Australian regulator’s capital calls stance won’t affect instrument ratings

Written by Michael Griffiths

07/11/2022

Fitch Ratings has stated that the Australian Prudential Regulation Authority’s (APRA) stance on capital calls will not affect instrument ratings.

The credit rating agency said that APRA’s latest letter to reinforce expectations on capital calls for insurers and banks would not change its view on the Additional Tier 1 (AT1) and Tier 2 (T2) capital instruments issued by Australian entities.

However, Fitch said it does believe the restrictions may “carry implications” for the pricing of such capital instruments, especially for cases where investors have factored in a high probability of the issuer exercising call options.

APRA’s letter on 1 November requires authorised deposit-taking institutions, which includes insurers, not to create any expectation for investors that a call will be exercised on AT1 and T2 instruments. This comes as global credit spreads have widened significantly over the past 12 months, resulting in the prospect of new capital instruments being issued at higher credit spreads than equivalent outstanding instruments.

Fitch stated that the letter is “consistent” with APRA’s existing prudential requirements that mandate its regulated entities to maintain a capital base of high quality, and a high degree of permanence. It added that the latter implies that issuers must not create any expectation that a call will be exercised.

“Such reinforcement of the existing capital requirements will not affect our view of AT1 and T2 instruments,” a statement from Fitch said.

“We take into consideration two key aspects when rating these hybrid securities – the level of subordination and what that means for expected recovery in a liquidation; and non-performance risk, which reflects the risk of investors facing a loss before a general default event for the issuer.

“Neither of these would change under the latest development. It will also not change our typical ‘regulatory override’ approach for insurers’ hybrid instruments that are afforded equity credit in Fitch’s Prism factor-based model.”

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