Next comes TLAC

  • By Elizabeth Fry

Australia’s major banks will need to raise a further $112 billion to satisfy new bail-in rules set by global regulators concerned about large bank failures.

The new capital demand comes just as Aussie banks are staring down the barrel of higher mortgage risk weights as APRA moves to combat the risks of a white-hot housing market.

The big four lenders are in strong positions to satisfy higher regulatory capital requirements as drawn up by the Basel Committee of financial regulators.

All four can comfortably meet the updated minimum 10.5 per cent common equity tier one capital ratio without the need for large equity raising.

But once the “unquestionably strong” capital benchmark is achieved, Morningstar’s David Ellis reckons that APRA will turn its attention to strengthening the total loss absorbing capital capacity of the major banks.

“We expect APRA to allow a three-to-five-year implementation period for this capital to be raised, which we don’t anticipate being an overly difficult task given the collective senior unsecured refinancing requirements of the major banks sits around $80 billion per year in the coming years,” Ellis said.

Top of mind

Issued by the Financial Stability Board, TLAC's purpose is to ensure an increased minimum amount of loss-absorbing and recapitalisation capacity within the world’s 30 global systemically important banks.

In essence, TLAC creates a new layer in the capital structure involving bonds that convert into equity capital if a bank gets into trouble.  

This reduces the need for taxpayers to bail out a "too big to fail" bank.

The first TLAC requirement will come into force as of January 1, 2019, followed by the second phase which comes three years later.

Although TLAC is explicitly targeted at GSIBs, APRA along with other regulators has agreed to adopt it for domestic systematically important banks.

“While progress may be relatively slow considering the plethora of other demands APRA must attend to, we expect TLAC to move up APRA’s agenda in 2018," added Ellis.

“Further, we expect APRA to follow Canada’s path in adopting the minimum GSIB TLAC standards over a similar time frame, about four to five years.”

Negligible impact

Ellis expects that the impact of TLAC on the major bank valuations and outlooks will be negligible.

“If we assume the capital structure composition remains unchanged between debt and equity, the overall impact will be a modestly higher weighted average cost of debt, which will flow through into a slightly higher cost of capital.

“This could be further compounded by any possible ratings downgrade that might accompany TLAC implementation.

“In this scenario, a higher cost of capital will likely be offset by further cost pass-throughs to customers.

“However, this will be occurring amid the backdrop of a stronger banking system, which will support bank valuations.

Boosting ratios

Two mimimum TLAC standards aim to bolster G-Sibs' capital and leverage ratios. 

The minimum required TLAC ratio for GSIBs will be 16 per cent by January 1, 2019, increasing to at least 18 per cent by January 1, 2022. 

The minimum TLAC leverage ratio for GSIBs must be 6 per cent of unweighted exposures in the form of TLAC eligible instruments by January 1, 2019, which increases to 6.75 per cent on January 1, 2022.

Incidentally, the analyst's calculation of $112 billion assumes APRA implements the same ratio requirements as the FSB.

Ellis reckons the domestic major banks will raise TLAC eligible capital mainly via the rolling over or issuing new bail-in senior unsecured debt.

Call feature

To a lesser extent, he argues,TLAC requirements will be satisfied via the continued issuance of additional tier one and tier two debt.

"Equity capital is another option; however, we consider it the least likely one."

One development he is seeing overseas - and expects to see replicated here - is the inclusion of a call feature in the TLAC eligible capital which allows the issuer to redeem the security 12 months prior to its maturity.

"This not only satisfies part of the definition for TLAC eligible capital but allows them to save on interest payments for debt with no regulatory benefit."

"Further, it also supports the regulatory TLAC requirement long-term debt must comprise 33 per cent of a bank’s TLAC."