Australia: Major banks


Our review of APRA’s June 2019 quarterly report on the four major banks — Commonwealth, Westpac, ANZ and NAB — concludes that they are collectively priced at a 16.5% premium over fair value.

Technically, the ASX 300 Banks Index ($XBAK) is experiencing secondary selling pressure and a correction is likely.

A correction would reduce the premium over fair value and may present buy opportunities.


We project:

  • long-term asset growth at 3.0% p.a. (down from 4.0%);
  • net interest margins at 1.65% of average total assets (down from 1.70%);
  • non-interest operating income of 0.5%;
  • operating expenses at 1.05% (previously 1.10%);
  • provisions for bad/doubtful debts averaging 0.2%;
  • additional equity capital required of $12 billion; and
  • a 30% tax rate.

That delivers a forward PE of 16.9 based on a market cap of $399 billion.

We estimate that the major banks are priced at a 16.5% premium over fair value, based on a 12-year payback period*.

*Note to readers: we have simplified our model by removing the margin of safety and use a lower payback period instead.

Technical Analysis

The ASX 300 Banks index retreated below its rising trendline, warning of a correction. Follow-through below support at 7600 would strengthen the signal, with a target of primary support at 6750.

ASX 300 Banks Index

Book Growth

Total assets are the primary engine of bank revenue. Heady growth of the last two decades ended in 2015, when the ratio of total assets to nominal GDP (right-hand scale) started to decline. Nominal GDP also slowed (5.4% p.a. in June 2019) and is likely to restrict future book growth.

Majors: Total Assets Annual Growth and compared to Nominal GDP

Household debt near saturation level, at close to 200% of disposable income, is another headwind to future book growth.

Australia: Household Debt to Disposable Income

Total asset growth of the major four banks slowed to 1.4% for the twelve months ended June 2019 and we have reduced our long-term projection to 3.0% per year.


RBA rate cuts are squeezing net interest margins, currently 1.73%, and we expect a long-term average of 1.65% of total assets.

Majors: Income & Expenses

Expenses declined to 1.09% of total assets but non-interest income, at 0.56%, is falling even faster.

Non-Interest Income

Fees and commissions — the major component of non-interest income — have suffered the largest falls. Transaction-based fees are the worst performer, while declining credit growth has reduced lending-based fees. The sharp drop in other fees, to 0.19%, is likely to be permanent as banks shed their wealth management operations.

Majors: Fees

We project non-interest income to average 0.50% of total assets in the long-term.


Operating expenses declined to 1.09% of total assets, as the majors attempt to cut costs in line with income, but personnel costs have proven sticky and are falling at a slower rate.

Majors: Operating Expenses

Non-Performing & Past Due Assets

Charges for bad and doubtful debts remain low at 0.09% of total assets but we expect a long-term average of 0.20%.

Majors: Charges for Bad & Doubtful Debts

Impaired loans are falling as a percentage of total loans and advances but past due loans have climbed to 0.6%, reflecting mortgage stress.

Majors: Impaired Assets

Provisions for impaired loans, however, are reasonable at 95.8% of impaired facilities including security held.

Majors: Provisions for Impaired Assets


Common equity Tier 1 capital (CET1) remains low, with a CET1 capital ratio of 10.8% in June 2019, based on risk-weighted assets. CET1 as a percentage of total assets is a low 4.96%.

The Reserve Bank of New Zealand has called for “more skin in the game“, asking the big four Australian banks to increase their capital holdings in New Zealand subsidiaries by $12 billion:

The RBNZ proposal calls for systemically important banks to hold a minimum of 16% Tier 1 capital against risk-weighted assets, of which 6% would be a regulatory minimum and 10% would act as a counter-cyclical buffer to absorb losses without triggering “resolution or failure options”.

A similar move by APRA is unlikely but RBNZ presents a problem for the big four banks as they will have to raise additional equity to capitalize their NZ subsidiaries. One alternative is to raise equity through a separate listing of their NZ subsidiaries but this is still likely to dilute returns on equity.

