Australia's Bank Bonds Punished on Housing Bubble Concern: Credit Markets

Investors in U.S. dollar-denominated bonds issued by Australian banks are demanding higher relative yields on concern the country’s property market is overheating.

The spread between Australia & New Zealand Banking Group Ltd.’s $500 million of 2.4 percent three-year notes and similar- maturity Treasuries widened to 109 basis points from an 87.5 basis-point issue price in January, according to Royal Bank of Scotland Group Plc. The cost of credit-default swaps tied to Melbourne-based ANZ and its three largest peers jumped at least 71 percent since the sale, outpacing the benchmark Australia Markit iTraxx index’s 55 percent increase, CMA prices show.

House values in Australia surged 18.4 percent this year, causing Nobel-winning economist Joseph Stiglitz to say this month that the nation’s property inflation gives “cause for concern.” Westpac Banking Corp., National Australia Bank Ltd., Commonwealth Bank of Australia and ANZ accumulated A$798 billion ($710.1 billion) of mortgage debt, almost 66 percent of their combined loans, according to their banking regulator.

“We don’t have the same type of bets on we would have had four years ago,” said Tom Farina, a director at Deutsche Insurance Asset Management in New York, who helps manage $188 billion. While Australian homeowners may not be facing a U.S.- style meltdown, “we’re certainly hitting some lofty leverage levels from a valuation perspective,” he said.

Photographer: Jack Atley/Bloomberg

Sydney harbour side residences stand in the suburb of Kirribilli, in Sydney. Close

Sydney harbour side residences stand in the suburb of Kirribilli, in Sydney.

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Photographer: Jack Atley/Bloomberg

Sydney harbour side residences stand in the suburb of Kirribilli, in Sydney.

Four Pillar Banks

The so-called Four Pillar banks, named for a law that forbids them from merging with each other, have raised more than $102.5 billion from bonds in the U.S. currency since the start of 2008, or about 46 percent of their total sales, Bloomberg data including issues by units show.

The lenders, facing regulatory reforms that favor long-term capital over short-dated funding, may need to sell A$162 billion of bonds in the 2011 financial year, 80 percent more than their annual average for the five years to 2007, Morgan Stanley analysts led by Viktor Hjort said last month.

Elsewhere in credit markets, the extra yield investors demand to own global corporate bonds rather than government debt rose. The cost to protect company bonds from default in the U.S. and Europe increased and Stanley Black & Decker Inc., the biggest U.S. toolmaker, plans to sell $400 million of 30-year bonds.

Global company bond spreads widened 1 basis point to 179 basis points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate index. The gap increased 2 basis points this month and is 3 basis points higher from Dec. 31. Yields fell to 3.478 percent from 3.751 percent on July 31.

Markets Faltered

The bonds returned 1.96 percent in August, the best monthly performance since July 2009, according to Bank of America Merrill Lynch index data, as equity markets faltered amid signs the economic recovery may be stuttering. The debt gained 1.47 percent in July, according to the index.

The Markit iTraxx Crossover Index of credit-default swaps tied to 50 mostly junk-rated European companies climbed 7.5 basis points to 532.5 as of 1:12 p.m. New York time, according to Markit Group Ltd. The index has risen 53.2 basis points this month.

A benchmark gauge of U.S. corporate credit risk rose to almost a two-month high even as confidence among U.S. consumers rose more than forecast in August, a sign the biggest part of the economy may avoid a slowdown that would derail the recovery.

The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, climbed 0.7 basis point to a mid price of 114.1 basis points, according to Markit. It earlier rose to 115.18 basis points, the highest since July 7.

Confidence Index

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements, and an increase signals a deterioration in investor perceptions of credit quality. A basis point on a contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.

The Conference Board’s confidence index increased to 53.5 from a five-month low of 51 in July, figures from the New York- based private research group showed today. The median forecast of economists in a Bloomberg News survey was for a 50.7 reading.

For the year, corporate bonds have returned 8.63 percent versus 6.17 percent for global government debt. The MSCI World Index has lost 5.5 percent including reinvested dividends.

Stanley Black & Decker plans to sell the 30-year bonds in its first fixed-rate debt offering since being formed in March through a merger.

Black & Decker

The bonds, set to be sold as soon as today, may yield 165 basis points more than similar-maturity Treasuries, according to a person familiar with the transaction, who declined to be identified because terms aren’t set. Proceeds may be used to reduce borrowings, the New Britain, Connecticut-based company said today in a regulatory filing that didn’t specify the size, maturity or timing of the sale.

