Is executive pay behind CBA's capital raising?

After announcing the largest-ever profit by an Australian bank, CBA (ASX:CBA), like ANZ and NAB before it, yesterday also notified investors of a rights issue of $5bn.

This unusual. A company that makes $9.1bn doesn't normally hit investors up for another $5bn in a capital raising. But this is the Australian banking sector, where things are never quite what they seem.

Companies usually announce capital raisings when they're in financial trouble or are on the cusp of a substantial takeover.

Australia's banks, all of which are announcing near-record profits and large capital raisings, face neither of these things. What's going on?

The simple explanation is that APRA, the financial regulator, is demanding that banks increase the level of capital they hold so they can better withstand a financial crisis. APRA wants the banks to lower their leverage by increasing their capital ratios to get them into the top quartile of international banks.

The more detailed explanation is more complex.

CBA could retain the $9.14bn in pre-tax profit away and keep the regulators more than happy. Instead, it's passing the hat around for another $5bn.

Seen as a safe haven for investors getting out of low yield term deposits and into higher yield bank shares, the banks have led the rush to yield. Despite recent falls, CBA's share price is still up 11% in the last two years, as well as paying a juicy yield along the way.

The bank's board knows this all too well, which is probably why it has opted to raise capital to strengthen its balance sheet rather than retain profits.

To do otherwise would spring a nasty surprise on investors – a reduction in that lovely dividend or cancellation of it altogether.

Now, there's a powerful argument that long term retail investors should welcome the temporary cancellation of the bank's dividend.

Raising capital is expensive and there's often a dillutionary effect because the big end of town tends to get preferential treatment at retail investors' expense, although that's not the case with CBA's issue, which is renounceable. Still, the argument about short term pain for long term gain is a good one.

But one interest group would be even less pleased to see dividends cut than shareholders – the bank's management team.

Their long term incentive scheme is heavily weighted towards what is known as total shareholder returns (TSR), which is the performance of CBA's share price over the given period of the scheme, plus - you guessed it – dividends paid to shareholders.

Had CBA's board cut or cancelled the dividend this would have had a big negative impact on TSR, producing a nasty share price fall and a reduced dividend.

That would have made it harder for bank executives to reach their Long Term Incentive targets, which can double already pretty high incomes.

Now shareholders are being asked to engage in the odd charade of receiving money in dividends and then being asked to give it back through a capital raising.

That might seem strange to you and me but not to CBA's management.