Good times, bad times for Australian major-bank funders

KangaNews and RBC Capital Markets held their annual roundtable for heads of funding at Australia’s big-four banks at a fascinating juncture for the sector. Limited credit growth and highly supportive demand conditions are clearly assisting the funding task in the near term. The requirement to build much bigger tier-two debt books and the ever-present threat of volatility pose medium-term – but manageable – challenges.

PARTICIPANTS

Alex Bischoff Head of Group Funding WESTPAC BANKING CORPORATION
Fergus Blackstock Head of Term Funding COMMONWEALTH BANK OF AUSTRALIA

Scott Mitchell Acting Head of Funding NATIONAL AUSTRALIA BANK
Simon Reid Director, Group Funding ANZ

MODERATORS

Laurence Davison Head of Content and Editor KANGANEWS

Gerard Perrignon Managing Director, Debt Capital Markets RBC CAPITAL MARKETS

LIQUIDITY AND EXECUTION

Perrignon Wholesale execution conditions have clearly been very strong for most of 2019. What have issuers’ experiences been?

BISCHOFF The last 12 months haven’t exclusively been plain sailing. There was a pretty significant period of market stress from last November until probably the second week of January. This is significant because it’s a good case study in how far the major banks have evolved in how we think about our funding. This includes the products and markets available to us and the way we work through periods of high volatility. We were able to use all the tools available to us, at different times, to maintain our funding path without disruption.

Things have certainly changed, and up until early August execution conditions were about as good as they have been for a considerable period. Again, though, it is about taking a long-term view. Looking at the first three TLAC [total loss-absorbing capacity] transactions the majors did, I think all the issuers took a really considered approach to volume and pricing that should ensure consistent market access.

Davison Has anything changed with regard to the execution approach the banks are taking in global markets? Volatility windows nowadays often seem to be short but dramatic, perhaps reflecting the world of ‘Twitter risk’ we are living in.

BLACKSTOCK Twitter risk has certainly changed some things. Execution windows have shrunk, largely because sentiment can change very rapidly in today’s environment. This isn’t the only reason, though. We are very focused on transparency and disclosure, which makes our own windows smaller regardless of what might be happening in the market.

MITCHELL The past 12 months have seen some peaks and troughs for execution conditions. We have to be as responsive to the market environment and as dynamic as possible.

July was something of a Goldilocks month with execution conditions about as good as they could be. This actually allows us to be a bit more patient and relaxed about our timing. In November-December last year and, to a slightly lesser extent, May this year we had less outcome certainty going into transactions but tended to push on because we were also aware that execution windows could be fleeting.

“Our structure is simple, our task is more manageable than originally proposed and the majority of global investors can buy our product. I don’t think the idea that it is going to be tougher for us in volatile markets than it is for banks selling senior nonpreferred is correct.”

Perrignon Domestic execution has been exceptionally strong over the past year, providing record-volume deals for the domestic majors as well as offering liquidity to financial-sector issuers from multiple global jurisdictions across the entire capital structure. Has there been a structural change, and if so does it influence issuers’ views on how much of their wholesale issuance they should be able to do in Australian dollars?

MITCHELL We have been surprised to the upside in almost all our recent domestic transactions. We spent some time comparing recent books to previous deals, and what was most noticeable was the maturation of the breadth of demand and the participation of real-money investors. The quantum of bids from real-money accounts was in many cases multiples of what it used to be.

I’m not sure exactly what the drivers have been. But it is certainly true that domestic books have been far broader than they used to be. They have behaved more like what we would expect in a US dollar transaction, by which I mean deep books that scale down through the orders instead of large, top-of-the-book tickets from bank treasury and semi-government investors.

BLACKSTOCK I certainly agree that there has been a maturation in the Australian dollar market. Domestic asset managers are long-term investors for us and I think the dialogue we have with them is really good nowadays. The increase in depth of liquidity they can bring to bear has also been noticeable.

Even considering all these factors, which we were already aware of, I have to say I have been surprised at just how productive the Australian dollar market has been for us over the past 12 months.

