Spotlight on Bendigo, BOQ as capital targets questioned

Returns for the regional banks are improving thanks to their hiking interest rates on riskier loans and avoiding the government levy. However, they may come under regulatory pressure to further shore up their balance sheets.

In the last two weeks, regional lenders like Bendigo and Adelaide Bank and Bank of Queensland have followed the big four banks in increasing rates on interest-only loans, although they have not lowered prices on the vast majority of principal-and-interest loans. 

Neither banks' share price reflects any risk of APRA's soon-to-be released capital paper affecting the regional banks. But, in a client note, Morgan Stanley’s Andrei Stadnik asked the question: what if APRA's measures are broader than expected and minimum core equity tier one capital or risk weights on mortgages move higher? 

In response, Bendigo chief executive, Mike Hirst, said that if APRA was to ask the regionals to hold relatively more capital than the majors, it would be against what the government said it wanted to achieve as set out in its major bank levy justification.

The banking analyst is not saying that APRA upping its capital targets (or mortgage risk weights for regional banks) is his base case but neither is he ruling it out as a possibility.

“But with major banks' target CET1 capital likely to rise from 9 per cent to 10 per cent or more would APRA allow the regionals to operate with an 8 per cent target? APRA is looking at absolute, relative and other measures of 'unquestionably strong', and we note S&P recently downgraded Bendigo and BOQ.” 

More granular

And as Stadnik sees it, the Queensland regional lender is better placed than Bendigo, which has no surplus capital.

“While the regionals are not domestically systemically-important banks, or D-SIBs, there are other measures that APRA could use to increase target capital, including the countercyclical capital buffer.”

Stadnik’s analysis shows that every 0.5 percentage point rise in the CET1 target would increase required capital by $200 million at Bendigo and $150 million at BOQ.

“With an 8.0 per cent CET1 ratio at Bendigo and 9.3 per cent at BOQ, our analysis suggests Bendigo is more likely to have a capital deficit than BOQ," he said.

And on the mortgage risk weights front? According to the analyst, every 3 percentage point risk weight change increases required CET1 capital by $100 million or reduces CET1 ratio by 25 basis points for Bendigo and by $70 million or 27.5 basis points for BOQ.  

“Risk weights could also become more granular, with higher loading for higher risk loans.”

For example, he added, investor property loans are 40 per cent of regional banks’ mortgage books, and analysis shows that a 10 percentage point rise in risk weights would increase required capital by $130 million at Bendigo and $100 million at Bank of Queensland.

Like-for-like comparison

However, Stadnik told clients that while Bendigo looks unlikely to achieve partial advanced accreditation by the June 2017 target, this could help address any capital shortfall within APRA's transition period. 

“If Bendigo can move halfway towards the major banks' mortgage risk weights, it could reduce its CET1 requirement by between $100 to $200 million or raise its CET1 ratio by between 30 to 60 basis points, depending on where major banks' risk weights end up.”

Separately, he argued, if APRA adopts Basel 4 proposals for standard risk weights on mortgages - without differentiated treatment of investor loans - BOQ’s mortgage risk weights could fall by 2 percentage points and the regional lender’s CET1 ratio rise 20 basis points. 

The Bendigo chief emphasised that with capital differentiated between the advance and standardised banks, the amount  of leverage off the capital base of the major banks is far greater than the leverage off the capital base off the regional banks.

“The only published like-for-like comparison of capital and assets is S&P’s risk-adjusted capital and that shows regional banks hold much more capital against their balance sheets than the majors," said Hirst.

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