Bank bond issuance could slow sharply

Markets do not appear to be pricing in the risk of a substantial slow-down in bank bond issuance
Christopher Joye

Coolabah Capital

Banks issue bonds to fund their balance-sheet growth alongside funding they source from deposits. Bank treasury teams are notoriously poor at forecasting balance-sheet growth and tend to suffer periods of under- or over-issuing. We are both observing and projecting a dramatic slow-down in Aussie bank balance-sheet growth, which could materially reduce both their senior and Tier 2 bond issuance needs in the next few years. 

There has been a striking slow-down in Aussie bank balance-sheet growth on a rolling, six month annualised basis from circa 10.6% per annum in April 2022, just before the RBA began to hike rates, to 4.2% per annum as at March 2023. The majors have been growing even more slowly at a 3.8% annualised pace over the half-year to March with Westpac only realising a sluggish 1.4% annualised lending growth over this same period.

Balance-sheet growth is likely to decelerate further to 2% per annum or less as the RBA's record 375bps of hikes begin to bite. There is also a real risk that the central bank continues to nudge-up rates given recent freedom of information disclosures that it considers a 3.8% cash rate (we are at 3.85% currently) to be the "neutral" cash rate that is unlikely to quell inflation sufficiently for it to meet its 2-3% CPI target by 2024 or 2025.

The question is what does this mean for the banks' bond issuance?

We model the banks wholesale funding needs, which includes all forms of debt issuance, and their Tier 2 bond requirements in particular. Our central case is that balance-sheet growth decelerates to 2'% per annum or less with the risk that we go through a period of no growth at all. The major banks are targeting holding Tier 2 capital worth about 6.5% of their risk-weighted assets. However, Tier 2 bonds are substitutable with hybrids or Additional Tier 1 (AT1) capital. And AT1 hybrid spreads are at historically low levels compared to Tier 2 bond spreads (ie, they are cheap for banks to issue whereas Tier 2 is expensive). The chart below shows the ratio of the spread of 5-year major bank hybrids compared to 5-year major bank Tier 2 bonds. It is normally around 1.8x. Today it is about 1.3 times.

So one might expect the major banks to issue a little more AT1 hybrid capital in the next year and a little less Tier 2. Consider CBA's new hybrid deal, launched today at 3% over the bank bill swap rate (BBSW) for an all-in yield of about 6.9% per annum franked.

The current coupon on the new CBA hybrid is 6.9% per annum, of which 4.8% is a cash payment before franking credits, which are worth 2.1%. The 4.8% cash cost to CBA represents a spread of 0.9% per annum above BBSW, which is much cheaper than issuing a Tier 2 bond at 2.35% above BBSW, as ANZ recently did. Post-tax, the cost is of course different.

So banks are targeting raising Tier 2 capital worth about 6.5% of their risk-weighted assets (RWA) by January 2026. At 3% annual balance-sheet growth, that implies about $17.5bn of issuance each year, which is almost exactly their average issuance volumes over the last 3-4 years. But if we likely see a combination of 1/ much slower balance-sheet growth of 0-2% per annum and 2/ a marginal substitution towards more AT1 hybrid issuance (noting there are no major bank maturities on the ASX this year that will encourage a pivot from T2 to AT1), then we could see less Tier 2 bond issuance. This could range from as little as $10.4bn ($2.8bn net) per annum (0% RWA growth and 6% T2) to $16.3bn ($8.7bn net) per annum (2% RWA growth and 6.5% T2).

Gross issuance

Net issuance

Investment Disclaimer Past performance does not assure future returns. All investments carry risks, including that the value of investments may vary, future returns may differ from past returns, and that your capital is not guaranteed. This information has been prepared by Coolabah Capital Investments Pty Ltd (ACN 153 327 872). It is general information only and is not intended to provide you with financial advice. You should not rely on any information herein in making any investment decisions. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. The Product Disclosure Statement (PDS) for the funds should be considered before deciding whether to acquire or hold units in it. A PDS for these products can be obtained by visiting Neither Coolabah Capital Investments Pty Ltd, EQT Responsible Entity Services Ltd (ACN 101 103 011), Equity Trustees Ltd (ACN 004 031 298) nor their respective shareholders, directors and associated businesses assume any liability to investors in connection with any investment in the funds, or guarantees the performance of any obligations to investors, the performance of the funds or any particular rate of return. The repayment of capital is not guaranteed. Investments in the funds are not deposits or liabilities of any of the above-mentioned parties, nor of any Authorised Deposit-taking Institution. The funds are subject to investment risks, which could include delays in repayment and/or loss of income and capital invested. Past performance is not an indicator of nor assures any future returns or risks. Coolabah Capital Institutional Investments Pty Ltd holds Australian Financial Services Licence No. 482238 and is an authorised representative #001277030 of EQT Responsible Entity Services Ltd that holds Australian Financial Services Licence No. 223271. Equity Trustees Ltd that holds Australian Financial Services Licence No. 240975. Forward-Looking Disclaimer This presentation contains some forward-looking information. These statements are not guarantees of future performance and undue reliance should not be placed on them. Such forward-looking statements necessarily involve known and unknown risks and uncertainties, which may cause actual performance and financial results in future periods to differ materially from any projections of future performance or result expressed or implied by such forward-looking statements. Although forward-looking statements contained in this presentation are based upon what Coolabah Capital Investments Pty Ltd believes are reasonable assumptions, there can be no assurance that forward-looking statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements. Coolabah Capital Investments Pty Ltd undertakes no obligation to update forward-looking statements if circumstances or management’s estimates or opinions should change except as required by applicable securities laws. The reader is cautioned not to place undue reliance on forward-looking statements.

Christopher Joye
Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs $7 billion with a team of 33 executives focussed on generating credit alpha from mispricings across fixed-income markets. In 2019, Chris was selected as one of FE fundinfo’s Top 10 “Alpha...

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