Euroweek Australia report: covered bonds

Euroweek, August 2013

Standfirst: Covered bonds from Australian issuers arrived with great expectations, first in Europe in late 2011 and then domestically in 2012. Since then, issuance has quietened as the banks have bedded in their new programmes. Future deals will be opportunistic because, right now, the banks don’t need to pay up for funds. By Chris Wright

The launch of the covered bond market in Australia was a long time coming, and a source of considerable fanfare when it came. Odd, then, that in the first half of this year it vanished as fast as it had arrived.

Well, not so odd, on closer inspection. In the space of two months between mid-January and mid-March 2012, Commonwealth Bank of Australia, Westpac and ANZ raised more than A$10.5 billion between them in the domestic covered bond market, in order to get their issuance programs underway following the passage of legislation the previous year allowing them to do so. Since then, by and large, they haven’t really needed the funds – from any source, covered or unsecured – and so haven’t rushed back to the market.

“Everyone has their covered bond programme up and running and available, but beyond that, if you can issue unsecured into a competitive market you will always do that first,” notes John Chauvel, head of debt capital markets at Westpac. “Only when issuing senior unsecured becomes more expensive, during a moment of illiquidity in the market, do you bring out your covered bonds programme for funds.”

Adam Gaydon, director, syndicate at ANZ, agrees. “In the first year there was always going to be more issuance as the banks ramped up their programmes from scratch. Now there has been a plateauing of issuance,” he says. “We do expect over the second half of the year to see some issuers look at opportunities in A$ covered bonds; there’s clearly strong demand for the product, as three of the domestic banks raised more than $3 billion each last year with oversubscribed order books. So it’s not a question of demand, but what time it is appropriate for them to come.”

Speaking in early August, he has since turned out to be right, as on August 9 ANZ brought the first domestic covered bonds from an Australian bank for a year and a half, raising A$700 million of 5% notes maturing 2023. This was a striking deal: 10 years is twice the maturity of the longest tranches in the early 2012 deals, and unusual for bank capital markets funding in Australia. Doing so cost the bank 100 basis points over swaps.

This sort of opportunistic dipping into the market is likely to be the pattern for the future.  “Covered bonds have become a fundamental part of banks’ funding, but there is a limit on how much they can do because they have a capacity constraint from APRA,” says Steve Black, head of bank capital at Credit Suisse., referring to Australia’s bank regulator. “For the moment, the banks have plenty of headroom to keep going and at the current rate of issuance it will take a few years before they begin to bump up against these limits.” Grant Bush, head of capital markets and treasury solutions at Deutsche, refers to the process as “keeping a balance between attractive funding today and keeping some powder dry for a product that works through the cycle if we do see a deterioration in markets. Most borrowers recognise the defensive nature of covered bonds.”

The locals apart, the covered bond market has offered funding to a range of foreign issuers, most recently Royal Bank of Canada, which raised A$1.25 billion of three year floating rate notes in July. Prior to that, issuers have included Stadshypotek (for Svenska Handelsbanken), CIBC, Bank of Nova Scotia and DnB.

The other side of the covered bond question is Australian banks issuing in international markets, chiefly in Europe. “The euro covered market is the deepest historically: it’s where the covered bond markets started,” says Duncan Beattie, managing director, debt capital markets at JP Morgan. “In the US the covered market is also available, mainly in the three and five year parts of the curve, but euros offer a deeper market.”

The Australians first arrived here, with some gusto, in late 2011, coinciding with miserable market conditions in Europe. ANZ and Westpac raised $2.25 billion between them in deals which went well for the issuer but sank dramatically in the secondary market, prompting one banker to accuse them of “blowing up the market before it even started” among bitter recriminations about inappropriate aggression and overconfidence. Still, time heals, and Commonwealth Bank of Australia and National Australia Bank – both of whom immediately postponed their own planned deals in the fallout – were able to come back successfully in January 2012, raising Eu1.5 billion and Eu1 billion respectively in consecutive days.

Just as in the domestic market, issuance then dropped back, as the banks contented themselves with having set their programs up and waited for the time to be right to issue again. CBA in particular made use of the market, issuing again in euros in April 2012 and then in sterling that August, raising £50 million in a 14-year bond that remains the longest-dated Australian covered bond.

The most recent addition to the market was a Eu750 million 12-year deal from National Australia Bank in May.  The deal sold to 40 investors – led by the French, who took 43% of it, followed by Germany with 40% – and paid 33 basis points over mid-swaps.

As always, Australian use of the international versus the domestic markets will depend on tenor and pricing, but it may be that they do more internationally than they do at home. “It could well be that deals happen more offshore than onshore,” says Steve Lambert, executive general manager, global capital markets at National Australia Bank. “It depends on demand.”