Morgan Stanley analyst Richard Wiles feels the market mistakenly expects a benign outcome when APRA releases its new capital framework. The analyst reckons there is a one-in-three in chance that capital requirements will be more onerous than expected and Commonwealth Bank could face a larger capital deficit than peers.
Wiles is further predicting that shares in the country’s largest lender will fall in the next 60 days and noted that CBA is trading on a P/E premium of 17 per cent compared to the other big three lenders.This premium is up on the historical average of 11 per cent.
“While repricing could support earnings in the near-term, the prospect of lower growth and a higher risk profile increases the chance of a de-rating,” he added.
Importantly, Wiles expects APRA chair Wayne Byres to clarify target ratios in its forthcoming information paper, but he believes that risk weightings may not be finalised until later in the year. In his opinion, there will be more clarity on the required common equity tier one ratios.
“However, we're not sure there will be resolution on changes to mortgage risk weightings given that APRA is planning a consultation on capital allocation for different risk exposures," he said. “Hopefully, there is some indication of minimum risk weights for different types of mortgages.
“Recent comments from Byres reinforce the view that the banks will need more capital. However, there is still considerable uncertainty over how much.”
The 'bear case'
Morgan Stanley’s ‘base case’ assumes a 1 per cent lift in the D-SIB buffer to 2 per cent (taking target CET1 ratios to 10 per cent) and a 3 percentage point increase in mortgage risk weights to 27.5 per cent.
“The banks could easily meet this requirement via organic capital generation and dividend reinvestment plans, and we believe share prices could react positively given the removal of uncertainty and reduced risk to dividends," Wiles said.
However, the firm’s ‘bear case’ - to which the analyst attaches a 35 per cent probability - would see the majors' target CET1 ratios lifted by 2 per cent to 11 per cent (versus a regulatory minimum of 10 per cent) and mortgage risk weights increased by 7 percentage points.
In Wiles’ view, share prices would drop significantly as it would be difficult for banks to bridge the capital deficit through DRPs - raising the prospect of capital raisings at the second-half results.
“What's more, we believe that National Australia Bank and Westpac would need to review their target payout ratios and cut their dividends," he said. “Overall, we think the likelihood of a more onerous than expected outcome is higher for mortgage risk weights than it is for the target CET1 ratio.
“In practice, we think risk weight calculations will become more granular, with more onerous treatment of high loan-to-value-ratio loans, debt-to-income-ratio loans, interest-only loans and borrowers with multiple loans."
No immediate clarity
On the home loan front, Morgan Stanley noted that growth rose by 7.5 per cent in May year on year from 5.8 per cent, year on year, in April. This compared with the March growth rate of 6.2 per cent, just prior to APRA's notice of tough new macro-prudential measures.
However, after adjusting for $1.4 billion of re-statements during the month, Wiles is now estimating that owner-occupier loans grew at a rate of 7.2 per cent during May and investment property loans increased at a rate of 7.0 per cent year-on-year.
While this suggests that APRA's measures and the banks' out-of-cycle variable rate re-pricing are not having an impact, there is room for the possibility that May’s strong growth simply reflected the volume of approvals made prior to APRA's announcement.
“In our view, the impact on investor loan system growth from mortgage re-pricing, interest-only loan caps, tighter lending standards and LVR restrictions will not be clear until the September quarter.”
The growth rate at each of ANZ, NAB and Westpac picked up in May, according to Morgan Stanley’s calculations.