REID I agree. There is a range of hypotheses regarding why this might be the case. We clearly have a very large superannuation industry in Australia which continues to grow, and it may be the case that demographic change is starting to cause a shift into fixed income from equity. It’s hard to find evidence of this, it has to be said – other than the excellent performance of the bond market and the demand we have been discussing.

There is no reason to suspect the conditions we have been experiencing in recent months won’t persist. It’s just hard to pin down precisely why they have come to exist.

Davison Is this purely a domestic investor story? Low rates might be expected to mute Australian dollar demand from offshore.

MITCHELL I think it’s a regional story. The proportion of offshore bid in our Australian dollar books hasn’t changed, but the transactions have been much larger – so there is a greater quantum of offshore demand.

“It’s fair to say that some very obvious questions continue to come up on Australian bank roadshows, particularly in relation to TLAC. There are things we might assume to be absolute baseline knowledge that clearly are not.”

TLAC APPROACH

Davison The domestic market has been incredibly receptive to senior-unsecured issuance in particular and the first couple of TLAC-related forays by the major banks into the US tier-two market went very well. Might certain asset classes suit certain jurisdictions and thus the majors end up targeting issuance more precisely?

BISCHOFF I honestly don’t think there is as much science to the funding task as this would suggest. The reality is we recognise that we have a reasonable requirement for tier-two issuance going forward and – just as we do with senior-unsecured and covered bonds – we will take a broad-based approach to the issuance task depending on which markets work at any point in time.

We have seen periods in which the Australian dollar market is working particularly well or badly while the price-competitiveness of euros comes and goes. All these dynamics will continue to be at play. It’s hard to say definitively that we will do more of a product in a particular market on an ongoing basis because of a specific factor.

The other thing I think is important is to look at tier-two in perspective. Speaking for Westpac Banking Corporation, we fund around A$30 billion (US$20.1 billion) in wholesale markets annually of which senior unsecured is and will continue to be the main component.

We will take a pragmatic approach with an eye to diversification. Over time, I suspect this will mean a relatively well-balanced book for tier-two – we won’t be doing it all in US dollars, Australian dollars or anywhere else.

BLACKSTOCK The way we think about it is that different investors have their own appetites – it’s not about a jurisdictional or market-wide view. I don’t think it would be practical for us to target certain types of issuance at specific markets.

I would also echo the comments that senior unsecured is still going to be our main wholesale-funding instrument – even if we are doing a bit less of it, and a bit more tier-two, on a proportional basis. TLAC isn’t going to overtake everything else.

MITCHELL What we are about to go through will require a lot of exploratory work. It would be too scientific to try to pin down the ‘right’ approach in advance: it will evolve and we will be responsive to appetite in various regions, formats and currencies as it emerges. My guess is that the breakdown of tier-two by tenor and currency will end up looking relatively similar to our senior books in respect of it being reasonably well diversified. There is certainly appetite in multiple jurisdictions.

BISCHOFF I also think it would be wrong to get caught up in the idea of comparing Australian tier-two with that of all the other global banks. The reality is that tier-two is a vehicle for meeting our TLAC requirements. Initially it seems a lot of global investors want to benchmark our tier-two against senior-nonpreferred bonds from other banks with a relative pickup.

It will be interesting to see how this evolves over time. Our structure is simple – there are just three layers instead of four – our task is more manageable than originally proposed and the majority of global investors can buy our product. I don’t think the idea that it is going to be tougher for us in volatile markets than it is for banks selling senior nonpreferred is correct. In fact, I think offering a product with spread in a low-rates environment could actually help with execution risk.

Australian TLAC primer

The Australian total loss-absorbing capacity (TLAC) regime has two particularly notable features: it is a very straightforward setup and its main funding tool is expected to be tier-two securities.

Australia’s big-four banks will be issuing a significant volume of tier-two securities under the new rules but senior-unsecured bonds will remain the backbone of their wholesale programmes.

In its initial proposal on TLAC in November 2018, the Australian Prudential Regulation Authority (APRA) set out an increase in the total regulatory capital requirement of 4-5 per cent of risk-weighted assets (RWAs) for the four Australian domestic systemically important banks.

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REID I think it will be important for us to position our tier-two as the equivalent to senior nonpreferred in other jurisdictions in the sense of where it sits in the capital stack and in relation to things like probability of default and loss given default.

