Running for cover

Australia’s domestic debt market is enjoying a new lease of life after the introduction of covered bonds. However, the popular new product is overshadowing unsecured and securitised bonds, and does nothing to make it easier for Australia’s corporate issuers.

Australia’s four major banks have been eager participants in the country’s fledgling covered bond market, following the passage of local legislation last October. Each bank had initially been expected to divert around 25% of its total bond issuance to the new market – about A$5bn (US$5.15bn) of each one’s A$20bn or so annual wholesale funding requirements.

Instead, as of the middle of July 2012, Australia and New Zealand Banking Group, Commonwealth Bank of Australia, National Australia Bank and Westpac had raised more than A$32.5bn combined under the new format.

The figure accounts for about 60% of all bonds the “Big Four” have sold since the Banking Act was amended on October 17 2011 to permit covered bond issues.

In stark contrast, issues of senior unsecured bonds declined from A$48.6bn-equivalent in January-June 2011 to just A$20.0bn in the first half of this year.

The enthusiasm for covered bonds in the local market has been another surprise. Almost a third (A$10.1bn) of the total has been printed domestically, with the rest raised in US dollars, euros, sterling, Swiss francs and Norwegian kroner.

A year ago, bankers had assumed that Europe’s deep and well-established covered bond market would be the best option. However, Aussie banks have proved willing and able to raise substantial volumes at home in a new open market with low execution risks and no currency risk.

The US has, ultimately, turned out to be a far deeper pool than its inauspicious beginnings in November 2011 had suggested. At that time, the debut US dollar covered bonds of ANZ and Westpac came unstuck amid accusations of excessive competitive haste against a difficult global backdrop.

Westpac made something of a triumphant return to New York on July 10, with a very well-received US$2bn dual-tranche three-year covered bond print that priced remarkably close to the Aussie major’s curve.

One American fund manager described the deal as “the next best thing to Canadian covereds, which trade extraordinarily tight” – a view that reflects the place of Australian major banks at the top of a shrunken table of Double A rated international banks.

If investors are happy, issuers are also delighted.

“Covered bond legislation has enabled Australia’s major banks to catch up with their offshore comps, especially from Europe, which have long been able to raise funds in this format,” said Simon Ling, head of DCM origination at Commonwealth Bank of Australia.

“In a tricky market, covered bonds have provided another funding vehicle that compliments senior unsecured issuance, which many investors still prefer,” he explained.

Price advantages

The major banks are primarily attracted to the significant price advantages available both internationally and domestically in senior secured format.

For example, ANZ’s covered 5.25% March 2016s were quoted in mid-July more than 40bp tighter than its senior unsecured 6.75% May 2016s, which pay 84bp over swaps versus 127bp.

Sean Henderson, head of DCM for Australia at HSBC, points to the cost and access advantages the covered market has provided to issuers. “Investors, at the moment, recognise the value of the collateral and extra liquidity, with covered bonds pricing at around 60% of the spread on senior bonds – or even lower,” he said.

Henderson attributes this strong demand, in part, to a cap on total supply, thanks to an APRA rule limiting covered bonds to 8% of a bank’s eligible assets. The figure represents “a meaningful improvement” on other jurisdictions, where there are larger limits on covered supply, or where there are no limits at all.

“A growing offshore bid has also helped, as foreign funds, banks and retail investors have taken comfort from Australia’s low sovereign debt levels, solid economic performance, as well as the banks’ conservative risk profiles,” he added.

These covered savings have further enhanced the funding cost advantages of Australia’s major banks over the non-major lenders.

The smaller banks find it harder to access the cheaper funds on offer in the covered bond market because they need to pledge significant amounts of their assets to collateral pools in order to secure the Triple A ratings that investors demand.

One recent deal, however, has raised hopes that the covered bond format may offer advantages beyond the country’s top banks.

Suncorp-Metway’s hefty A$1.6bn dual-tranche debut on May 30 was originally launched as a A$750m fixed-rate 4.5-year fundraising. High demand, however, allowed it to enlarge the deal to A$1.1bn before pricing in line with 140bp over asset swaps guidance.

The borrower then added a A$500m 2.5-year floating-rate tranche at 105bp over three-month BBSW, making significant inroads into its modest US$5bn covered bond programme.

