Aussie Banks' Debt Is Ugliest in More Than a Decade Versus U.S.

  • Australian lenders remain reliant on wholesale funding market
  • Cost of borrowing has increased amid global market turmoil

Australian bank bonds haven’t been this expensive to insure compared to U.S. financial debt in more than a decade. 

As the prospects for world growth have dimmed and global markets have been thrown into turmoil, Australia’s banks face additional risks including a reliance on offshore wholesale funding. They are also being buffeted by a housing market that’s showing signs of stuttering, the end of a decade-long mining bonanza and an economy that’s trying to adapt to slowing demand from China.

The average cost of protecting the bonds issued by the four largest lenders in Australia last week climbed to 29 basis points more than the mean for the current four biggest American banks, the widest gap on record in credit default swap prices stretching back to 2004, data compiled by Bloomberg show. This comes at a time when the Aussie institutions are paying more than they were previously to borrow in the primary market.

Australian banks are underperforming on the “expectation of high issuance this year,” said Gus Medeiros, a Sydney-based analyst at Deutsche Bank AG. “Some of the banks have issued paper at higher spreads than before, contributing to wider CDS spreads.”

The rout in global credit drove the cost of protecting Australian bank bonds to a more than three-year high of 139 basis points on Feb. 11, CDS data show. It was at 126 on Friday. In the meantime, the average CDS cost on the biggest American lenders has retreated from its Feb. 11 high of 122 basis points to 104 at the end of last week.

There has been a concerted effort by Aussie banks to boost the use of deposits, and bond issuance is now a smaller part of their funding mix than it was five years ago, according to the Reserve Bank of Australia. Wholesale markets nevertheless remain a key source of funds. Australia’s top four banks raised more than A$27 billion ($19 billion) in the local bond market last year and the equivalent of more than $49 billion abroad, according to data compiled by Bloomberg.

Australia’s banks “stack up well compared to their global peers, but they are not immune to the forces of re-regulation which will require ongoing capital raising at more onerous costs of capital,” said Robert Mead, a money manager at Pacific Investment Management Co. in Sydney. Market-reliant Australian banks are “impacted by the issuance requirements of their global peers and the finite demand for credit from the global investor base,” he said.

The four largest lenders raised a record A$20 billion in equity capital last year to meet new regulation and may need a similar amount over the next two years. 

Paying More

National Australia Bank Ltd. last week sold A$2.25 billion of three-year bonds in its home market at a spread of 98 basis points over the bank bill swap rate. That compares with 88 basis points for a similar tenor A$1.4 billion deal last month from Australia & New Zealand Banking Group Ltd. and 78 basis points for a A$2 billion Commonwealth Bank of Australia transaction in October.

More expensive funding has already spurred some lenders to increase what they’re charging customers. The largest banks last year increased mortgage rates for both landlords and owner occupiers, while NAB and Westpac both confirmed this month that they’ve lifted interest rates for some business borrowers.

Funding Pressure

“The industry is facing a lot of pressure with significant increases in wholesale funding costs and increased capital,” Westpac said by e-mail on Monday. “While we have been disciplined in managing our margins, over the long term all businesses must deliver sustainable returns.”

Part of the increase in credit risk premiums for Australian banks probably stems from people using them as a “cheap hedge” against broader concerns about China, resources and domestic housing, according to Philip Miall, head of credit research and strategy at QIC Ltd. Although these issues do pose risks, he reckons Australia’s banks are well positioned and doubts that there will be a housing crisis.

While mortgage arrears are still under control, there are signs that the nation’s housing market is slowing. Home values in Sydney declined 2.1 percent in the three months to Jan. 31, while they fell by 0.6 percent across the country’s capital cities, according to data from CoreLogic Inc.

“Our banks are continuing to perform strongly from a financial standpoint and asset-quality standpoint,” QIC’s Miall said from Brisbane. “In terms of valuation, spreads have widened out, it’s getting to good levels.”

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