to reflect higher risk but is much more likely due to market swings that don’t reflect the underlying strength of the bank.