The company, created by Stanley Works’ acquisition of Black & Decker Corp., is marketing debt after boosting its annual profit forecast in July to $3.35 to $3.55 a share from $3.10 to $3.30. The senior unsecured notes will be guaranteed by Black & Decker, according to the filing.

Loan prices fell for the month, with the Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index declining 0.31 cent to 89.34 cents on the dollar. Loans have returned 3.85 percent in 2010, based on the index, which tracks the 100 largest dollar- denominated first-lien leveraged loans.

Leveraged loans and junk bonds are typically rated below Baa3 by Moody’s Investors Service and lower than BBB- by S&P.

Household Debt

Spreads on bonds issues by Australian financial companies have widened to 215 basis points on average from 209 on June 11, while the gap for bonds issued by similar borrowers around the world has narrowed to 224 from 256, according to Bank of America Merrill Lynch index data.

Home prices in the most populous cities of Melbourne and Sydney climbed 24 percent and 21 percent in the year to June as Australia continued almost two decades of uninterrupted economic growth, statistics bureau data show.

Australia’s ratio of household debt to disposable income was 157 percent as of March 31, central bank data show. It was 133 percent in the U.S. before the housing collapse began in 2007, according to the Federal Reserve Bank of San Francisco.

“I’m not persuaded by arguments that houses are sustainably priced, I’m not persuaded by the view that debt is not a problem, and I’m not persuaded that policy-makers could prevent collateral damage to banks,” Gerard Minack, chief strategist for global developed markets at Morgan Stanley’s Australian unit, wrote in an Aug. 17 report. “Dodging the worst of the global financial crisis didn’t demonstrate that there’s no bubble, in my view it just showed we dodged the prick.”

Housing Slowdown

Rising borrowing costs are a “revenue headwind” and may remain inflated for 18 months, Gail Kelly, the chief executive officer of Sydney-based Westpac, said when the lender reported quarterly earnings this month. They will be “permanently” higher, said Mike Smith, ANZ’s CEO.

Omega Global Investors Pty Ltd., a fund management firm based in Melbourne, bought Macquarie Group Ltd. bonds in July and August from U.S. and European investors concerned about a housing slowdown, according to Investment Director Mat McCrum.

“Australia’s increasing population and limited supply make the market very different from the U.S. and Europe,” McCrum said in a telephone interview.

Home Prices

Australia, a nation of 22.4 million, faces a housing shortage and needs to build about 420,000 more homes in the next decade than it did in the last, according to Harley Dale, chief economist at the Canberra-based Housing Industry Association.

The median cost of an urban home was A$465,000 in July, research by real estate monitoring company RP Data show. The median price of a new home sold in the U.S. that month was $204,000, while sales unexpectedly dropped to the lowest on record, according to Commerce Department data published Aug. 25.

National Australia Bank priced $1.25 billion of three-year, 2.5 percent bonds in January to yield 87.5 basis points more than Treasuries. The spread has since widened to 105 basis points, according to ANZ.

The extra yield investors demand to own Westpac’s $2 billion of five-year notes instead of Treasuries widened to 144 basis points yesterday from 137 basis points when sold on July 26, Citadel Securities prices show. The spread on Commonwealth Bank’s $1 billion of 5 percent 2020 notes sold in March surged 27 basis points this month to 158, according to ANZ.

‘Attractive Banks’

Investor demand for corporate debt globally will support Australian bank bonds, said Mark Kiesel, global head of corporate bond portfolio management at Pacific Investment Management Co. The Newport Beach, California-based firm oversees the world’s biggest bond fund and is among the largest holders of Australian bank debt.

While that may benefit the securities, “when we look around the world, the most attractive banks from a valuation perspective are U.S. and U.K. banks,” he said.

Investors have allocated $480.2 billion into debt mutual funds in the two years ending in June, according to data compiled by Bloomberg and the Washington-based Investment Company Institute.

Bank of America Corp., rated three grades lower than ANZ at A by Standard & Poor’s, priced $1.5 billion of five-year bonds on Aug. 17 to yield 230 basis points more than Treasuries, according to Bloomberg data.

Similarly-rated RBS, the U.K.’s biggest state-owned bank, sold $1.5 billion of 2013 notes at a 265 basis point spread, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

To contact the reporters on this story: Sarah McDonald in Sydney at smcdonald23@bloomberg.net; Shannon D. Harrington in New York at sharrington6@bloomberg.net

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