Australian Bank Profitability Seen at 2009 Lows on Capital

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Australia’s biggest banks may see a key measure of profitability drop to the lowest level since 2009 as fresh regulatory measures to shore up the financial system force lenders to hold more capital.

The lenders’ average return on equity could fall to 14.5 percent by 2017 from 15.6 percent in their latest fiscal years, according to the mean estimate of five analysts surveyed by Bloomberg in the wake of new rules announced the past week by the Australian Prudential Regulation Authority.

To avoid the drop, analysts say banks from Commonwealth Bank of Australia to National Australia Bank Ltd. will need to lower expenses, raise mortgage rates or reduce the interest paid on deposits -- a challenging prospect with borrowing costs at a five-decade low and banks discounting to win customers.

“The question is how do they do that,” said Omkar Joshi, a Sydney-based investment analyst at Watermark Funds Management. “The repricing of mortgages and deposits is not going to be easy and as such they should prepare to cut costs or cede ROEs.”

The banking regulator said last week Australia’s biggest lenders would need to increase capital by 2 percentage points to be ranked among the world’s safest banks. On Monday, APRA ruled they must hold more capital against potential losses on home loans, with the average risk weight on residential mortgage exposures rising to at least 25 percent next year from the current 16 percent.

The four largest lenders may need to boost capital levels by at least A$28 billion, according to Goldman Sachs Group Inc. to Credit Suisse Group AG.

Higher Rates

The return on equity estimates are based on the 25 percent risk weight, and the assumption that common equity Tier 1 capital ratios will rise to at least 10 percent under revised APRA guidelines, from the current 8 percent.

The last time the banks’ cash return on equity, which is based on cash profits that exclude one-time items, was lower than the 14.5 percent projected for 2017 was in 2009, when it averaged 13.5 percent for Commonwealth Bank, National Australia, Australia & New Zealand Banking Group Ltd. and Westpac Banking Corp., according to regulatory filings.

Lenders may need to raise mortgage rates by 10 to 20 basis points as they seek to pass on the costs of raising capital, according to the range of estimates from the five analysts in the Bloomberg survey.

Westpac’s Chief Financial Officer Peter King said Monday the cost of holding more capital come at a cost and “will inevitably be borne by customers and shareholders.”