Positioning for the looming bond supply shock

Christopher Joye

Coolabah Capital

One significant event risk that we have been actively positioning for is a tsunami of senior bond issuance from Australia’s banks as they seek to gradually repay the $180 billion they will have eventually borrowed under the Reserve Bank of Australia’s three-year term funding facility (TFF).

In contrast to the consensus, we forecast that this wave of supply would start hitting before June 30 when the TFF expires. In March I asked two major bank treasurers at The Australian Financial Review Banking Summit what their expectations were for senior bank bond issuance, and both guided towards the second half of the year.

The day I posed this question, ANZ broke the drought with a one-year senior deal in Aussie dollars, which was followed by a five-year issue by Macquarie Group in the UK. And this week we had Bank of Queensland launch the first five-year senior bank issue in Aussie dollars in a very long time. (Banks have not needed to borrow from debt markets, given they had so much cheap funding available via the TFF.)

Earlier this year our analysts built detailed financial models that allowed us to forecast the quantum of senior bank bond issuance that will be required as a function of two crucial variables: balance-sheet growth and changes in deposit funding.

The enormous surge in deposits that flooded into the banking system in 2020 reduced the need for banks to issue wholesale bonds. Assuming, however, that this starts to slow down while balance sheets expand more rapidly on the back of the housing boom and a recovery in business lending, it is easy to arrive at the conclusion that the major banks alone will have to issue more than $150 billion of senior debt over the next few years.

This supply shock should result in the cost of five-year debt normalising from its historically low level around 45 basis points, which has not been seen since 2007, back to the 70 basis point area that represented the low-watermark for these spreads in the post-crisis period.

There are complex nuances that influence this analysis. First, the banks will not likely issue much, if any, three-year paper because they need to extend their liabilities beyond the three-year repayment date of the TFF to avoid concentrated refinancing cliffs. This is why we are predicting longer tenor issuance with a focus on five-year deals in Australia and 10-year deals in US dollars and euros.

Second, the banks will have to shift more of their funding offshore given they will be restricted from being the biggest buyers of their own bonds in Aussie dollars as the Australian Prudential Regulation Authority winds-back the committed liquidity facility (CLF).

When Australia had few government bonds on issue, the RBA and APRA created the CLF as a substitute. But with massive coronavirus-induced issuance, now underscored by the federal government’s military procurement needs, there is no real need for the CLF.

This eliminates what has historically been the single-biggest buyer base for senior-ranking Aussie bank bonds: the banks themselves.

Possible Rating Upgrades for Tier 2 and Hybrids

A related development over the week was Standard & Poor’s banking analysts making a raft of changes to their credit rating assessments. S&P has upgraded the “negative” economic risk trend for Australia to “stable” (as we had suggested) while also upgrading the banking sector’s industry risk score from “stable” to “positive”, which was a welcome surprise.

S&P advises that there is now a one-in-three possibility that it will lift Australia’s Banking Industry Country Risk Assessment (BICRA) score to put our financial system alongside Canada, Singapore and Switzerland in safety terms. Bizarrely, S&P reckons that a now non-democratic Hong Kong is the safest banking jurisdiction in the world, which is exhibit A in farcical rating agency decisions.

If S&P does belatedly decide to normalise Australia’s BICRA score to being equal with Singapore and Canada, it would trigger a chain reaction in ratings. The major banks’ Tier 2 bonds would jump from BBB+ to A-. Their hybrids would likewise lift a notch from BBB- to BBB. While the major banks’ senior bond ratings would not change, all regional banks would benefit from rating upgrades to their senior, subordinated and hybrid ratings.

A final word on last week’s inflation data. It was obviously very weak, shocking the market, and underscored how much heavy lifting the RBA has to do to get employment and wages growth running at a level that can sustain consumer price inflation within its target band. It was therefore unsurprising to see Toronto-Dominion Bank raise its forecast for the RBA’s third round of quantitative easing from $50 billion to $100 billion, joining Westpac and ourselves, among others.

If any of the above analysis is news, you should consider getting superior advice.

Access Coolabah's intellectual edge

With the biggest team in investment-grade Australian fixed-income, Coolabah Capital Investments publishes unique insights and research on markets and macroeconomics from around the world overlaid leveraging its 13 analysts and 5 portfolio managers. Click the ‘CONTACT’ button below to get in touch

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 www.coolabahcapital.com. 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.

2 topics

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...

I would like to

Only to be used for sending genuine email enquiries to the Contributor. Livewire Markets Pty Ltd reserves its right to take any legal or other appropriate action in relation to misuse of this service.

Personal Information Collection Statement
Your personal information will be passed to the Contributor and/or its authorised service provider to assist the Contributor to contact you about your investment enquiry. They are required not to use your information for any other purpose. Our privacy policy explains how we store personal information and how you may access, correct or complain about the handling of personal information.


Sign In or Join Free to comment