ANZ cooks up a capital solution

ANZ Banking Group’s $425 million buyback is another sign that the major banks have accepted that the current subdued settings for the sector aren’t going to change anytime soon.

While the buy-back is quite modest in the context of ANZ’s size, as was the earlier Westpac decision to pay a 10 cents a share special dividend, it is indicative of the newish recognition among the banks that the post-crisis environment in which they have been operating is likely to endure for quite some time.

The recent performance of the major banks has been driven by a combination of cost-cutting and falling impairment charges. That has enabled them to produce solid earnings growth and capital generation.

With all the banks already carrying strong levels of capital – the Australian system is as well capitalised as any in the world – and with some momentum left in the cost-reduction programs and their average funding costs finally starting to fall, they ought to be able to continue to generate excess capital.

Perversely, because writing new business tends to carry upfront costs, the low levels of demand for credit could also have a short-term positive impact on profitability.

In ANZ’s case, its buy-back will essentially offset the capital raised through its dividend reinvestment plan but it is likely that all the banks will contemplate capital management initiatives over the next few years because the weak demand for credit from both households and business means that they are generating more capital than they can profitably deploy.

Given the low levels of business and consumer confidence, the job shedding now occurring across the economy and the continuing increase in household savings, it isn’t likely that there will be a sharp rebound in consumer confidence.

If they want to avoid dilution of their performance statistics the banks will have to finesse their levels of capital.

They would also be aware that having soared to record levels earlier this year as investors – foreign and domestic – chased yield, their share prices have retreated sharply over the past month.

As discussed previously (Australia's banks are bleeding hot money, May 28), that appears to be due to an exodus of foreign investors, who had been chasing positive yields, exploiting the near costless funding available in the US and perhaps Japan.

The merest hint that the US Federal Reserve might begin tapering its $US85 billion a month of bond and mortgage buying punctured that trading strategy and forced the dollar well below parity as the foreign investors rushed for the exit.

Whether the continuing hunger among domestic investors for yield is satisfied by special or increased dividends or a reduction in capital bases, bank shareholders are keen to see any excess capital returned to them rather than sitting lazily on balance sheets.

The ANZ and Westpac initiatives aren’t major but perhaps provide a guide to what may become more routine behaviour from the banks while the environment of low credit growth persists: regular special dividends or buybacks to fine-tune their levels of excess capital and protect their returns and share prices until more buoyant times emerge.