APRA dials back TLAC-equivalent requirement but sticks to tier-two as instrument of choice

The Australian Prudential Regulation Authority (APRA) has reduced the incremental total-capital uplift initially required of Australia’s big-four banks under its total loss-absorbing capacity (TLAC) equivalence regime. The regulator believes it should be possible for Australian banks to fund a smaller initial uplift with tier-two securities rather than via a new asset class.

In a 9 July update, APRA revealed that it plans to reduce the additional total-capital uplift required of the Australian majors to 3 per cent of risk-weighted assets (RWAs) by the start of 2024. Its initial proposal, published in November last year, was that the majors increase their total capital by 4-5 per cent.

APRA says its “overall long-term target of an additional 4-5 percentage points of loss-absorbing capacity remains unchanged”. However, it has eased the timeframe in which it expects this higher requirement to be fulfilled by the banks.

The introduction of a new additional-capital asset class, such as the senior-nonpreferred securities issued by European banks to fulfil their TLAC requirements, is not quite off the table. APRA says it will “consider the most feasible alternative method of sourcing the remaining 1-2 percentage points, taking into account the particular characteristics of the Australian financial system”.

“Although APRA’s proposed response may increase funding costs for tier-two instruments issued by major banks, overall funding cost increases can be expected to remain small.”

Tier-two still the call

However, APRA still believes the initial – and largest – capital uplift can be funded in tier-two format. “APRA expects the issuance of an additional 3 per cent of RWA in tier-two instruments can be achieved in an orderly manner, and be maintained through varied market conditions,” the regulator says.

It has formed this opinion based on a consultation following the November proposal which included “concerns raised in a number of submissions about a lack of sufficient market capacity to absorb an extra 4-5 per cent of RWA in tier-two issuance and the potential to excessively increase bank funding costs”. APRA says it also had “extensive dialogue” with banks, and with arrangers and significant investors in the tier-two market.

APRA’s deputy chair, John Lonsdale, said in a statement: “Although APRA’s proposed response may increase funding costs for tier-two instruments issued by major banks, overall funding cost increases can be expected to remain small. Having taken into account feedback on market capacity, increasing total capital requirements by 3 percentage points by 2024 – instead of the 4-5 originally proposed – will be easier for the market to absorb and reduce the risk of unintended market consequences.”

The regulator estimates that its updated TLAC-equivalence proposal will have an impact of less than 5 basis points on the big-four banks’ overall funding costs, adding that a cost of this magnitude would be “well within the range” of analysis conducted by the Reserve Bank of Australia based on historical market data.

A Westpac Institutional Bank research note published immediately after the APRA update estimates the incremental tier-two requirement for the majors in aggregate would be around A$50 billion (US$34.8 billion) over four years. This is lower than the approximately A$75 billion expected under the original proposal but the Westpac note argues it is “still considerable” for an asset class with current outstandings closer to A$35 billion.

The same note also estimates that the expected increase in tier-two supply combined with the rally in senior credit spreads can be expected to push major-bank tier-two margins up to two-and-a-half times senior spreads, from a more recent equilibrium of somewhat less than two times.