In light of the ongoing COVID-19 impacts, in late March and early April, European and Australasian regulatory authorities took various actions which either strongly pressured or outright blocked the payment of ordinary dividends in these stressed times.
Below we chronologically summarise the announcements and conclude on the likely impact to Australian Additional Tier 1 instruments.
European Central Bank
On Friday 27 March 2020, the European Central Bank (ECB), as part of its response to the coronavirus crisis released an announcement that it “considered it appropriate that significant credit institutions (banks) refrain from making dividend distributions and share buy-backs aimed at remunerating shareholders”.
The ECB’s purpose in the above is to conserve the capital held by such entities that they can retain their capacity to support the real economy through lending and to absorb losses where they arise rather than make discretionary capital actions. The ECB’s Recommendation lasts until at least 1 October 2020.
Bank of England
The UK’s Prudential Regulatory Authority (PRA) was quick to follow suit. On Tuesday 31 March 2020, it published a statement welcoming the decisions by the boards of the seven large banks it wrote to in agreeing to similar action on ordinary shares for the remainder of 2020 and the cancellation of payments of any outstanding dividends from 2019. The PRA also expects banks not to pay cash bonuses to senior staff (including material risk takers) and is confident that boards are already considering the accrual, payment and vesting of variable remuneration over coming months.
Reserve Bank of New Zealand
Not to be outdone, on Thursday 2 April 2020, the Reserve Bank of New Zealand (RBNZ) announced a Term Lending Facility (TLF) to help support its local banking system.
As part of this, and other recent initiatives, the RBNZ has agreed with local banks that during the current period of economic uncertainty, there will be no payment of dividends on ordinary shares and they should not redeem non-CET1 capital instruments.
No timeframe of the length of the above restrictions was formally given, only that they may be revised when the economic outlook has sufficiently recovered.
The New Zealand regulator (the same RBNZ) has been quite proactive over the last year in formulating much higher local capital requirements (mostly CET1) for its locally incorporated entities.
Unfortunately for New Zealand’s regulator, the parent entities of each of its four largest banks are of course Australian, with the potential to upstream dividends (and which can flow offshore).
Each of the Australian major banks noted this action would only affect them on a Level 1 basis (which excludes offshore subsidiaries) with Level 2 capital measures unaffected (which includes offshore subsidiaries).
ANZ noted the announcement and confirmed it will prevent it from redeeming its NZ$500 million Capital Notes on 25 May 2020, but that it is able to continue to make interest payments on them.
ANZ also took the opportunity to remind the market that the terms of the Capital Notes also provide for their conversion into a variable number of ordinary shares in May 2020 or May 2022. Conversion would result in an equivalent increase in ANZ's CET1 capital of ~12 basis points on a Level 2 basis.
NAB’s only external capital instrument is the BNZ Subordinated Notes, issued in December 2015 with a first optional call date on 17 December 2020. Perhaps anticipating the RBNZ action will be reversed by then, NAB has not yet made the decision not to call but reminds investors that should BNZ choose to redeem, this is subject to approval of both APRA and the RBNZ, which should not be assumed.
Australian Prudential Regulatory Authority
Following the RBNZ announcement, initial media reports quoted an unnamed APRA spokesman who stated that banks would be able to make their own decision on dividends and the Australian Prime Minister, Scott Morrison, was recorded as confirming that the issue was being examined by the Council of Financial Regulators but that no advice on preventing dividends had yet been given.
Late on Tuesday 7 April 2020, APRA released a formal letter that it had written to all authorized ADIs and insurers (including life, general and health) on capital management.
Unsurprisingly (aside from the somewhat late timing), APRA took a middle path, essentially verifying the early reports and which affords some discretion on the part of such entities’ Boards.
During the period of the COVID-19 disruption, APRA expects that all ADIs and insurers will:
- take a forward-looking view on the need to conserve capital and use capacity to support the economy;
- use stress testing to inform these views, and give due consideration to plausible downside scenarios (periodically refreshed and updated as conditions evolve); and
- initiate prudent capital management actions in response, on a pre-emptive basis, to ensure they maintain the confidence and capacity to continue to lend and support their customers.
APRA expects that ADIs and insurers will seriously consider deferring decisions on the appropriate level of dividends until the outlook is clearer.
Even where a Board is confident that it is able to approve a dividend in this time, robust stress testing results will have to be discussed with APRA and any dividend should be at a materially reduced level. Dividend payments (cash leaving the ADI) should be offset to the extent possible through the use of dividend reinvestment plans (DRPs) and other capital management initiatives.
Hybrid Impacts
Whilst not explicitly stated in the release we believe that, in-line with offshore regulatory stances, the discretionary payments of AT1 distributions will not be directly affected by APRA’s announcement. Individual ADIs may, of course, at their own discretion, decide not to make such distributions. However, on balance, taking into account the much smaller relative magnitude of AT1 payments and the common (ordinary) dividend stopper feature, we expect AT1 distributions to still be made and we expect minimal change to local hybrid assumptions, but note the below:
- If our assumptions are correct, this is a positive for AT1 investors but which then puts hybrid distributions next in line for regulatory pressure should problems persist.
- APRA may prevent the redemption of capital instruments, which would have a clearly adverse impact on some securities, particularly those close to their optional call dates.
- The RBA’s $90 billion term funding facility offers a very cheap source of funds for ADIs. Up to 3% of outstanding credit may be obtained initially with further funding available if they increase lending to business, especially SMEs. The negative here though is that these counterparties typically have much higher risk weights and loan books tilting towards SMEs would likely depress regulatory capital levels a little.
- Franking %’s for some AT1s (eg ANZ’s & MQG’s) may (transiently) rise closer to 100%.
