Big four returns set to suffer under APRA's new terms

APRA's announcement of an increase in the average residential mortgage "risk-weight" applied by Australia's "internal-ratings based" (IRB) banks from 16% currently to "at least" 25% has important consequences for expected returns from bank securities...The substantial increase in equity will inevitably lower the major banks' shareholder returns and close the gap with regional banks that are still stuck using 40 per cent risk-weights (this disadvantage disappears if regionals can secure IRB status). The reduction in major bank leverage is a material credit positive for higher ranking securities that do not possess the 5.125% Common Equity Tier 1 (CET1) capital equity conversion trigger embedded within AT1 hybrids. The surge in CET1 reduces the probabilities of default/loss on subordinated bonds, senior bonds and deposits, making them more valuable, ceteris paribus. While AT1 hybrids benefit insofar as their 5.125% equity conversion trigger may be further away from the new-normal 10 per cent benchmark, these securities may get caught up in efforts by banks to boost "going concern" capital. Read the full AFR article for free clicking (twice) here (VIEW LINK)