As a follow up to my post on the Commonwealth Bank’s (CBA) entrance into the European covered bond market, please find below some additional commentary from Phil Bayley, Principal of ADCM Services, who is a capital markets consultant.
It’s not a good headline number is it? But it is not as bad as it seems.
CBA issued the covered bonds in the Euromarket at 100bps over, NAB (National Australia Bank) followed later in the week at the same level. It needs to be remembered that ANZ and WBC issued in the US in November at 115bps over.
To compare apples with apples the issue margins need to be converted back to an Aussie dollar cost. ANZ and WBC achieved 150bps over and CBA and NAB are paying 220bps over. The difference for CBA and NAB is the basis swap from euros back to USD and then a further basis swap from USD to AUD.
CBA and NAB have incurred the cost of two basis swaps and the euro to USD swap is currently at very wide levels as the euro is being dumped for the (perceived) safety of USD.
Nevertheless, CBA and NAB have opened a market for their covered bonds that will be useful in the future (pricing is anybody’s guess). ANZ and WBC have effectively closed the US market for Aussie covered bonds with poorly executed issues that have since seen the credit spread widen to 150bps, incurring losses for investors.
For the time being, the banks will be unable to issue covered bonds in the US but still should be able to issue unsecured bonds (different investors). Unsecured issuance is virtually impossible in Europe with only covered bonds being accepted by investors.
The banks now need to move quickly to issue unsecured bonds in other markets, at much lower levels, to prevent these latest Euromarket issues setting a new pricing benchmark. The 220bps Aussie cost suggests a 270bps spread for a five year, unsecured bond.
Five year CDS for the majors is currently at 170bps, domestic secondary market spreads for five years are around 160bps and NAB issued for three years in mid-December at 130bps over. The banks need to quickly confirm these pricing levels.
The advantage of covered bond issuance for the banks is the funding flexibility it allows. But at these pricing levels I would expect the banks to use covered bonds strategically and try to create some rarity value, bearing in mind that outstanding covered bonds cannot exceed more than 8% of the banks’ Australian assets.
I think CBA and NAB have paid a price to open a market. I don’t expect that they will be rushing back.
So until we see the European market’s issues dissipate we are unlikely to see the cost of EURUSD swaps come down. This means the effective price for European covered bonds issuances is likely to remain high and therefore it appears that the banks are going to have to rely on unsecured debt in the US for funding roll-over. The problem is that the these covered bond issuances have set the price for secured debt which could have a flow-on into the price of unsecured issuances. Unless the banks are able to get the unsecured rate back down they may end up paying more than in Europe for covered bonds.
Watch the size and placement of the next unsecured bond issuance by an Australian bank very closely.