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Smash and NAB

7 May 2015 By Peter Thal Larsen

National Australia Bank has jumped out of the blocks in the race to raise capital. It is issuing shares worth A$5.5 billion ($4.4 billion) in the expectation that Australian regulators will soon force the country’s biggest lenders to fund themselves with more equity. Shoring up the industry before it runs into trouble makes sense. For investors, though, the era of supercharged returns is ending.

Australia’s banks have been braced for higher capital demands since a government commission last year recommended lenders should be in the top 25 percent when ranked against global peers. Last week, Australia’s chief bank regulator suggested the country press ahead with reforms “sooner rather than later”.

NAB has particular reasons to shore up its reserves. It’s eager to offload its underperforming UK unit. Buoyant investor demand for smaller British lenders has made an initial public offering of the business which owns the Clydesdale and Yorkshire banks possible. However, the UK regulator has demanded that NAB set aside 1.7 billion pounds ($2.6 billion) to cover future claims for mis-selling payment protection insurance and other products. Though actual demands for compensation will probably be much lower, NAB must deduct the contingent liability from capital.

The rights issue will boost NAB’s core tier 1 capital ratio to around 10 percent of risk-weighted assets, from 8.9 percent at the end of March. But the fundraising will also weigh on returns, knocking about 1.4 percentage points off the bank’s return on equity, which was an annualised 14.7 per cent in the six months to March.       

Chief executive Andrew Thorburn believes NAB can boost earnings by focusing on its home market. Yet even if the economy keeps growing, Australian banks can’t expand at the rate they managed over the past five years. Regulators are reining in mortgage lending, while bad loans are bound to rise from very low levels. With return on equity still in the mid-to-high teens and shares trading at multiples of between 1.7 and 2.6 times historical book value, it makes sense for Australia’s banks to issue fresh equity. But crisis-proofing the industry will mean future rewards for shareholders are far more pedestrian.


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