Australian Covered Bond Boom Wanes as RMBS Sales Double

Australia’s covered bond boom is waning less than two years after the market started as yield-hungry buyers more than double purchases of residential mortgage-backed securities.

Issuance of the debt, backed by the borrower and mortgages that stay on its balance sheet, fell 64 percent to $9.9 billion this year, data compiled by Bloomberg show. The decline in Australian offerings outpaced a 41 percent slump from banks worldwide, according to the data.

Renewed appetite for RMBS, as the market recovers after being decimated by the 2008 U.S. subprime collapse, has seen sales surge while banks reserve covered-bond allowances for when market conditions worsen. Commonwealth Bank of Australia’s 2017 covered securities offered just 33 basis points more than swaps last month, compared with a 47 basis-point premium on shorter-dated unsecured notes sold by Westpac Banking Corp., Bloomberg-compiled data show. Global financial debt pays a 141 basis-point spread, Bank of America Merrill Lynch data show.

“We prefer the higher-yielding assets,” said Raymond Lee, a portfolio manager at Kapstream Capital in Sydney. “Funds like us that are targeting a certain yield will favor either AAA rated RMBS or AA senior-unsecured bonds from the big four banks over covered bonds, given the yield pick-up for the incremental risk.”

Sales of Australian RMBS, which differ from covered bonds in that they aren’t backed by the mortgage provider, jumped to A$11 billion ($10.4 billion) this year from A$4.4 billion in the same part of 2012, Bloomberg data show.

Weathering Turbulence

Commonwealth Bank, Westpac, Australia & New Zealand Banking Group Ltd. and National Australia Bank Ltd., known as the big four, also raised A$11.2 billion selling unsecured debt in their home market, from A$11.9 billion in the same period last year, according to the data.

Australian covered notes sold in Europe, where the securities were pioneered in 18th century Prussia, pay an average 1.41 percent, compared with 1.60 percent on other financial debt issued by the nation’s lenders in the currency, according to Bank of America Merrill Lynch indexes.

The bonds were first sold by Australian lenders in November 2011 after politicians, seeking to reduce bank funding costs, amended laws to allow the issuance. Because covered securities are typically rated AAA, they’re more attractive to investors when risk sentiment deteriorates.

The ability to sell the notes “has been critical in helping our financial institutions weather heavy market turbulence,” Australian government Treasurer Wayne Swan said in a speech last year.

Sales Slow

Westpac, the nation’s second-largest bank, more than halved covered debt issuance this year, data compiled by Bloomberg show. The lender priced A$2.1 billion of mortgage-backed securities in February, almost double its RMBS issuance in all of 2012, data compiled by Bloomberg show.

Australian banks can sell covered bonds up to a value of as much as 8 percent of their assets, limiting potential issuance.

Suncorp-Metway Ltd. has opted not to sell the securities this year, after raising A$2.2 billion in 2012. The Brisbane-based lender issued A$1.15 billion of RMBS in May.

“We’re still bearish on some markets overall so we want to keep our powder dry with the amount of covered that we’ve got left to issue,” said Tim Hughes, treasurer at the lender. “We’ll continue to look at diversifying our funding mix but, at this point in time, wouldn’t intend on issuing any covereds this year.”

Suncorp should have capacity to sell about A$1 billion of covered bonds from 2014, according to Hughes.

Narrow Spreads

While RMBS offer investors attractive spreads versus covered bonds, issuers are paying the least to sell such debt since the financial crisis. Commonwealth Bank, the nation’s largest lender, paid an 80 basis-point premium for a portion of the notes in February, the least since 2007, data compiled by Bloomberg show.

Premiums on unsecured financial bonds have also fallen. The average spread on Australian-dollar securities narrowed to 130 basis points more than government debt on May 29, the least since November 2007, Merrill Lynch indexes show.

“With spreads tightening, the differential between covered bonds and senior debt is becoming smaller,” said Sofie Sullivan-Becaus, Sydney-based executive director of securitized products at JPMorgan Chase & Co. “In more volatile markets, we would expect this differential to widen again and covered bond issuances to represent a larger portion of overall term issuance globally.”

Stimulus Concern

Federal Reserve Chairman Ben S. Bernanke said May 22 the central bank could slow the pace of asset purchases if officials see indications of sustained improvement in growth, sending bond yields and the U.S. currency surging.

Interest rates on benchmark Australian 10-year sovereign bonds rose 10 basis points to 3.39 percent as of 12:18 p.m., climbing from 3.09 percent at the end of April.

The Australian dollar, which has tumbled 9.7 percent against the greenback this quarter, bought 94.09 U.S. cents as of 12:21 p.m. in Sydney. Australia’s economy expanded at the slowest annual pace in almost two years in the first quarter, according to data released last week.

Firstmac sold 92 million British pounds ($143 million) of securities as part of a A$500 million RMBS offering last week, its first foreign-currency deal since June 2007, according to data compiled by Bloomberg. The issuer considered selling notes in euro and U.S. dollars before settling on sterling, according to a Fitch Ratings report before the offering.

Barclays Plc expects European RMBS issuance to slump 50 percent this year, providing more buyers for Australian sales.

“There is more demand out of Europe and it’s a question of how you tap that,” said Kevin Lee, division director in debt origination and structuring at Macquarie Group Ltd. “It’s good to see some foreign currency sales providing a bit of variety so long as it makes sense economically for the issuer.”

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