A new capital security issued on Tuesday night by Westpac Banking Corporation (Westpac) has highlighted the lack of higher-yielding opportunities available for New Zealand-based investors.

Banks fund the loans they make from deposits, bonds and shareholders’ contributions.  In Australia, that’s also the order in which funds are repaid in the event of default.  To go into further detail, there’s also a class of securities that sit between shareholders’ funds and senior bonds; securities in this class are issued with various features under a range of names but, broadly speaking, they fall under the umbrella of ‘additional capital’.

Last week, the Australian Prudential Regulation Authority (APRA) finalised an amended requirement that Australian banks raise an additional three percentage points of total capital. It is expected this increase will take the form of additional capital, or more specifically, Tier 2 capital, ie coupon-paying bonds that are subordinated to senior bonds.

The Reserve Bank of New Zealand’s (RBNZ) view of Tier 2 capital stands in stark contrast to APRA’s.  Firstly, APRA requires Tier 2 securities to include a clause, known as a non-viability trigger, which requires that the securities are written off or converted into equity if APRA deems it appropriate.  In order for New Zealand dollar securities to be consolidated onto the parent bank’s balance sheet and count towards group Tier 2 capital, APRA requires a non-viability trigger.  The RBNZ is sceptical of non-viability triggers for several reasons, including its view that non-viability triggers may not be able to be implemented in a timely or practical manner to be able to save a bank from failure. The RBNZ has prohibited these securities as components of the regulatory capital stack.  Therefore, any Tier 2 securities issued in NZ ultimately become very expensive funding when considered at a group level.