Return on Equity

Declining return on assets and increased capital requirements are both exerting downward pressure on return on equity (ROE), from a peak of 20.5% in 2007 to 9.7% in March 2019.

Majors: Return on Total Assets & Return on Equity

Management & Culture

Australian regulator APRA is suffering from regulatory capture. A 146-page capability review, stemming from David Murray’s Financial System Inquiry found APRA “slow, opaque, inefficient, and in urgent need of a culture and leadership overhaul.”


Staff of The Patient Investor may directly or indirectly own shares in the above companies.

Aussie banks get a wake up call from across the Tasman

I have long called for Australian banks to increase their equity capital in order to withstand a potential banking crisis in Australia. The Murray Commission found that banks, in a crisis, would act as “an accelerant rather than a shockabsorber”.

Now the RBNZ has announced plans to force the big four banks to hold more capital in their New Zealand banking operations. From Clancy Yeates at the Sydney Morning Herald:

The Reserve Bank of New Zealand has mounted a firm defence of its plan to force Australia’s major banks to hold $NZ12.5 billion ($A12.12 billion) more in capital in their banking operations across the Tasman, saying the “highly profitable” businesses would have to accept lower returns.

In an interview on Wednesday, RBNZ deputy governor Geoff Bascand also justified the plan to bolster bank balance sheets by emphasising the social costs of banking crises and arguing New Zealand could not rely on Australian parent companies for a bail-out in severe shock.

……The big four Australian banks made $4.4 billion in cash profits from their New Zealand operations in 2018 representing about 15 per cent of their total combined profit with ANZ tipped to experience the most significant hit.

Mr Bascand said the central bank had estimated the big four’s NZ return on equity, until recently 14 to 15 per cent, would decline by between and 1 and 3 percentage points as a result of the change.

Earlier, Bascand said:

“At one time, the owners of a bank had plenty of skin in the game; in fact, there was a time when banks got most, or all, of their money from their owners. However, over the last century, banks have started to use less of their own money and more of other people’s, and the balance has almost entirely reversed. While we are not attempting to turn back the clock …..We believe that more ‘skin in the game’ for banks will result in:

  • Banks being better able to absorb large, unexpected losses
  • Society being less at risk from banking crises
  • Reduced fiscal risk…..As the global financial crisis illustrated, when banks fail there can be a severe domino effect that puts pressure on governments to step in with financial support
  • Bank shareholders and management being less inclined to take excessive risks”

(Gareth Vaughan,

The RBNZ proposal calls for systemically important banks to hold a minimum of 16% Tier 1 capital against risk-weighted assets, of which 6% would be a regulatory minimum and 10% would act as a counter-cyclical buffer to absorb losses without triggering “resolution or failure options”. Bear in mind that risk-weighting significantly understates total assets and that leverage ratios, reflecting un-weighted assets, are about 55% of the above (i.e. 8.8%).

The banks have protested, warning that increasing capital will raise interest rates to borrowers.

…..The RBNZ has acknowledged interest rates charged by banks will probably rise as a result of the change, but Mr Bascand said it estimated the impact would be about half a standard 0.25 percentage point move in official interest rates.

If banks’ borrowing rates did rise more sharply than expected, he said the RBNZ could offset this through monetary policy…..

What the banks failed to consider (or mention) is that investors are prepared to accept lower returns on equity if there is lower associated risk. Also banks with strong balance sheets have historically experienced stronger growth. Both lower risk and stronger growth would help mitigate the costs of additional capital.

Question is, why are RBNZ raising concerns about bank capital and not APRA? Another case of regulatory capture?

