Kangaroo Sales Dry Up as Regulator Bars Bonds: Australia Credit

Sales of bonds by top-rated overseas borrowers in Australia have evaporated following a record start to 2011 after the nation’s banking regulator ruled they don’t qualify under new international capital rules.

The World Bank, Germany’s Kreditanstalt fuer Wiederaufbau and other supranational and agency issuers have avoided the kangaroo bond market since the Australian Prudential Regulation Authority said Feb. 28 their notes can’t be considered liquid assets under Basel Committee on Banking Supervision rules. The AAA rated securities represented 27 percent of new bond sales in Australia in 2010, according to data compiled by Bloomberg.

APRA’s decision spurred the nation’s banks to purchase federal and state government securities that do qualify, pushing Australian sovereign yields to the lowest in two months. The 10-year government bond has fallen 5 basis points since the guidelines were announced, while the extra yield investors demand to own New South Wales state debt instead of government notes is at a record low.

“Supranationals were potentially the most attractive asset for bank liquidity books,” said David Plank, Sydney-based head of research at Deutsche Bank AG. “Since APRA’s decision to leave them out, semi-governments are now the default asset of choice.”

Sales of kangaroo bonds, or Australian dollar notes issued by overseas borrowers in the nation, surged 88 percent to a record A$37.3 billion ($37.8 billion) last year. Borrowers were drawn to the market by swap rates that cut funding costs once proceeds were exchanged into U.S. dollars. Bank demand for top-rated kangaroo notes rose on anticipation they would meet global capital requirements.

Basel Requirements

Under Basel rules coming into force by 2015, banks must hold enough assets that can be converted into cash to meet their needs for 30 days in a sudden crisis. APRA announced last month that only sovereign and semi-government bonds were traded in sufficiently “large, deep and active markets” to meet the criteria.

The ruling was “surprising,” said Eila Kreivi, head of funding at Luxembourg-based European Investment Bank, the third-largest issuer of kangaroo bonds last year at A$5.45 billion. “I would not agree that our bonds are not liquid enough,” she said in an e-mailed response to questions.

Some state governments have less debt than EIB and their notes aren’t traded as much in the secondary market, she said. EIB has A$18.5 billion of kangaroo bonds outstanding and last sold the notes on Feb. 23, according to data compiled by Bloomberg. Australia’s Tasmania state owes A$3.3 billion in domestic bonds, according to its website.

The regulator’s ruling caused yields on kangaroo bonds sold by some supranational issuers to rise relative to similar-maturity government debt.

Borrowing Costs

The spread on EIB’s A$3.1 billion of 6.5 percent August 2019 notes widened to as high as 112 basis points on March 3 from 96 basis points on Feb. 25 and was at 100 on March 11, according to Australia & New Zealand Banking Group Ltd. prices. Relative yields on the 5.75 percent October 2019 notes issued by the World Bank’s International Bank for Reconstruction and Development widened to 82 basis points on March 3 from 66 and were last at 68, ANZ prices show.

Heike Reichelt, a spokeswoman for the Washington-based World Bank, declined to comment on APRA’s decision.

At the same time, borrowing costs are falling for state governments. Spreads on New South Wales’ A$3.7 billion of 6 percent bonds due in 2016 have narrowed 9 basis points since Feb. 25 to 34, the lowest on record, ANZ prices show. Bonds issued by Queensland state and due the same year yield a spread of 42 basis points more than benchmarks, the narrowest this year, according to ANZ prices.

Debt Burden

Banks were drawn to AAA rated kangaroo bonds to strengthen their balance sheets because there is so little Australian government debt available.

The sovereign burden of A$184 billion is 22 percent of gross domestic product, compared with 59 percent in the U.S., Bloomberg data show. The government says it is committed to delivering a surplus in the financial year ending June 30, 2013, as the country’s biggest resources boom in a century spurs growth.

The Reserve Bank of Australia has responded to the shortage of government bonds outstanding by offering lenders contingency loans to help them meet the liquidity requirements. Debt sold by supranational issuers, bank bonds rated A- or higher and AAA rated mortgage bonds are among securities that can be used as collateral to access the facility, for a fee that has yet to be determined, according to the RBA.

Economic Growth

The central bank, which raised borrowing costs seven times from October 2009 to November last year, is forecasting a 4.25 percent economic expansion in 2011, the biggest annual increase since 1999.

The yield on Australia’s 10-year government bond fell 10 basis points last week to 5.48 percent, the lowest since Jan.

11. Yields on similar-dated Treasuries declined to 3.4 percent from 3.49 percent.

The Australian dollar climbed 11 percent in the past 12 months against the greenback, the third-best performance among major currencies tracked by Bloomberg. It ended the week unchanged at $1.0138.

The five-year Australian dollar basis swap rose 5.5 basis points to 27 basis points, the highest this year, after the APRA ruling and was at 22 on March 11, according to data compiled by Bloomberg.

Basis Swap

The swap measures the cost of switching interest based on the London interbank offered rate for payments linked to Australia’s bank bill swap rate. It falls when overseas borrowers sell debt in Australia and seek to swap the proceeds for U.S. dollars, and rises when Australian issuers make the opposite transaction. Libor is the rate banks charge to lend to each other.

It will be “challenging” to match bond sale sizes that were achieved before the ruling, said the EIB’s Kreivi. “We might see smaller deal sizes in the future.”

Stefan Goebel, head of treasury at Landwirtschaftliche Rentenbank, Germany’s development agency for agribusiness, agreed.

“I would expect smaller new issue sizes and a slower process to build up a liquid line while taps of already large issues may be less affected,’ Goebel said by e-mail.

Frankfurt-based Rentenbank issued A$2.15 billion of kangaroo bonds in 2010 and last sold the securities on Feb. 9. Supranational bond issues this year averaged A$407 million, Bloomberg data show.

‘‘The slowing of primary activity is clearly a reflection of the recent APRA guidelines, which the market had expected to include some of the supranational borrowers,’’ said Dean O’Hara, Sydney-based head of fixed income syndicate at UBS AG. ‘‘The immediate response by some investors was to move to the semi-government sector.’’