Simon Lewis, Suncorp’s head of funding, estimated that the 4.5-year bond printed around 25bp wide of where the Australian majors would price. The December 6 2014 floater priced around 20bp over a new major issue, according to Lewis.

A syndication manager away from the deal said it was a great result for the issuer.

“Suncorp has greatly diversified its investor base and sold a lot more, with a longer tenor (for the 4.5-year tranche), than it would from RMBS or the senior unsecured bond, and at significantly tighter levels,” the manager said.

However, he was not convinced that the new market makes much economic sense to smaller, regional financials because of their shallower mortgage pools and the upfront costs associated with setting up a covered bond programme.

As one of the largest and best regarded of Australia’s non-majors, Suncorp’s offering may prove to be the exception rather than the rule, although other leading non-majors, such as ING and ME Bank, are believed to be looking to access the covered bond market.

Alternatively, Australia’s smaller mortgage lenders, which do not individually have ample assets to create sizable and liquid bonds, can establish larger joint pools. Double A rated covered bonds may also be a possibility.

Bankers, however, do not believe the covered bond market has greatly changed the playing field as far as smaller Australian banks are concerned. CBA’s Ling points out that smaller Australian financial institutions were already struggling to access wholesale markets following the global financial crisis when investors began to concentrate on “the bigger names with higher ratings”.

Henderson at HSBC agrees. “The smaller banks have never funded at levels close to the major banks, so covered hasn’t opened a differential that wasn’t already there. If anything, it has helped the larger names with enough critical mass to raise covered bonds, as well to narrow the differential, such as Suncorp.

“For reasons of scale, it has often been more cost effective for them to raise a greater share of their funds through deposits and RMBS,” he said.

RMBS has been one obvious casualty of the “covered bond age”, as the four major banks have chosen to use their portfolios of residential mortgages as collateral for covered bonds instead.

While there was RMBS supply A$7.2bn in the first half of last year from CBA, NAB and Westpac, there was only one in the first half of 2011– Westpac’s A$1.15bn of Series 2012–1 WST Trust notes on May 15.

The latest Westpac RMBS, however, actually underline the cost savings available in the covered bond market as the A$1.058bn tranche of Triple A rated Class A notes, with a three-year weighted average life, printed 140bp wide of one-month BBSW.

This compares with the ANZ 5.25% March 2016 covered bonds, which were trading around 86bp wide of swaps at the time.

The return of Westpac’s RMBS, nevertheless, showed that securitisation remains an attractive option for the major banks, easing fears that the advent of covered bonds legislation would completely kill off the asset class for the Big Four.

Ling at CBA argues that May’s Westpac RMBS will not prove a one-off. He expects the major banks to tap this space from time to time when opportunities appear.

The RMBS market still provides several benefits to Aussie issuers. For a start, the structured finance market appeals to a different group of investors to covered bonds, allowing the likes of Westpac to diversify their funding sources.

Also, the amortising profile of RMBS better suits certain investors, while covered bonds appeal to buyers of senior unsecured paper, accustomed to the bullet maturity.

In addition, the 8% APRA cap, restricting Australian banks to using no more than 8% of their assets as collateral, will ultimately limit covered bond issues.

The bankruptcy-remote structure of a securitisation also allows investors to increase exposure to the bank. A Westpac RMBS, via WST Trust, will not count towards an investor’s limits on single-issuer exposure, unlike senior unsecured or covered bonds.

Non-majors still participate

Non-major banks in Australia have continued to issue RMBS. ING, Suncorp, FirstMac, Members Equity Bank and AMP Bank have all priced offerings year to date, with the support of the AOFM’s purchasing programme for second-tier RMBS.

Westpac priced 15bp below where AMP Bank’s enlarged A$650m RMBS printed two days later (May 17) through its Progress 2012–1 Trust. AMP Bank priced A$602.75m of Class A notes at 155bp over one-month BBSW. The Class As had a WAL of 3.4 years.

A syndication manager suggested that 5bp of the 15bp premium over Westpac reflected AMP Bank’s longer WAL since “demand tends to drop away after three years”. The remaining 10bp can be put down to investors’ typical preference for major bank paper and a deteriorating global backdrop.

In good times, non-majors generally price just 5bp wide of the leading banks in the RMBS market.