Inevitably we are not going to have as many investors as a jurisdiction offering senior nonpreferred, purely because our product doesn’t have “senior” in its name. But there is clearly a lot of room for spread improvement when you compare our tier-two to other global banks’ tier-two, let alone senior nonpreferred.

I’d also like to add that different investors buy different products in different jurisdictions – even if this might mean a range of portfolios within the same investor firm. We sell US dollar secured, senior unsecured and tier-two to different pockets of liquidity.

Davison The Australian tier-two market continues to favour 10-year non-call five (10NC5) bonds. Any bonds issued with this term structure now will be getting close to call dates when TLAC standards come into effect at the start of 2024. Does this mean there is a marginal preference for issuing the longer-tenor tier-two that is available in US dollars and elsewhere?

MITCHELL I don’t think there is a single right answer to this, and I suspect we will all take our own approaches. This said, I don’t think there is anything wrong with wanting to have a continual pipeline of refinancing through the cycle.

If the whole system decided only to issue 10-year bullets or 15NC10 bonds, we’d be setting up a big problem for ourselves in a decade’s time. Issuing a 10NC5 now might only give six months of value after the January 2024 compliance date but I don’t think that’s necessarily a bad thing from a portfolio perspective.

I suspect we will want to have the ability to refinance through the cycle and the kind of portfolio insurance we get from longer-dated notes. Exactly how the balance is managed will come down to the proclivities of individual banks.

BLACKSTOCK The end state is clearly to have a reasonable refinancing profile through the cycle. There are advantages to going long, but it’s also not a flat curve. Shorter-dated tier-two costs less.

“There has been a maturation in the Australian dollar market. Domestic asset managers are long-term investors for us and I think the dialogue we have with them is really good nowadays. The increase in depth of liquidity they can bring to bear has also been noticeable.”

Davison Did ANZ Banking Group (ANZ) do any sounding on tenor before it issued its Australian dollar 10NC5 tier-two in July?

REID No. A 10NC5 deal made sense for us for a number of reasons, including the fact that it filled a gap in our maturity profile. Most importantly, we were confident this was the format that would be best received in the Australian dollar market and therefore gave us the best chance of a good trade. We felt this was especially important as the first such transaction domestically following the Australian Prudential Regulation Authority (APRA)’s announcement on TLAC.

We are hopeful that the Australian market will develop more demand for 12NC7, 15NC10 and 10-year bullets as we build out our tier-two outstandings. Indeed, we have had demand for longer-dated tier-two in Australian dollars from investors in other jurisdictions. We are hopeful that this demand will develop with the local investor base, too – but it may take some time.

Davison Would you be open to doing smaller placements of longer-dated Australian dollar tier-two to satisfy offshore demand and, hopefully, develop local interest at the same time?

REID Yes. We certainly expect to issue in a wide range of currencies and formats. Helping to develop markets is an important reason why – as well as, of course, building our maturity profile and growing the tier-two stack in an orderly manner.

MITCHELL Domestic 12NC7 and 15NC10 issuance isn’t something for which we have ever had to test the waters previously. The new paradigm makes tier-two a far more relevant issuance format for us so it would be remiss not to explore those avenues.

Whether there is substantial appetite remains to be seen. But we hope investors are aware of our issuance profile and are therefore considering whether longer tenor could be relevant to their portfolios.

BISCHOFF If investors look at what has happened offshore and believe Australian rates are going lower still, one of the outputs eventually has to be demand for extended duration.

We have done A$350 million of 12NC7 tier-two in EMTN format in the past, and I believe others have done 15NC10 EMTNs. We know there is a base pool of demand and I expect we have all received reverse enquiries for long-dated Australian dollars since the APRA announcement. It’s just a question of when we want to test the waters.

BLACKSTOCK I agree that there hasn’t really been any need for us to go hard at the demand side before. I think now it would be really good for market development if we could build an Australian dollar tier-two curve.

“Domestic 12NC7 and 15NC10 issuance isn’t something for which we have ever had to test the waters previously. The new paradigm makes tier-two a far more relevant issuance format for us so it would be remiss of us not to explore those avenues.”

