Faster Than Expected Fed Rate Hikes Could Cost Australian Banks

  • Commonwealth Bank watching U.S. economy ‘very carefully’
  • ‘Unpredictable’ rate rises a possibility: Morningstar Inc.

Australian Lenders Risk Heavy Fed Hit

The prospect that interest rate increases by the Federal Reserve will drive up bank funding costs looms particularly large about 15,000 kilometers away in Australia.

The four biggest banks there have historically gotten a bigger proportion of their funding from wholesale debt investors than peers in Europe and Japan, and the majority of that is sourced outside the local Aussie market.

“Sharp, unpredictable rises in rates” are a possibility as the White House prepares to fill several vacancies at the Fed board in Washington, according to John Likos, Sydney-based head of credit research at Morningstar. “As inflation goes up, borrowing costs particularly at the long end of the curve will face pressure upwards.”

Australia & New Zealand Banking Group Ltd., Commonwealth Bank of Australia, National Australia Bank Ltd. and Westpac Banking Corp. get about two-thirds of their funding from deposits and the rest from debt markets including the U.S., according to regulatory data. One way lenders could deal with higher funding costs is to pass it on to the nation’s $1.2 trillion mortgage holders, increasing expenses for borrowers in a heated property market.

ANZ declined to comment. NAB, CBA and Westpac didn’t have any immediate comment.

Fed funds futures contracts on Friday point to 38 percent odds of a rate increase next month. Money managers including Pacific Investment Management Co. and BT Investment Management have said the Fed could turn hawkish and tighten policy quicker than market expectations this year, after President Donald Trump promised to stimulate the economy with tax cuts and spend $1 trillion on infrastructure.

Australian banks got 34 percent of their funding from debt markets including via certificates of deposits, compared with 20 percent for German and French lenders, and 21 percent for Japanese firms, according to data compiled by the Reserve Bank of Australia in December 2013.

The cost of shifting funds from U.S. dollars into the Aussie currency has also surged to around 32 basis points from 12 this time last year, adding to the expenses faced by the banks, Bloomberg-complied data on cross currency basis swaps show.

Funding could become more expensive if Australia’s top sovereign rating is cut by S&P Global Ratings on the back of the nation’s fiscal deficit, as that would cast a shadow also on lenders’ credit scores.

Click here for a Bloomberg Intelligence primer on Commonwealth Bank

While yield premiums may widen as investors demand more compensation for holding Aussie bank paper in an inflationary environment, stronger investor confidence in the U.S. can also keep a lid on costs, according to John Sorrell, Nikko Asset Management’s head of credit in Sydney.

Ian Narev, chief executive officer of Commonwealth Bank, told a media briefing last week that the company was watching the U.S. economy “very carefully” as it remained a key funding market for the bank.

“A strong, well functioning U.S economy is going to be very important for us,” he said. “Not because we’ve got a big business there -- because we don’t -- but because we have a lot of investors there and we get a lot of our funding from the United States.”

— With assistance by Emily Cadman, Matthew Burgess, and Benjamin Purvis

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