Shockingly corrupt APRA releases bank dividends

So shockingly predictable (if you’ll pardon the oxymoron):

The Australian Prudential Regulation Authority (APRA) has updated its capital management guidance for banks and insurers, in particular easing restrictions around paying dividends as institutions continue to manage the disruption caused by COVID-19.

APRA’s updated guidance replaces its recommendation in April this year that banks and insurers “seriously consider deferring decisions on the appropriate level of dividends until the outlook is clearer”.

Uncertainty in the economic outlook has reduced somewhat since then, and APRA has had the opportunity to review banks’ and insurers’ financial projections and stress testing results. Taking these and other developments since April into account, APRA has today written to banks and insurers advising they should maintain caution in planning capital distributions, including dividend payments.

In additional guidance for the banking sector, APRA has indicated that for the remainder of the calendar year boards should:

• seek to retain at least half of their earnings when making decisions on capital distributions (and utilise dividend reinvestment plans and other initiatives to offset the diminution in capital from capital distributions where possible);
• conduct regular stress testing to inform decision-making and demonstrate ongoing lending capacity; and
• make use of capital buffers to absorb the impacts of stress, and continue to lend to support households and businesses.

APRA Chair Wayne Byres said the updated guidance balanced the need for banks and insurers to keep supporting households and businesses, while also maintaining a prudent approach in the face of a very sharp and severe economic contraction.

“Today’s announcement strikes a balance in recognising the strength of the financial system, while at the same time acknowledging the difficult path ahead,” Mr Byres said.

“Although the environment remains one of heightened risk, we now have a stronger sense of how Australia’s economy and financial institutions are being impacted by COVID-19. On that basis, APRA believes that banks and insurers do not need to continue to defer capital distributions, provided they moderate payments to sustainable levels based on robust stress testing, and continue to prioritise supporting their customers and the economy.

“In the current environment, banks face additional challenges to their capital resilience, including the material volume of loan repayment deferrals (which are subject at present to regulatory concessions), greater financial impact from COVID-19, and restrictions on dividends from their New Zealand operations. APRA has therefore set an expectation that dividend payout ratios for ADIs will be maintained below 50 per cent for this year.”

APRA’s letter to ADIs also highlights the importance of utilising current capital buffers to absorb losses and meet the needs of customers.

“The years spent building up the capital strength of Australia’s banking sector to historical highs have been precisely for a time such as this. Further, APRA is committed to ensuring any rebuild of capital buffers, if required, will be conducted in an orderly manner,” Mr Byres said.

The only reason the banks were prevented from issuing dividends was the public support that they are receiving to stay afloat. The economic outlook is irrelevant except to that extent.

Has the public support stopped? Ask the Lunatic RBA:

Another initiative from the Bank was the Term Funding Facility to lower borrowing costs and support lending, particularly to businesses. The TFF does this by providing a guaranteed source of funding to ADIs for 3 years at the low cost of 25 basis points, with an incentive to increase lending to businesses, especially small and medium-sized enterprises (SMEs). Funds provided under the TFF are secured against collateral, as is the case with the Bank’s other facilities.

The TFF provided banks with the option of an initial allowance of around $90 billion. This has since grown to around $150 billion, with additional allowances granted to individual banks that have increased their lending to businesses since the facility began in April.

Take-up of the TFF is currently around $26 billion, or around 17 per cent of the total currently on offer (Graph 7). There are a few reasons why banks have not taken up more of this funding at this stage in the program. One is simply that many banks have accessed even cheaper funding from other sources in recent months, albeit at shorter tenors than three years. In particular, banks have been able to issue bank bills at rates below 25 basis points. Similarly, bank deposits have grown, and an increasing share of deposits have been paying rates below 25 basis points. Also, the TFF provides funding for three years from the date of the drawdown, so the longer an ADI waits to draw funds, the later they will have to repay the money. With no pressing funding need right now, and ample alternative short-term funding at low cost, delaying the drawdown is a useful option.

The calculus underpinning the decision of some banks to delay drawing on their initial TFF allocations will change closer to the deadline of 30 September. At that time, it will make sense for banks to compare the certain 25 basis point cost of the TFF with the uncertain cost of other sources of funding over the next three years, including bonds that would mature over that period. So our expectation and liaison with the banks suggest that the take-up of the TFF will ramp up as we get closer to the end of September.

Despite only part of the funding being drawn down to date, it’s worth noting that the TFF – combined with the Bank’s other policy measures – has already had a significant impact. On the funding side, the ability to draw on the TFF means that banks can be selective in how they raise money, and this has contributed to overall bank funding costs falling by around 60 basis points since February. And on the lending side, we have seen interest rates on new fixed-rate mortgages fall by around 65 basis points since February, and rates on SME loans fall by around 60 basis points.

Private Sector Fixed Income Markets

I now want to turn my attention to what all of these developments imply for private sector fixed income markets.

Like government bond markets, private sector fixed income markets also became dysfunctional in March. These markets were significantly disrupted for a time as concerns and uncertainty about the economic and financial effects of the pandemic rose sharply. Issuers typically try to avoid going to market with new bonds at such times, given the very high premiums demanded by investors, particularly if they have the option of waiting because they are already well funded or have other funding options. However, with the aid of monetary and fiscal policies, it did not take too long for financial conditions to settle and fixed income markets to ‘reopen’. Issuance though has varied considerably across different types of issuers.

The major banks have let their existing bonds mature without replacement, so their issuance has declined in net terms, and they have not issued any residential mortgage-backed securities (RMBS, Graph 8). This is not surprising given a number of forces at work. First, with credit growth likely to remain low or even decline, their funding needs will remain modest for a time. Second, they had issued quite a lot of bonds prior to the pandemic and have subsequently found themselves flush with other sources of funding, including low-cost deposits. While those sources do not have the same maturity profile as longer-term bonds, they lessen the need for near-term issuance. And third, they have the option of accessing funds from the TFF at a cost of 25 basis points, while the cost of a newly issued bond of similar maturity is around 30-60 basis points (based on secondary market prices in recent weeks).

In short, pubic support is growing and the RBA is egging the banks to get ever more of it.

Shut APRA. It is corrupt beyond repair.