The big four banks could cut borrowing costs by as much as 40 per cent selling covered bonds after European lenders pushed sales of the asset-backed debt to a record.
Westpac, Commonwealth Bank, ANZ and NAB may be able to issue three-year covered bonds priced to yield about 50 basis points more than the bank bill swap rate, less than the 85 basis-point spread on senior debt, according to Royal Bank of Scotland. Moody’s Investors Service estimates savings of 20 per cent.
Covered bonds are “essential weapons as banks look for cheaper and more diversified sources of funding,” said John Manning, a credit analyst at RBS in Sydney. Even when global credit markets seized up, European banks “had good access to covered bond markets and were able to access the funding they required at quite commercially acceptable rates,” he said.
The federal government will amend the law to let financiers issue the securities for the first time, Treasurer Wayne Swan said on Sunday as he announced an overhaul package aimed at spurring competition in the banking industry.
Global sales of the securities, including Pfandbriefe, as they are known in Germany, have surged 33 per cent to a record 329 billion euros ($437 billion) in 2010, as investors seek the relative safety of debt backed by both the issuer and an underlying pool of assets.
Backed by assets
The securities typically get higher credit ratings and pay less interest because they’re backed by assets such as mortgages that stay on the lender’s balance sheet and can be sold in the event of a default. Australian lenders are barred from selling the securities because they conflict with local laws stating that depositors’ interests should come ahead of creditors.
Investors in Europe demand 177 basis points of extra yield to hold covered bonds instead of government debt, according to Bank of America Merrill Lynch’s EMU Covered Bonds index. Spreads average 237 basis points, or 2.37 percentage points, on the region’s financial debt, a separate index shows.
The government will release draft amendments to the Banking Act to allow the sale of covered securities during the first sitting of parliament next year, according to a federal document detailing the planned changes.
‘Safety and sustainability’
Allowing covered bonds will help “secure the long-term safety and sustainability” of the banking system, the document states. Treasury may impose a cap on the amount of covered bonds that each bank can sell, “for example five percent of an issuer’s total Australian assets,” it said.
Limiting sales to that amount would allow for about $100 billion of covered bond issuance in total, Deutsche Bank analysts Gus Medeiros and Colin Tan wrote in a report to clients yesterday.
The first sale of covered notes in New Zealand in June, a $NZ425 million ($320 million) offering by Bank of New Zealand, was priced at a 38 per cent discount to what the nation’s banks would otherwise, Moody’s said in a report at the time.
Cameron Clyne, chief executive of National Australia Bank, yesterday said his bank plans to sell $28 billion of bonds in the year ending September 2011, and would be able to cut costs if some of that debt was covered securities.
The big banks may need to raise as much as $130 billion from selling bonds in 2011, with the majority issued in offshore markets, according to Nomura Australia credit analyst Ben Byrne.
Senate inquiry
Until mid-2007, Australia’s banks were able to issue three- year debt at a spread of about 50 basis points more than government bonds, the Reserve Bank wrote in a November 30 submission to a Senate inquiry into banking competition. The spread for domestic sales peaked at about 220 basis points amid the global credit freeze in late 2008 and is now about 120 basis points, according to the RBA.
“No one is sure how long bank funding costs will remain elevated,” Westpac wrote in its submission to the inquiry. “We expect those costs to eventually settle at a new equilibrium, lower than current levels, but certainly more expensive than before the crisis began.”
Being able to issue covered debt “would strengthen the banks’ funding positions as covered bonds provide access to a broader class of investors,” the lender stated.
Canadian Imperial Bank of Commerce raised $750 million in October in the first sale of Australian dollar-denominated covered bonds since the start of the credit crisis in 2007. The Australian laws don’t block overseas banks issuing the notes.
CIBC sale
The 5.75 per cent notes due December 2013 were priced to yield 91.25 basis points more than similar-maturity government debt, according to a statement at the time. The spread has narrowed to 87 basis points, according to ANZ Bank prices. A basis point is 0.01 percentage point.
RBS’s Manning said his estimate of the costs for Australian banks issuing covered bonds was based on the CIBC sale.
Covered bonds will probably be about 20 per cent cheaper for Australian banks to issue compared with senior unsecured debt, Jennifer Wu, a senior analyst at Moody’s, said in a phone interview.
Lower-rated smaller Australian lenders are unlikely to benefit as much as the main banks from legislation allowing covered bonds, as it is “highly unlikely” they will be able to secure AAA credit ratings, said Mark Bayley, a Sydney-based credit strategist with advisory company Aquasia.
“A covered bond market is actually more likely to decrease competition within the Australian lending market,” he said.