Perrignon The market has known for the best part of a year that the Australian major banks were eventually going to have A$50-75 billion of additional loss-absorbing capital, in one form or another, sitting under their senior-unsecured debt. Yet it is only very recently that the US dollar market, for instance, has traded Australian senior curves relatively flat to Canadian loss-absorbing senior debt. Are you surprised at how long this has taken?

REID I think this is partly because there has been less Australian supply to the US dollar market – in our case, we have not issued there for the past 18 months. This is the longest period of time we have had without issuing a US dollar benchmark since we first had access to that market. I think this technical factor has been as important as the fundamentals.

MITCHELL We tend to assume that everyone is as focused as we are on the relative value of Australian major banks but of course this isn’t the case. Investors need to be able to see something relevant in the market to have transparency on relative value. When there is a live deal it helps highlight whether or not the existing relativities are appropriate.

I’d note that the pricing differential of Australian bank tier-two to its Canadian equivalent is quite wide. Obviously there are different supply dynamics but I still expect this will narrow as we become more relevant as issuers of tier-two in US dollars. We need this to be articulated and transparently shown to the market before it normalises, however.

BLACKSTOCK To some extent this pricing differential shows the potential of good investor relations, because I think the Canadian banks have done a good job of marketing their TLAC product.

PERRIGNON It’s fair to say that some very obvious questions continue to come up on Australian bank roadshows, particularly in relation to TLAC. There are things we might assume to be absolute baseline knowledge that clearly are not.

MITCHELL Some of the questions we received through the execution of our US dollar tier-two deal indicated there were still some misunderstandings of the format and structure we are issuing, even though it is something we have been issuing for some time. There is certainly still some education needed.

BISCHOFF We made a decision not to put a lot of focus on tier-two terms and conditions in the investor presentation for our recent US dollar deal. This was a considered part of the deal process. We wanted to remind investors that, in effect, “you already know this product” – that we didn’t need to start with an education process.

The reality is we are always going to get questions that, at times, show less understanding of our market than we might assume. This is because we don’t issue every week – and we’re still not going to be, even with the increased requirement. International investors are focused on multiple transactions in the market every day, so inevitably they are going to query some aspects of ours. I wouldn’t be surprised if we were still answering the same questions in a year’s time.

The Australian bank story and investor relations

The Australian big-four banks say their investor-relations task has matured significantly over the years. They are telling a relatively simple and increasingly well understood story to global investors that, in most cases, have now been following them for some time.

PERRIGNON The April 2019 financial stability report from the Reserve Bank of Australia (RBA) pointed to the continued resilience of the Australian banking complex. This includes capital ratios that have become significantly higher over the past decade, simplified banking models, extensive culture and governance reviews, strengthened lending practices and essentially robust credit quality – albeit with a few pockets of stress.

It feels like it ought to be an incredibly solid investor-relations story for the sector. What are the banks hearing from investors domestically and globally?

REID International investors tend to have a broader perspective than we do domestically – we are ‘in the bubble’, so to speak, and of course the banking sector has been going through a tough time in Australia.

By contrast, offshore investors have witnessed the global banking community going through similar challenges over a long period of time. When we get past the obvious talking points of the royal commission and the housing market, we find that the conversations move on to the kinds of positive dynamics discussed by the RBA.

Most debt investors globally are certainly very happy to buy our bonds and are comfortable with how we stack up relative to our international peers. If anything, offshore investors would like to see more issuance from us. Luckily for them, they’re going to get quite a bit more subordinated issuance.

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Davison Are you talking about questions on the Australian TLAC framework or on the structural aspect of Australian tier-two?

MITCHELL Various, but including comparisons with other types of capital issuance that are somewhat removed from ours.

REID I imagine a strategy of not emphasising an education element should work fine in the US dollar market. But investors in other jurisdictions won’t be as conversant with the Australian banks, and indeed I’d like to think that tier-two issuance will bring new investors to Australia including in euros, yen and elsewhere in Asia. More education may well be needed in some of these cases.

IBOR TRANSITION

Perrignon How significant are the resources the banks are deploying internally to get to grips with the consequences of interbank offered rate (IBOR) transition?

