Maybe we’re not quite done on the major bank capital raising just yet
The volatility in equity markets over the last week is likely to be making a few bankers a little nervous.
We have discussed the need for the major banks to raise their equity capital bases to meet heightened tests of capital adequacy on a number of occasions. The first round occurred recently for CBA and ANZ with the announcement of equity raisings in early August that would allow them to meet the increased capital requirements stemming from the increase in mortgage risk weights by APRA applying from 1 July 2016. CBA raised A$5 billion and ANZ A$3 billion. The market crunched the numbers, adjusted its Earnings Per Share (EPS) forecasts for the dilution, and it moved on.
There’s one problem, not all of the new equity capital was raised immediately. Both capital raisings included a retail component that closes on 8 September.
ANZ’s equity raising comprised of a $2.5 billion institutional placement at A$30.95 per share and a shareholder purchase plan (SPP). The SPP allows retail investors to purchase up to A$15,000 of new shares at the lower of: a) the A$30.95 institutional placement price and b) a 2 per cent discount to ANZ’s volume weighted average share price (VWAP) between 2 September and 8 September.
The SPP opened on Monday and closes on 8 September. Despite a reduction in the issue price, meaning the future return on the new shares will be higher for investors, the current volatility could have a detrimental impact of the willingness of retail investors to put fresh capital into equities, resulting in a shortfall on the A$500 million ANZ expects to raise from the SPP.
In the context of ANZ’s A$81 billion market capitalisation, having to potentially reprice a A$500 million equity raising would have limited impact of EPS. For example, if the issuance was repriced to a 2 per cent discount to the current price (ie. A$27.50), it would result in an extra 0.9 million shares being issued. This would dilute ANZ’s total capital base by 0.03 per cent. Not a major concern.
The issue is a little more serious for CBA and its underwriters.
Around A$2.9 billion of the total A$5 billion equity raising by CBA is expected to come from the retail entitlement offer. Unlike the ANZ offer, there is no reset to the retail entitlement offer price of A$71.50. Instead, CBA decided to have any shortfall in the amount raised underwritten by the lead investment banks on the deal.
The A$2.9 billion raising at A$71.50 implies around 40 million new CBA shares are to be issued to retail investors, equating to 2.4 per cent of the total CBA shares outstanding at present. If retail investors do not take up their entitlements due to increased uncertainty, this could leave the underwriters with a significant amount of stock to on-sell into the market from 9 September.
But that’s not the end of the story. Under the underwriting agreement, the underwriters have the right to tear up the agreement if the ASX 200 index falls more than 12.5 per cent from its closing level of 5473 on 11 August on two consecutive days between 24 August and 8 September. While the ASX 200 is currently 8 per cent above this level of 4789, given the volatility in global markets over the last week, it is not impossible to believe that this clause could get triggered.
In this eventuality, CBA is likely to be forced to reprice the transaction in order to raise the necessary capital resulting in increased EPS dilution.
It must also be remembered that this is likely to be only the first of many increases in capital adequacy requirements for the major banks over the next few years, with the final outcome of Basel 4 expected to further raise mortgage risk weights and APRA yet to finalise the level of core equity tier 1 capital the major banks will be required to hold to meet its as yet undefined measure of ‘unquestionably strong’. The major banks will be keen to see these raisings perform well in case additional raisings are required down the track.
Stuart Jackson is a Senior Analyst with Montgomery Investment Management. To invest with Montgomery domestically and globally, find out more.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
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tony
:
Opps
I suspect i will join the rest of the retail side and pass on this offer having sold my ANZ shares the day before the halt and let the dust settle. CBA raising was reported to have been a failure
tony
:
Hi Roger/Stuart
Thanks
Sophisticated investors laws which i hate might have saved me a few dollars.
tony
:
Why don’t the underwriters just let people with the required application apply for more than the $15,000 then scale it back if necessary. ?
That way there wont be a large amount of shares to dump back on market assuming retail investors don’t apply
Roger Montgomery
:
Interesting Tony. I think there would be an even larger amount to dump on the market.
Stuart Jackson
:
Hi Tony, the reason why this doesn’t occur is a regulatory one. Company’s use SPPs in order to allow retail investors (those that are not designated as sophisticated investors) to participate on capital raisings without having to provide the full prospectus required under a rights issue. The low documentation routes to equity raisings (ie institutional placements and SPPs) significantly reduce the cost of raising new capital, and can be completed far more quickly. However, regulations prevent SPPs from raising more than A$15,000 from any one retail investor. If CBA wanted to allow retail investors to acquire more than A$15,000 worth of new shares, it would have to undertake a full rights issue.
Aaron Somner
:
Hi Stuart. My question is what tier 1 instrument do the big 4 prefer to hold. Do they hold bonds and if so which nation? Thanks Aaron.
Stuart Jackson
:
Hi Aaron, the capital adequacy changes largely refer to common tier 1 equity (CET1). This is essentially just equity (ie shares). Other less onerous measure of Tier 1 and Tier 2 equity measures will also include hybrid debt and other equity based instruments. Bond holdings are not included in these types of capital adequacy ratios.