The Reserve Bank of New Zealand (RBNZ) released its final capital rules following an extensive 12-month consultation process. Ord Minnett expected a modest softening of the rules and this was delivered, albeit the RBNZ allowed for more hybrids in the tier-one mix, which exceeded our expectation.
The rules have been watered down in three key areas:
- The RBNZ will allow redeemable preference shares in the tier-one capital mix, having listened to market feedback that it would be impractical to allow only non-redeemable preference shares.
- The common equity tier-one (CET1) ratio requirement has reduced from 14.5% to 13.5%, with the additional tier-one (AT1) ratio increasing from 1.5% to 2.5%. Thus the tier-one capital mix has improved in favour of a cheaper capital form.
- The phase-in period for the higher capital ratio requirements has extended to seven years from five years. The higher internal ratings-based scalar/output floor will come into effect from July 2020, although none of the major banks expect this to affect Level 2 capital ratios.
ANZ Banking Group (ANZ, Hold) remains the most affected by the rule changes due to the scale of its New Zealand operations. ANZ expects a $3bn impact on its Level 1 CET1 capital over seven years, including a $1bn management buffer. Revisions to the Australian Prudential Regulation Authority’s (APRA) APS 111 standard – which determines how a bank’s regulatory capital is measured – and its interaction with the higher RBNZ requirements, is the key area of uncertainty for ANZ.
For the other major banks, however, we see a path of gradual improvement in New Zealand capital ratios through retained earnings with little impact on Level 1 ratios. Under this scenario, we don’t see obvious negative implications for group dividends, depending on the prevailing earnings environment over coming years.
The small bounce in the sector following the announcement was unsurprising to us given the above factors, even though the broader earnings picture remains challenging. National Australia Bank (NAB, Accumulate) remains our top pick among the major banks, while we maintain a Hold rating on ANZ, Commonwealth Bank (CBA) and Westpac (WBC), with CBA our least preferred.