Global alignment of tier-two cost
It is hard to quantify the price global markets charge Australian banks for tier-two relative to what it would be if the same issuers had access to a more senior instrument for loss-absorbing capacity purposes. But intermediaries agree the Australian majors are paying more than banks in other jurisdictions for capital that performs the same purpose.
Ollie Williams, managing director, head of debt capital markets Australia and New Zealand at Citi, says US money centre bank TLAC [total loss-absorbing capacity]-eligible holdco senior debt generally trades at a materially smaller premium to the same issuers’ senior opco-level issuance when compared with the difference between Australian major bank tier-two versus senior bonds. “Tier-two is an expensive form of TLAC financing from a relative global perspective,” Williams confirms.
In theory, Australian major bank tier-two should price somewhere in the middle of where equivalent banks in other jurisdictions price ‘tier-three’ and tier-two, given it performs both roles. Dealers say it is hard to quantify the mispricing, but they are convinced Australian banks’ tier-two is not given sufficient credit for not being subordinated to an additional layer of capital.
“Investors arguably do not give enough credit to Australian bank tier-two ratings, as they compare favourably to global peer group TLAC,” says Gerard Perrignon, managing director, debt capital markets at RBC Capital Markets. “The counterargument is that it is a case of supply and demand, and investors are more concerned right now with the regulatory build out to a full 6.5 per cent of RWAs [risk-weighted assets] via tier-two issuance”.
“Tier-two is more expensive than what is being used to solve for TLAC in other jurisdictions and the five-year non-call minimum duration aspect is an extra imposition on tier-two borrowers.”
The reality is that tier-two pricing is such a small slice of the capital and funding stack that banks may simply have to live with the global issuance circumstances created for them by regulators and investors alike.
“Deposits account for the majority of funding for all the major banks and tier-two is only a small part of the whole portfolio,” says Duncan Beattie, managing director at Barclays. “The cost of tier-two is very important, but it has to be considered in context. Deposits move the dial more than one or two tier-two trades.”
On the other hand, Williams believes the cost is very relevant. “The banks have to meet a 6.5 per cent RWA tier-two target by 2026 – which is a relatively material amount of tier-two to hold on a global scale,” he says. “Tier-two is more expensive than what is being used to solve for TLAC in other jurisdictions and the five-year non-call minimum duration aspect is an extra imposition on tier-two borrowers.”
This means elevated cost of funds will likely linger even after 2022’s challenging market conditions have dissipated. Williams tells KangaNews: “The banks are locking in TLAC funding that will be on the balance sheet for the next five years or more, depending on the structure chosen.”
