One of the major themes talked about during 2011 was private sector debt. The big unanswered questions were not only whether the private sector would re-find its appetite for debt, but also whether the banking sector would be in a position to match that appetite if it did appear.
Moving into 2012 that theme still stands, so one of the big questions for the Australian economy, and more specifically the Australian housing market, is whether the Australian banks are going to be able to source funds at a rate that allows them to maintain interest rates in line with any movements by the RBA.
One of the big hopes from the banks was that recent changes to legislation allowing them to issue covered bonds would alleviate some of the funding strain. Covered bonds are a form of secured debt issuance and should, in theory, provide a more affordable source of funds over standard unsecured bonds.
However, back in November last year Houses & Holes observed that the initial use of covered bonds hadn’t gone according to plan with some banks paying around 150 bps over bank bills and CBA pulling an auction because the rate had spread out to 175bps.
Those rates are high and certainly not what you would expect to pay for secured debt in normal circumstance. As a reference government guaranteed unsecured debt was being issued at +190bps during the GFC and that included the government fee.
This week the Australian banks returned to the markets with new covered bond issuances, this time in Europe, under the perceived shelter of the ECB’s LTRO that was supposed to provide them with some cover from the European banking stress. The problem is that , as I have explained over the last few days, the LTRO hasn’t really gone according to plan and the results for the Australian banks are not good at all.
From the AFR:
Australia’s banks are battling escalating wholesale funding costs as they establish their presence in the 200-year-old European covered bond market.
“Price is going to continue to be an issue for all banks around the world so long as there is continued uncertainty in the market and none of the pressures have gone away,” said Commonwealth Bank of Australia group treasurer Lyn Cobley.
On Wednesday, CBA became the first Australian bank to issue a euro-denominated covered bond, raising €1.5 billion ($1.9 billion) in a five-year transaction.
CBA got in ahead of a competing deal from rival National Australia Bank, which launched its own trade with similar terms as CBA was finalising orders for its bond issue.
CBA’s issue was managed by BNP Paribas, HSBC and Royal Bank of Scotland and was the largest covered bond sale by an Australian bank since the federal government first allowed local financial institutions to issue the securities in November.
“To get €1.5 billion for an inaugural deal in this market, despite considerable competing supply, is a great result, and demonstrates the depth of the European covered bond market,” said BNP Paribas managing director Kate Stewart.
Despite the success of the transaction the debt raising was expensive and converted back into Australian dollars at about 2.2 percentage points over the benchmark bank swap rate, or 6.6 per cent.
220bps for secured debt is a very high price to pay. Given that the general rule of thumb is that secured bond spreads should be half to two-thirds that paid on unsecured bonds it is obvious that unsecured debt markets are effectively closed to Australian banks, perhaps even in the event of a renewed government guarantee.
That CBA was prepared to pay this price speaks volumes about its need to roll over debt. And that’s not great news for mortgage holders. As John Symond observed today, also in the AFR:
There is not a bank out there lending on new loans that is making a cracker. But they know that in the next six to 12 months they will be able to reprice their books by not passing on all the rate cuts.
And who’s to say funding costs have peaked?