Matthew Macreadie
What’s happened?
In its announcement, APRA made clear how it wants bank/insurance treasurers and senior executives to act in relation to capital calls. More specifically, the language used by APRA expressed the view for capital calls to be economically as opposed to capital markets access (or reputationally) driven.
We would note economic capital calls have already been a focus offshore. Thus, this news is not new from a global capital standpoint – and if anything, APRA is moving in line with global standards as it inevitably should. However, in the local market, many investors have not priced in much risk in relation to potential missed capital calls. It’s effectively been a highly improbable event.
What does this mean?
Effectively, banks and insurers will need to justify their capital call decisions to APRA considering numerous factors:
1. Cost of issuing a replacement instrument versus cost of keeping instrument outstanding
2. Comparative spread levels and issuance volume
3. Where relevant, any loss of T2 capital benefit due to amortisation (note T2 capital instruments amortises in the 5 years to maturity; for example, at year 6 – 80% capital/20% senior debt). In comparison, AT1 capital has no amortisation so they remain 100% capital in perpetuity if not called.
4. Access to capital markets (note – not sole driver)
Basically, APRA wants to keep key capital decision makers accountable… and fair enough.
What will it mean for markets?
Inevitably, the larger banks will have more of a justification than smaller banks and insurers. Thus, we don’t expect capital calls to just start being missed by the larger banks because the economics are unfavourable. Remember – it’s effectively been a highly improbably event and we don’t see this changing anytime soon for the larger banks. If anything, this might be a good time to opportunistically add larger bank T2 off the back of any spread weakness.
The story may be different for smaller banks and insurers. Here the access to capital markets and tenor extension argument(s) are a bigger issue versus the larger banks respectively. Thus, it would be wise to tread carefully here and manage portfolio exposure. This doesn’t mean you sell, just be comfortable with the underlying credit stories and in a worst-case scenario work out what is the yield to maturity rather than yield to call.
For context, our comments really refer to the T2 market. The AT1 market is still mainly a retail driven funding market.
Market moves to date – Not any huge moves in the Major T2?
Source: Indicative market levels, subject to IAM’s pricing matrix
