But this is the story of two markets, where things are getting more and more confusing.
Which brings us to a running key, launched by APRA’s new president, John Lonsdale. His first act as head of the prudential regulator was to write to banks and insurers and explain his position on “uneconomic calls” in the bond market.
The prudential regulator approves all new bank fundraisings and approves all capital repayments and refinancings. But he is mildly irritated that banks are asking for permission to issue new capital at increasingly expensive rates to refinance existing capital as call dates approach, but pay lower yields.
The reason banks and insurers redeem Tier 1 and Tier 2 bonds on their call dates is simply because it has always been done and capital providers have a strong expectation that barring systemic catastrophe , they get their money back. This expectation does not sit well with APRA.
“This suggests a misalignment of expectations between regulators and investors,” incumbent chairman Wayne Byres said in his final speech last month, shaking bond investors.
To take a step back, the purpose of these tier one and tier two bonds is to provide a layer of protection for depositors if banks run into trouble.
This is done through various features such as the ability to stop distributions or convert them to shares (or be written off at zero) in the case of Tier 1 bonds.
In the case of Tier 2 bonds, issuers may extend the redemption period beyond redemption dates to preserve capital in place to absorb losses before depositors.
These characteristics make depositors’ funds safer but, in doing so, increase the risks of level one and level two securities.
This is why there is an eternal tension between APRA, who want these securities to perform as they should, and the banks, who want to convince investors that these securities are safe and should therefore charge a low cost of funds.
That tension arose with Byres’ comments in October and intensified this week when his successor, Lonsdale, wrote to the banks to further clarify the issue of unprofitable calls, which he says have become more frequent as financing costs were rising.
Institutions that raise new capital or refinance notes face steep cost increases – Challenger and AMP are an example of this, as both entered into new Tier 2 deals to refinance securities on their first call date .
Call economy
As Byres mentioned, these institutions are meeting their first call date because there is a strong expectation that they, and the wider Australian market, will be punished if they choose not to.
New APRA President John Lonsdale wrote to the banks this week. Christopher Pearce
But APRA thinks that expectation undermines the role of equity securities which are meant to be flexible and have features that can and should be used.
“A logic based solely on exercising appeals to maintain access to capital markets, or limit reputational damage, would undermine the permanence and quality of capital that prudential standards seek to maintain,” the letter states. of Lonsdale.
The letter merely reaffirmed APRA’s current position, but it triggered a mini-sale of Tier 2 bank bonds.
The fear is that some banks will be told to extend their securities beyond their buyback dates, which could alter expectations and undermine confidence.
It’s tough talk from APRA, but will anything change? Most expect not. Banks and insurers will, for the most part, be allowed to refinance their equity securities even if the cost of funds is significantly higher. Indeed, the nature of these securities means that it becomes economical to refinance them in a short time.
And more importantly, Australian banks are still in the process of building their Tier 2 capital buffers in accordance with the APRA guideline.
The letter reminds us that when it comes to equity securities that provide a layer of systemic insurance, the prudential regulator is faced with a paradoxical balancing act.
That is, it must inspire enough confidence in the system for financiers to provide that assurance, but enough paranoia for APRA to not hesitate to enforce its terms.