BISCHOFF This is a major focus for the banks and we know the Australian Securities and Investments Commission is also very interested in how banks are responding and preparing. As major issuers in offshore markets, there is obviously a major funding element and perhaps an even bigger one on the customer side.

When it comes to funding, several of us have now issued sterling product benchmarked off the sterling overnight index average (SONIA). This is a well-established market and there is plenty of liquidity in it: we have issued almost £750 million (US$911.7 million) of one-year SONIA paper in the past week because the pricing relativities work, just as we would in any other market.

The US secured overnight funding rate (SOFR) is more challenging because it is not clear where the market is heading. We are not a significant market-making presence so we do not have the same impetus to push ahead with product.

We have seen a multitude of coupon conventions used in issuance, which makes it challenging to determine what is the appropriate longer-term convention for us to use. I think it’s coming, though, and I expect we will start to see certainty by early 2020.

Other markets are less progressed. It is very hard to see how the Eurozone meets a 2021 implementation timeline when it doesn’t even have market making in a new IBOR. Overall, our best approach is to watch each market individually and decide what to do on a case-by-case basis.

The main goal for us it to mitigate potential back-end risks and at the very least put appropriate fallback language in place to make sure we and our investors are appropriately positioned for any change that could happen.

BLACKSTOCK We have a group-wide team looking at IBOR transition and its workstreams include new issuance and the back book. There is a lot of work going on across the Commonwealth Bank of Australia (CommBank) group, in other words.

On the funding side, when we issued our first SONIA deal the main purpose was to test our own ‘plumbing’ – to check that we were ready for the change we know is coming. I agree that there is a little way to go with SOFR, in particular in the sense that there is more progress needed before we would be comfortable with the documentation and language. Europe feels a long way down the track.

In the Australian context, we are looking at what we might be able to do with Australian overnight index average (AONIA) as an alternative reference rate. Of particular relevance are the comments the RBA has made around one-month bank-bill swap rate (BBSW). As a large securitisation issuer, we are making sure we are able to react to investor demand or any regulatory impetus in this space. At the very least we need to make sure we have appropriate fallback language in place.

Davison Could there be a challenge to the competitiveness of the securitisation market if it uniquely transitions from BBSW in Australia? Local investors certainly seem to prefer BBSW, so if vanilla floating-rate notes continue to use BBSW as a benchmark but securitisation does not it could presumably have an impact on relative demand and thus pricing and liquidity.

BLACKSTOCK CommBank offered a three-month BBSW tranche in a securitisation deal a couple of years ago and we were a bit underwhelmed by the demand it attracted. This could certainly have been at least in part because investors wanted to buy the larger, more liquid notes. That would be a reasonable response.

Three-month BBSW is one of the alternatives under consideration in the securitisation market as it looks to replace one-month BBSW. But I think we also need to investigate other options, especially given the RBA is telling us to look for alternatives to BBSW in fallback language.

Our experience with investors so far has been mixed. Those with more international horizons – that have been buying UK residential mortgage-backed securities linked to SONIA, for instance – tend to have no issue with the idea of Australian product priced off the cash rate. Others haven’t looked at it as much.

It would be wrong to assume all investors are thinking the same way. There is a range of views, and also a variety of levels of interest and engagement with the discussion.

REID My hope and expectation is that Australia will end up with two robust benchmarks and that they will be used as appropriate. Bank funding and lending is probably best linked to BBSW while nonbank funding and lending is probably best linked to the cash rate.

I think the South Australian Government Financing Authority has done a fantastic job highlighting the issue of benchmark appropriateness in the process of getting its AONIA-based bond into the market. It’s not appropriate for a state-government financing vehicle to be issuing off the short-term bank funding rate, but it is entirely appropriate for ANZ to do so.

Mortgage-backed issuance could go either way. One-month BBSW has done a fine job and continues to do so – for now. Most investors are comfortable with it. But I wouldn’t consider it to be an issue if the securitisation market and even some corporate issuers – utilities, for instance – decided it was more appropriate for them to issue off the cash rate.

“My hope and expectation is that Australia will end up with two robust benchmarks and that they will be used as appropriate. Bank funding and lending is probably best linked to BBSW while nonbank funding and lending is probably best linked to the cash rate.”

