APRA has growled and launched a review of the capital treatment of ADIs’ investments in banking and insurance subsidiaries. Changes are now proposed to APS 111 at Level 1 to increase equity required to support investments in large subsidiaries but reduce that for smaller ones. This is aimed more at the major banks with substantial New Zealand operations. The current Level 1 treatment provides an average uplift of 100bp to the majors’ CET1 ratio. This is based on 400% risk weighting of the subsidiary investment after deducting intangibles and APRA believes this capital support may be overstated. APRA is proposing to limit the tangible amount of exposure to an unlisted individual subsidiary to 10% of net Level 1 Group CET1 capital and with amounts over this limit to be “met dollar-for-dollar” (i.e. any investment in excess of this 10% limit will be fully deducted from net Level 1 Group CET1 capital while anything below this limit will be risk weighted at 250%). While there is no impact on the majors’ Level 2 CET1 ratio, the Level 1 CET1 impact is estimated (by the majors) as follows:
- ANZ -75bp although certain management actions would offset much of this;
- CBA -30bp although announced divestments and regulatory changes would more than offset this;
- NAB minimal impact; and
- WBC -40bp although the ratio has since been lifted by 25-30bp through intra-group transactions.
In a nutshell, all the majors appear well placed to weather any capital increase under APRA’s proposals (as evidenced by share price reactions today and yesterday). ANZ would have to be the most resilient major purely based on CET1 flexibility (Level 1 and Level 2), followed by CBA, NAB and WBC – that is also reflected in our pecking order.
We've lowered NAB’s rating from Buy to Hold and its price target from $30.80 to $30.20 in our 2 October FY19 result preview note. This was largely based on capital concerns (following nearly $1.2bn after tax charges in 2H19 for customer remediation and software write-downs) that implied the bank is unlikely to achieve APRA’s “unquestionably strong” minimum CET1 benchmark of 10.5% by 1 January 2020. NAB has now clarified it expects to achieve this benchmark at both levels and we have revised our FY19 final dividend forecast from 79¢ back to 83¢. As a result, the price target is increased by 1% to $30.50 and NAB’s Buy rating is reinstated based on easing capital concerns (although our 2H19 underwritten DRP assumption remains).