Big four banks protest against higher capital

“The big four banks are trying to convince the prudential regulator to reconsider its proposal to force them to raise an additional $75 billion of so-called Tier II bonds to meet “too big to fail” capital requirements.” ~ Jonathan Shapiro, Australian Financial Review

What is APRA thinking? They are deluding themselves if they think that Tier II bonds will shore up capital.

Imagine the panic in financial markets if bond-holders take a haircut. It could lead to a Lehman-style meltdown.

The same applies to Tier I hybrids which banks are happily flogging to retiree investors. Convert their investments into near worthless bank scrip after a financial meltdown and nan and pops will turn up in Melbourne Docklands and Darling Harbour, demanding their money back. I suspect regulators would rather face Ned Kelly.

The only true capital is Common Equity (CET1). Anything else is simply putting lipstick on the pig.

Aussie taxpayers are being duped if they believe that they are covered if there is a financial meltdown and that banks carry enough capital to absorb potential losses.

I would rather see legislation that calls it like it is and provides for government to backstop the banks in the event of a crisis. But at a price that makes their eyes water, as the Swedes did in 1992. It’s the best way to keep the banks honest.

Australia: APRA capitulates to Big Four banks

From Clancy Yeates at The Age:

Quelling investor fears over moves to strengthen the financial system, the Australian Prudential Regulation Authority on Wednesday said major banks would have until 2020 to increase their levels of top-tier capital by about 1 percentage point, to 10.5 per cent.

The target was much more favourable to banks than some analyst predictions, with some bank watchers in recent months warning lenders may need to raise large amounts of equity or cut dividends to satisfy APRA’s long-running push for “unquestionably strong” banks.

Markets are now confident banks will hit APRA’s target, estimated to require about $8 billion in extra capital from the big four, through retained earnings or by selling new shares through their dividend reinvestment plans…..

“The scenario where banks had to raise significant capital appears to be off the table for now,” said managing partner at Arnhem Asset Management, Mark Nathan.

Mr Nathan said the banks’ highly prized dividends also looked “safer”, though were not likely to increase. National Australia Bank and Westpac in particular have high dividend payout ratios, which could put dividends at risk from other factors, such as a rise in bad debts……

APRA’s chair Wayne Byres said the changes could be achieved in an “orderly” way, and the new target would lower the need for any future taxpayer support for banks.

“APRA’s objective in establishing unquestionably strong capital requirements is to establish a banking system that can readily withstand periods of adversity without jeopardising its core function of financial intermediation for the Australian community,” he said.

APRA chairman Wayne Byres used the words “lower the need for any future taxpayer support.” Not “remove the need…..” That means banks are not “unquestionably strong” and taxpayers are still on the hook.

A capital ratio of 10.5% sounds reasonable but the devil is in the detail. Tier 1 Capital includes convertible (hybrid) debt and risk-weighted assets are a poor reflection of total credit exposure, including only that portion of assets that banks consider to be at risk.

Recent bailout experiences in Europe revealed regulators reluctant to convert hybrid capital, included in Tier 1, because of fears of panicking financial markets.

Take Commonwealth Bank (Capital Adequacy and Risks Disclosures as at 31 March 2017) as a local example.

The Tier 1 Capital Ratio is 11.6% while Common Equity Tier 1 Capital (CET1), ignoring hybrids, is more than 17% lower at 9.6%.

But CBA risk-weighted assets of $430 billion also significantly understate total credit exposure of $1,012 billion.

The real acid-test is the leverage ratio which compares CET1 to total credit exposure. For Commonwealth this works out at just over 4.0%. How can that be described as “unquestionably strong”?

Minneapolis Fed President Neel Kashkari conducted a study last year in the US and concluded that banks need a leverage ratio of at least 15% to avoid future bailouts. Even higher if they are considered too-big-to-fail.

APRA fiddles while housing risks grow

From Westpac today (emphasis added):

….With the Reserve Bank sharing our caution around 2018, along with ample capacity in the labour market (unemployment rate is 5.9% compared to full employment rate of 5.0%) and stubbornly low wages growth, there is only scope to cut rates. But as we have argued consistently, a resurgent housing market disallows such a policy option. Indeed, the minutes refer to “a build- up of risks associated with the housing market”. A tighter macro prudential stance seems appropriate.

