Aussie bank bonds shrug off ratings downgrade

NEW YORK: Australia's big four banks are still being treated as elite borrowers in the global capital markets, despite Moody's Investor Service's decision to downgrade them earlier on Wednesday.

Spreads on euro- and US dollar-denominated structured and unsecured bonds barely changed for National Australia Bank , Commonwealth Bank of Australia, Australia and New Zealand Bank and Westpac during Wednesday's trading, even after Moody's lowered them to Aa2 from Aa1 on concerns about their funding needs.

"They are still the creme de la creme of the banks, along with the Canadians," said a senior trader of structured Medium Term Notes (MTNs) in London. "The news hasn't affected any of the spread levels or rate of enquiries we've seen today."

ANZ's 3.25% of 2016 US dollar bonds were trading unchanged at 118 basis points bid/113 basis points offered on Wednesday, compared with 131/126 for JP Morgan and 172/167 for Bank of America Merrill Lynch. Their euro spreads were about 1 basis point wider on the day, but in a weaker market.

"The Canadian banks trade tighter than the Aussies, but the Canadians have always been in an entirely different stratosphere," said a senior trader of Financial Institutions Group (FIG) bonds in New York, noting that Royal Bank of Canada, for instance, trades 75 basis points bid/70 basis

Points offered in the five year part of the curve.

Australian banks' continued trading strength was attributed to the Moody's action being widely anticipated. The agency's rating is now simply in line with S&P and Fitch's AA ratings for the big four.

"The overall strength of the Aussies is still there," said the MTN trader. "None of the fundamentals have changed -- this downgrade is based on how much reliance they have on wholesale funding, but we all know that for years. They have a very good diverse investor base and as far as investors are concerned over here, they don't have any exposure to Europe."

CAPTURING RETAIL DEPOSITS

The rating move was based specifically on the heavy reliance all four banks have on wholesale, or capital markets funding, which accounts for about 40% of liabilities.

Moody's is particularly concerned about their dependence on the international markets, "and the global financial crisis has underlined the speed with which shifts in investor confidence can impact bank funding," said Patrick Winsbury, senior analyst at Moody's in a press release.

According to ThomsonReuters data, CBA, ANZ, NAB and Westpac collectively raised $90.7 billion in total last year, $68.5 billion of which was raised outside of the Australian dollar market.

So far this year the big four have raised about $20 billion internationally -- ex Australian dollars, and $37 billion in total.

The biggest issuer is NAB, raising $29 billion in total and $21.6 billion ex-Australian dollars in 2010. It's followed by Westpac, ANZ and CBA at the bottom, with $15.17 billion total issuance last year, $11.24 billion of which came from outside of Australia.

Winsbury acknowledged that the four Australian banks have moved to curb growth in their wholesale funding needs, by for instance increasing their deposits.

They have also reduced their sensitivity to changes in global capital markets by extending their bond maturities, increasing liquid assets and further diversifying their funding base by tapping a multitude of markets in different currencies, as well as issuing a greater range of maturities and structures.

One large diversification move will be their issuance of covered bonds later this year when Australian legislation is passed. US bankers, for instance, are expecting several billions of dollars worth of covered bonds to be issued by Australian banks in the US dollar market in the second half.

Nonetheless, Winsbury points to a fundamental, entrenched problem for the Australian banks -- the small size of the Australian domestic bond market and the lack of retail deposit growth of any significance because Australians prefer to put their savings in superannuation funds.

"The fundamental funding structure of the major Australian banks remains in place," he said. "Australia's mandatory superannuation scheme will continue to capture retail savings, of which only a low proportion are available to fund the banks. This situation is due in turn to the low allocation -- by international comparison -- of superannuation savings to fixed-income investments and deposits."

The rise in deposits at the Australian banks is largely due to corporate deposits at a time when there's a weak demand for credit.

"When the cycle turns and credit demand eventually picks up, the ratio of corporate deposits to loans may.deteriorate," said Winsbury. "Retail deposit growth will then likely be insufficient to fund the banks' needs, driving them to increase wholesale funding once more."

Unless authorities move to increase the amount superannuation funds invest in domestic fixed income securities, Australian banks will continue to be exposed to the whims and fancies of the international markets.