CBA prints monster $4bn bond, biggest Aussie credit issue ever

Commonwealth Bank's recent $4 billion bond is the first big issuance of 2022, and the largest of its type in Australian history. It dwarfs the previous record holder from all the way back in 2005 by $500 million. Christopher Joye from Coolabah Capital shares his thoughts on the deal here. 
Christopher Joye

Coolabah Capital

CBA opened-up the Aussie bank debt issuance market for 2022 with a record $4 billion 5-year, senior bond transaction involving both a floating-rate ($3.1 billion) and an unusually chunky fixed-rate ($900 million) tranche. According to CBA, this is the largest bank or corporate bond issue ever consummated in Aussie dollars. 

Apparently the next largest was Mayfield Group (?), which issued a single tranche $3.5 billion deal in 2005. The $3.1 billion floating-rate tranche is also the biggest Aussie dollar single tranche from a bank (Westpac issued a $3.05 billion single tranche deal in 2015). 

We previously profiled the prospective CBA deal here. At the time, we argued that the secondary market fair value curve with no new issue concession was circa 70-71 basis points (bps) above the quarterly bank bill swap rate (BBSW). At it happened, CBA printed at 70bps above BBSW. (We were an investor in both tranches.) 

While for the issuer this is the cheapest 5-year senior bond in the post-GFC and pre-COVID period, it is materially more expensive than the miniscule 41bps spread above BBSW that NAB paid in August 2021 in a 5-year senior Aussie dollar deal that was always going to set a record low watermark for the banks' cost of senior capital. 

The main difference this time around is a much smaller bid from the bank balance-sheets. Since APRA announced the shuttering of the banks' Committed Liquidity Facilities, they no longer have $140 billion of cash that they can use to buy each other's bonds. Of course, there will still be some bids from smaller banks that are classified as Minimum Liquidity Holding (MLH) institutions rather than Liquidity Coverage Ratio (LCR) banks. MLH banks can continue to hold bank paper as a substitute for government bonds. LCR banks are now only allowed to hold government bonds.

And the demand for government bonds will be significant: on our modelling (click here), banks have to buy about $408 billion of government bonds over the next few years as the CLF comes to a close, balance-sheets continue to grow (driving regulatory liquidity needs), and the RBA destroys over $188 billion of digital cash as the banks repay the Term Funding Facility and bonds mature off the RBA's balance-sheet.  (This digital cash is currently included in the banks' LCRs and will evaporate over time.)

While CBA initially launched its new 5-year senior deal around our proposed target of 75bps (we suggested they print at between 75-80bps), they were able to grind the spread down to 70bps on the back of more than $5 billion of investor demand. This 70bps figure was exactly in line with our secondary fair value curve.

Dealers reported very little switching into the transaction, highlighting the substantial excess cash swirling around the financial system. There was some evidence of modest switching from bank paper, although nothing from other asset-classes like government bonds. On the break, CBA's new deal performed strongly with some dealers bidding as tight as 66.5bps over BBSW, although it seemed to settle at a bid around 68.5bps. 

CBA's landmark transaction will presumably pave the way for other bank issuers, including both the majors and the regionals, although the majors have the luxury of issuing in multiple currency formats. In the first week of January, NAB issued US$4.75 of bonds in US dollars (we participated) with the 5-year issue swapping back to Aussie dollars around 70-71bps (ie, in line with the CBA trade). NAB also printed a GBP$1.5 billion covered bond. There is little doubt that there is tremendous global demand for Aussie bank paper. 

When the $140 billion CLF bid was there to keep Aussie dollar bank bond spreads tight, they used to trade inside, or tight to, equivalent Aussie bank issues in US dollars and Euros. The closure of the CLF will likely see domestic spreads normalise in line with global counterparts. This has already happened with the Aussie 5-year senior curve very similar to the US dollar curve right now (historically it traded tight to the US curve).

One interesting feature of the CBA deal was the $900 million fixed-rate tranche, which is the biggest observed in years. Prior to the GFC, most bank and corporate bond issues were in fixed-rate format. But the advent of the CLF meant that bank buyers of bonds wanted floating-rate issues since banks hedge all their assets to a floating-rate return. 

This drove a surge in floating-rate issuance in the post-GFC period. As long-term interest rates climb, and the CLF disappears, it would be reasonable to expect banks to tap into deeper fixed-rate demand with larger fixed-rate tranches, which they can then swap back to floating-rate format.

Demand for fixed-rate issuance is being amplified by APRA’s decision to benchmark super funds’ investment performance against a fixed-rate as opposed to floating-rate bond index, namely the AusBond Composite Bond Index. There has been substantial shifts of super fund capital from floating-rate to fixed-rate strategies to minimise tracking error to the Composite Bond Index benchmark. This will in turn fuel demand for fixed-rate rather than floating-rate bond issuance, which offshore and bank issuers can hedge to floating-rate.

Another consequence of the rise of fixed-rate Composite Bond Index strategies will be an increase in the demand for the assets included in the index, which is mainly comprised of Commonwealth and State government bonds with only circa 7-8% allocated to credit. As we have previously written, this begs the question as to how super funds can comfortably beat the index (and accordingly pass APRA's terrifying performance tests) with relatively low tracking error. The most obvious solution is simply tilting Composite Bond strategies towards higher-yielding members of the index. Our findings were summarised below (read more here):

What we find is that a portfolio 75% weighted to State government bonds (proxied by the relevant duration-matched AusBond indices) and 25% in credit (proxied by the duration-matched AusBond Credit Indices) beats the Composite Bond Index by 0.56% annually over the last 10 years with almost identical volatility of 3.74% pa (vs the index volatility of 3.71% pa). It therefore has a superior Sharpe Ratio of 0.86 times (vs the index's Sharpe of 0.71 times). It also has a low tracking error to the index of just 0.40% pa with a high Information Ratio of 1.39 times. 

One concern with just loading up on credit, however, is the illiquidity risk, which was exemplified in March 2020 when many Aussie credit funds de facto froze. The risk of liquidity shocks has been amplified with the precedent of the Commonwealth government allowing super fund members to release their savings early, as occurred in 2020, forcing many super funds to liquidate assets. (Some discovered that they were carrying too much illiquidity in the form of unlisted assets that were difficult, if not impossible, to dispose of.)

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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