The risks inherent in the Australian banks’ heavily reliance on offshore funding has received a lot of attention on this blog (for example see here). Now with the European debt crisis seemingly reaching a crescendo, it looks like these borrowings might now be coming back to bite.
From the Australian:
AUSTRALIAN and South Korean banks are the most exposed in Asia to Europe’s debt crisis, because of their heavy dependence on offshore wholesale funding markets, a senior official at Fitch Ratings says.
Fitch Asia-Pacific sovereign ratings head Andrew Colquhoun said while direct exposure was low, but if the Greek debt crisis imploded and spurred a major dislocation in global credit markets, Australian and South Korean banks and economies would suffer the most.
“Among the countries in Asia I would regard as relatively more exposed are both Korea and Australia, which have an issue of short-term and long-term external debt of the banking system,” Mr Colquhoun said.
“If the banks found it more difficult to refinance that debt, then there could be repercussions for the economies,” he said, adding “quite a lot” of risk still remained in the process to firm up a second bailout package for Greece.
He said Australia also faced some domestic issues, with a housing market that looked “overstretched”.
If interest rates were to go much higher to contain a mining boom, stress would soon become evident among borrowers.
Mr Colquhoun said Australia’s four biggest banks had in recent years leaned heavily on foreign currency borrowing and were among the biggest issuers of debt in the world using their respective governments’ funding guarantees during the financial crisis.
For anyone relatively new to this blog, the banks’ increasing reliance on offshore funding is illustrated clearly by the below chart, which shows a sharp increase in external liabilities by Depository Corporations over the past 20 years [note: the below chart also includes offshore borrowings by building societies, credit unions and registered financial corporations, although the banks account for the lion’s share].
These offshore borrowings have been used predominantly to fund Australia’s housing bubble – a largely non-productive activity.
The key risk is that the banks’ ability to refinance their borrowings rests with the willingness of foreign investors to continue to lend them money. But in times of heightened risk-aversion – such as the impending European debt crisis – foreign investors can become nervous and less inclined to continue extending credit, which could leave Australia’s banks, house prices, and broader economy exposed to a sudden liquidity shock.
Indeed, the markets already appear to be re-pricing Australia’s debt upwards because of the riskiness of Australia’s housing market and the banks’ offshore funding vulnerabilities. As reported in Business Day on Wednesday:
Debt markets appear to be betting Australian banks will suffer fallout from any European debt crisis…
Analysis by Banking Day suggests that the Big Four Australian banks’ credit risk continues to be priced higher than the debt of other AA-rated banks.
Banking Day has compared five-year Australian bank CDS spreads for the year to date with those of AA-rated HSBC and BNP Paribas. These spreads, sourced from Markit, are a proxy for the major banks’ cost of wholesale debt…
When we want to assess investor perceptions of banks’ credit risk, what matters is the spread paid by the banks over the base rate.
As can be seen from the chart, the Australian banks have been at a cost-of-debt disadvantage for most of the past five months. (The chart uses ANZ spreads, but spreads for other Australian banks are virtually identical.)
CDS spreads for AA-HSBC have remained around 80bps over the period and now sit some 40bps below those of the Australian banks.
AA-rated BNP Paribas is one of the banks considered most exposed to the Greek crisis. Ratings agency Moody’s announced a week ago that it was considering cutting the bank’s rating because of its exposure to Greek debt. Yet CDS spreads for BNP Paribas are no worse than those of the Australian banks, even though they have widened since early May, as the Greek crisis re-emerged.
Out of interest, also included in the chart are the five-year CDS spreads for A+-rated JPMorgan Chase & Co. While JPMorgan is rated two notches lower than the other banks shown, its CDS spreads align more closely with those of HSBC.
Clearly, the sharp slowing of household credit growth is working in the banks’ favour as it has significantly reduced their offshore funding requirements. Even so, the market appears to be unconvinced, deeming the Aussie AA- banks riskier than their peers (hat tip AusHousingCrash for the Banking Day link).
Further, with the banks in the sights of regulators, ratings agencies and investors for their heavy reliance on wholesale money markets, it is questionable whether they would be able to ramp-up their offshore debt raisings even if the demand for credit from households was there.
And with offshore funding seemingly on the nose, and credit growth likely to remain sluggish, the banks’ ability to support further house price growth appears to be limited. A prolonged period of price stagnation, therefore, now appears to be the best case outcome for the Australian housing market.