Indeed, as we go to press, APRA has announced new controls, restricting the “flow of new interest-only lending to 30 per cent of total new residential mortgage lending” with a particular focus on limiting interest only loans with a loan-to-value ratio [LVR] above 80%. Currently, “interest-only terms represent nearly 40 per cent of the stock of residential mortgage lending by ADIs”, so this policy will restrict the terms at which a marginal borrower can access credit (investors and owner-occupiers). APRA also noted that they want banks to manage growth in investor credit to “comfortably remain below the previously advised benchmark of 10 per cent growth”. This is not a hard change to the target as had been mooted recently in the press (some suggesting the 10% limit could be as much as halved), but it does suggest lending to investors will continue to grow at a pace meaningfully below 10%. Looking ahead, the next RBA Stability Review (April 13) may provide more clarity on the macro prudential policy outlook and potential triggers for further action. For the time being though, the 2015 experience offers an understanding of the potential impact of this further tightening.

To head off a potential bubble burst, the RBA and APRA need to drastically slow house price growth. I am sure the big four banks are urging caution but they would be the worst hit by a meltdown. What APRA is doing is fiddling around the margins. To make housing investors think twice about further borrowing, APRA needs to cut the maximum LVR to 70%. And half that for foreign borrowers.

APRA waves wet lettuce at bank offshore funding | MacroBusiness

From Leith van Onselen at Macrobusiness:

…..the banks’ reliance on offshore funding hit an unprecedented 54% of GDP in the December quarter:

As always, the key risk is that the banks’ ability to continue borrowing from offshore rests with foreigners’ willingness to continue extending them credit. This willingness will be tested in the event that Australia’s sovereign credit rating is downgraded (automatically downgrading the banks’ credit ratings), there is another global shock, or a sharp deterioration in the Australian economy (raising Australia’s risk premia).

The Federal Budget, too, is now hostage to the banks’ offshore borrowing binge as it cannot borrow to spend on infrastructure or other initiatives for fear that Australia will lose its AAA credit rating, potentially leading to an unraveling of the private debt bubble created by Australia’s banks.

That APRA could stand by and allow the banks’ to borrow externally like drunken sailors is a hallmark of regulatory failure.

One in four dollars of bank assets is funded by offshore borrowing. A precarious position even for a stable economy (like Ireland?), let alone one hitched to the boom and bust commodity cycle. Smacks of moral hazard by the banks.

Source: APRA waves wet lettuce at bank offshore funding – MacroBusiness

CBA, ANZ, NAB and Westpac: The incredible shrinking big four banks |

Great article by Chris Joye:

Welcome to the world of that beautiful $140 billion behemoth, the Commonwealth Bank, which has inverted the axiom that there is a trade-off between risk and return. Years ago I highlighted a perversion embedded at the heart of our financial system: the supposedly lowest (highest) risk banks were producing the highest (lowest) returns. Normally it works the other way around.

…..contrary to some optimistic reports, the capital-raising game has only just begun.

The terrific news for shareholders is that this belated deleveraging will transform the majors into some of the safest banks in the world, which will be able to comfortably withstand a 1991-style recession, exacerbated by a 20 per cent decline in house prices.

In the past I have been critical of APRA’s failure to properly police Australia’s vastly-undercapitalized banking system but must now give them credit for their leadership towards creating a world-class system that will be able to withstand serious endogenous or exogenous economic shocks.

Shareholders face lower returns from reduced leverage but will benefit from improved valuations due to lower risk premiums and stronger, more stable, long-term growth.

