Covered bond auction a fizzer for CBA

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Covered bond auction a fizzer for CBA

Australia's attempt to lower bank funding costs with covered bonds is still leaving the nation's biggest financial institution paying investors the highest domestic yield premiums on record.

Commonwealth Bank of Australia sold $3.5 billion of five-year covered notes to yield 175 basis points more than swap rates yesterday in the biggest ever offering of financial debt in the currency. That's higher than the spreads paid by the nation's four biggest banks on benchmark domestic senior bonds in data compiled by Bloomberg since 1991.

The Sydney-based bank sold $500 million of three-year floating-rate notes at a 160 basis-point premium in December 2008.

Australia's government announced plans in December 2010 to end a ban on banks selling covered notes, which are typically lower-yielding and rated AAA because they are backed by a pool of mortgages.

Europe's debt crisis has engulfed credit markets since then, driving the extra yield unsecured global financial bonds offer over government securities up 139 basis points in the past 12 months to 349, while the gap in Australia widened 120 to 304, Bank of America Merrill Lynch indexes show.

“Banks have decided that it is better to pay up to get the deals done and the cash in the door,” said Mark Bayley, a Sydney-based credit strategist with advisory company Aquasia. “Their cost of funding continues to increase. Those costs will be passed on to their customers through higher margins for business loans and mortgages.”

Global sales

Covered bond sales globally surged to 33 billion euros ($41 billion) this month, from 15.5 billion euros in December as Europe's crisis damps demand for all but the safest debt. Australia's parliament passed legislation allowing sales of the notes in October.

More than 90 investors bought Commonwealth Bank's fixed-rate bonds, while the floating-rate notes had more than 70 buyers, according to Simon Maidment, the lender's head of group funding.

“Relative to all the other five-year funding opportunities in wholesale markets, this was more efficient from a pricing perspective,” Maidment said in a telephone interview. “But nevertheless, it's expensive versus where term wholesale funding was six to 12 months ago.”

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Commonwealth Bank, the nation's biggest mortgage lender, sold five-year bonds in December 2008 under a government guarantee program introduced in the wake of the collapse of Lehman Brothers, paying a 120 basis-point spread to investors and a 70 basis-point annual fee to the government in return for the backing, Bloomberg data show.

Yield premiums

The bank's covered bond sale yesterday, the first domestic offering of such securities, helped spur an increase in yield premiums on senior unsecured financial debt. The spread on Westpac Banking Corp.'s 7.25 percent notes due November 2016 surged 42 basis points this week to 204 yesterday, the highest since they were issued in November 2009, Bloomberg data show.

European covered securities yield 142 basis points less than senior unsecured notes, Bank of America Merrill Lynch indexes show.

“The ramifications of the covered bond deal for the senior market are severe,” said John Sorrell, head of credit at Tyndall Investment Management Australia Ltd. in Sydney, which manages about $15 billion of fixed-income assets. “The market wasn't reflecting reality and is now suffering a dramatic widening in spreads.”

Benchmark rates

Higher funding costs for Australian lenders may stop them from reducing mortgage rates if the central bank lowers the benchmark interest rate next month to stimulate the economy, as forecast by analysts.

Reserve Bank of Australia Governor Glenn Stevens will reduce the rate to 4 percent from 4.25 percent, according to 15 of 20 economists surveyed by Bloomberg on January 4. Traders are betting on a 64 percent chance of a cut, cash-rate futures show.

Australia's benchmark 10-year bond yield rose 12 basis points to 3.79 percent as of 6:30 p.m. in Sydney, or 190 basis points more than similar-maturity Treasuries.

Australia's dollar, the world's fifth-most traded currency, rose to $US1.0406.

The Markit iTraxx Australia index of credit-default swaps that gauges perceptions of corporate bond risk dropped 5 basis points to 174 as of 6:06 p.m., according to Deutsche Bank AG.

Commonwealth Bank opened the euro-denominated covered bond market for Australian banks this month, selling 1.5 billion euros of five-year notes that cost about 220 basis points more than Australian benchmarks once swapped into the local currency, Bloomberg data show.

The nation's banks first issued covered notes in November, when ANZ and Westpac sold a combined $US2.25 billion of US dollar-denominated securities, the data show.

The ANZ securities, priced at 115 basis points more than the US swap rate when sold, were quoted at 146 basis points yesterday, according to National Australia Bank prices.

“The banks pressured the government to allow covered bonds by saying they would reduce funding costs,” said Tyndall's Sorrell. “It doesn't seem to have been very effective.”

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