Perrignon Will there be challenges around cross-currency swaps for offshore funding if the world evolves to using risk-free rates like SONIA and SOFR while the Australian bank market continues to use BBSW?

REID Probably. But I see it as a derivatives and hedging issue rather than one that influences Australian dollar floating-rate notes.

MITCHELL Ultimately we would still be talking about two cash flows where the price will change appropriately if one changes. What we’re talking about is the convenience or even the aesthetic of having similar benchmarks facing each other rather than a risk-free rate on one end and a credit benchmark on the other. It would not be as neat but I imagine the market will dictate what’s appropriate when it comes to hedging.

BISCHOFF What we have seen offshore tells us that regulators, the benchmark authority, issuers and market makers – predominantly banks – are all working together with a set of common goals to establish a market with liquidity and all the other necessary functionality. It is not easy, and we have seen it happening successfully in some jurisdictions and less successfully in others.

If we were to consider such a change in Australia all these parties would need to have a clear direction and motivation. This would help investors develop confidence in where the market is going and, ultimately, what they are buying.

MITCHELL I think investor hurdles to changing their format preference include having the infrastructure in place, being able to view relative value and having observable pricing differentials with a tradeable basis. Opacity creates reluctance to participate.

BLACKSTOCK We have been very pleasantly surprised by the rate of growth of liquidity, especially in derivatives markets, in other jurisdictions. This has been encouraged by regulators, to be fair. But I think we sometimes get too focused on the near-term obstacles with issues like this at the expense of thinking about the long-term benefit of where we are trying to get to.

In this case, some of the benefit lies in future-proofing our market. But we also saw bouts of volatility in BBSW last year, which had implications for a lot of our customers and other stakeholders. It isn’t lost on us that market volatility has a real impact on the bank’s customers. If there is a better way to do things we should certainly explore it.

Davison What views do banks have on forward- versus backward-looking risk-free rates (RFRs)? It has been hard to produce a forward-looking rate but if it were possible to do so in a credible and robust fashion would this be a superior outcome?

MITCHELL A forward-looking RFR would be easier because it would effectively replicate what we have now. The reason we’re moving away from what we have now, though, is the obvious issues around calculation methodology. A forward-looking RFR would need transactions occurring in that format and we currently don’t have this. Until we have transaction activity in a term sense it is going to be very difficult for the new benchmark world to adopt a forward-looking RFR.

REID I agree that a forward-looking format would be much better. But it doesn’t just need transactions – there is a whole framework needed to ensure the market is managed appropriately. A number of participants would likely not want to be involved in a market in which their transactions form part of benchmark calculation.

BLACKSTOCK I agree that a forward-looking rate would be simpler. But to be honest we haven’t found the backward-looking aspect particularly taxing in the two SONIA transactions we have done.

REID We can deal with it but we have been trading overnight index swaps for years. It might be a different story for investors and in the corporate loan market.

BLACKSTOCK The biggest question in Australia is what the regulators decide to do. If they determine that the market has to move in a particular direction it could change everything.

Credit growth and funding forecasts

Regulatory change, a housing-market correction and economic slowdown have all contributed to minimal credit growth in the Australian banking system. The big four are forecasting a pickup, but only at the margin.

PERRIGNON The regulator has expressed some concern about tighter financing conditions and lending standards playing at least some part in slow credit growth in the Australian system. Have the banks seen any transmission effect to credit provision from the relaxation of some macroprudential measures? How might this affect credit growth in the medium term?

REID Our chief executive has been very vocal lately with the view that all these factors have contributed to an overly risk-averse attitude to lending that has had an impact on credit growth – at least this is certainly the case at ANZ.

The changes to macroprudential policy, along with other factors, are supportive of credit growth. Another factor is banks simply getting a better handle on the changing environment for consumer lending in particular. Our view is that the market is off the bottom, and I believe we are forecasting 2-4 per cent annual credit growth.

It is not going to be a v-shaped recovery, though. We have been through a pretty painful period of adjustment and although we should be in better shape going forward I don’t think we are expecting to return to the higher growth levels we experienced, not recently but in the not-too-distant past.

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