In August 2018, the Commonwealth Bank raised $3.5bn by issuing a dual tranche three and five year bond deal at a credit spread of 73 basis points (bps) and 93bps (respectively), in what was the largest corporate bond transaction since the Global Financial Crisis. Three months later Westpac took over this mantle with a dual tranche deal that raised $4.25bn for the bank, at a credit spread of 73bps and 95bps.
Flashing forward three months to 28 November, and ANZ has issued a $3.25bn dual tranche three and five year bond deal. While smaller than the other two major bank bond deals, what is noteworthy about this issue is not the size of the transaction, but the size of the credit spread the bank had to pay investors.
When the ANZ treasury team decided to launch their new five year bond deal, it was launched at a credit spread of 105bps. This is a meaningful difference from where secondary market pricing was and we suspect that this new issue premium was designed to ensure that ANZ would be able to attract the level of demand it required.
In effect the bank traded off a higher credit spread for execution certainty and this worked. They printed $3.25bn in total, with the five year tranche being $2.25bn in size and priced at a credit spread of 103bps.
While Westpac’s five year bond had become the new proxy for all major bank five year bonds, they were being marked at a credit spread of approximately 97bps in the secondary market just prior to the launch of the ANZ transaction. As weakness in credit markets over the last couple of weeks had caused this spread to widen, ANZ needed to provide an ample premium for its five year bond to drive investor demand.
A few observations from this transaction:
- Earlier in November, APRA announced its proposals for the adoption of loss-absorption for Australian banks, with a focus on increasing the amount of Tier 2 subordinated debt in the coming years. All things equal, this would be a positive for major bank credit spreads, although there is no evidence of this when looking at the credit spread from the ANZ deal.
- This trade-off in credit spread for execution certainty may point towards ANZ’s perception of how funding markets will perform over the next couple of months. If they thought there is likely to be increased volatility, combined with negative sentiment, then it would be prudent to pay the additional credit spread to achieve their funding task ahead of this.
- We don’t see this increased cost being related to the short term funding cost squeeze that took place earlier in the year. However, there remains a real risk that this pressure point will return in the coming months.
The one certainty is that bank funding costs have risen throughout 2018. Chart 1 shows the movement in the three month bank bill swap rate (BBSW) since the start of 2017.
While the current level of 1.94% is below the 2.11% peak reached in late June, it is well above the 1.80% that existed at the start of the year. Not only does this impact short term funding costs, but also long term funding costs, as the credit spread the banks pay is an additional cost on top of this three month BBSW level.
Chart 1: 3 month Bank Bill Swap Rates Source: Bloomberg, Janus Henderson Investors. As at 28 November 2018.
Turning our attention to five year major bank credit spreads, Chart 2 shows the performance since the start of 2017, illustrating the significant spike in this spread in the last month, but also the general direction of spread widening over the course of 2018.
Chart 2: Australian major bank five year FRN traded margin Source: Bloomberg, Janus Henderson Investors. As at 28 November 2018.
In March this year, when credit spreads spiked to 95bps, it was difficult for asset managers to acquire a significant amount of bonds at these levels, as few bond holders were willing to sell. With recent primary market deals being at this level (or in ANZ’s case even wider), it has given the opportunity for investors to purchase senior bonds that are meaningfully wider in credit spread compared to the start of the year.
We should not be surprised that the combination of weakness in the housing market, a reduction in the pace of credit growth, the impact of the Royal Commission and a general weakness in global credit markets is affecting major bank credit spreads. While this increase in funding costs will impact bank profitability (not taking into account any further adjustment to lending rates), we still see major bank credit profiles as being robust.
It is market movements like these that create opportunities, and we feel that major bank senior credit spreads represent value at these levels and have added the new ANZ bond to our portfolios as a result.
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