Read more at CBA, ANZ, NAB and Westpac: The incredible shrinking big four banks |

APRA confirms further capital adequacy measures

From Robin Christie:

The Australian Prudential Regulation Authority (APRA) has confirmed that the country’s largest banks will face increased capital adequacy requirements for residential mortgage exposures – and hasn’t ruled out further rises.

The regulator made it clear yesterday that the new rules would be an interim measure based on the Financial System Inquiry’s (FSI) recommendations – and that it was keenly awaiting guidance from the Basel Committee on Banking Supervision before making any further changes.

The new measures, which come into effect on 1 July 2016, mandate that authorised deposit-taking institutions (ADIs) that are accredited to use the internal ratings-based (IRB) approach to credit risk must increase their average risk weight on Australian residential mortgage exposures to at least 25 per cent. According to APRA, the current average risk weight figure sits at around 16 per cent….

This is a welcome first step. Increases in bank capital will improve economic stability. Even at 25 percent, however, a capital ratio of 10% would mean that banks are holding 2.5 percent capital against residential mortgages. Further increases over time will be necessary.

Read more at APRA hints at further capital adequacy measures.

APRA considers two per cent capital adequacy increase

by Robin Christie | 14 Jul 2015

The Australian Prudential Regulation Authority (APRA) has stated that the major banks would need to increase their capital adequacy ratios by at least two per cent to meet Financial System Inquiry (FSI) recommendations.

APRA has been comparing the capital position of the Australian major banks against a group of international counterparts, and the results of this study, released today, have led to the two per cent figure being mooted.

The study was implemented as a direct response to the FSI final report’s first recommendation, that APRA should “set capital standards such that Australian authorised deposit-taking institution [ADI] capital ratios are unquestionably strong”. This would mean making sure that Australian ADIs sit in the top quartile of internationally-active banks in capital adequacy terms.

….the statement adds that APRA is committed to ensuring that any capital adequacy requirement improvements occur “in an orderly manner”. This process would take into account Australian ADIs’ ability to manage the impact of any changes “without undue disruption to their business plans”.

While APRA hasn’t made a decision on whether it will go as far as mandating a two per cent increase in capital adequacy ratios…. it has stated that Australian ADIs should be well placed to accommodate its directives over the next few years – “provided they take sensible opportunities to accumulate capital”.

Bear in mind that capital adequacy ratios are measured against risk-weighted assets, where asset values are adjusted for the perceived risk of default. Australian banks have historically used risk weightings as low as 15% for residential mortgages compared to 50% in the US. That means that a bank with a capital ratio of 10% would only hold 1.5% capital against residential mortgages. And a 2% increase, to a capital ratio of 12%, would only increase capital cover to 1.8%. Revision of risk weightings is more important than an increase in the capital ratio, especially given Australia’s precarious property market.

Read more at APRA considers two per cent capital adequacy increase.

Big banks may need $41b more capital, UBS says

From Chris Joye at AFR:

UBS’s more likely scenario of a 3 per cent TBTF capital buffer combined with an increase in the average mortgage risk weight to 25 per cent gives a total capital shortfall of $41.1 billion for the majors.

Risk-weightings, especially for residential mortgages are coming under increased scrutiny. The big four banks have a major advantage in this area, employing risk-weightings as low as 15% to 20% based on their historical record of low defaults. But that history includes a credit boom lasting more than 2 decades which fueled an unprecedented rise in housing prices and is unlikely to be repeated in the future.

APRA alluded to this problem in its second FSI submission:

..APRA also highlighted the problem with the major banks’ predicting their own probabilities of defaults on home loans in the absence of a recession in 23 years and the much lower levels of housing leverage in 1991.“The Basel Committee is currently reviewing the validity and reliability of risk weights generated under the IRB approach [used by the majors] in response to studies showing that the variability … is much greater than could be explained by differences in underlying risks,” APRA said.

Only when the tide goes out do you discover who’s been swimming naked. ~ Warren Buffett

Read more at Big banks may need $41b more capital, UBS says.