Expectations were high when the enabling legislation to allow Australian banks to issue covered bonds passed through Canberra’s parliament in October.
For banks, there was the prospect of a new, cost-effective, diversifying funding source. For US and European investors, there would be exposure to one of the most secure, steady and reliable banking sectors in the world – in the agreeably high-ranking form of a covered security.
However, it didn’t work out like that. In November, ANZ became the first Australian bank to launch a covered bond, swiftly followed by Westpac. From the issuer’s perspective, they were successful: they raised $2.25 billion between them at attractive terms.
Yet within 10 days, both deals were being bid 30 basis points outside their reoffer. Granted, markets were exceptionally difficult, but there was also a sense that the Aussies, galvanized by their strong domestic standing, had demanded pricing that was too tight for their role as vanguards of a new market.
In the fallout, Commonwealth Bank of Australia cancelled a planned deal in euros; National Australia Bank, the first of the big four to roadshow and announce a planned deal, has still not formally mandated one.
There has been a great deal of finger-pointing among the issuers and their lead managers – ANZ, Citi, Nomura and UBS on the ANZ deal; Barclays, Bank of America Merrill Lynch and Westpac on the Westpac deal. Some blame the issuers, others the bookrunners.
| "Investors were disappointed by the spread-widening seen after the launch. They thought that the pricing pushed the envelope a bit too much – especially for inaugural covered bond deals from an inaugural covered bond market" |
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"Investors were disappointed by the spread-widening seen after the launch of the first Australian covered bond issues," says Ted Lord, managing director at Barclays Capital. "These investors have strong confidence in the Australian banking system, but they thought that the pricing pushed the envelope a bit too much – especially for inaugural covered bond deals from an inaugural covered bond market." There is also a sense of Australians not having properly conveyed the strength of their own system to investors who are used to troubled European banks. Australian banks weathered the financial crisis better than any developed nation bar Canada; they still pay dividends and have a great economic story underpinning them. However, that’s not obvious to European investors.
In particular, there is a feeling that Australian banks were so intent on beating each other on pricing that they missed the broader point: a favourable start to a new market that will be important to all of them. "The investor market really wants to have a very strong, successful Australian covered bond market, because people feel comfortable about the country, the banks and the future, but they want the process of creating this to be much more collaborative," says Lord. "That’s the message."
The prize is potentially big. The Australian Prudential Regulation Authority limits covered bond issuance to 8% of total-system resident assets for each bank. "That could equate to about A$160 billion ($164 billion) for the major Australian banks overall if they maxed out capacity," says Fergus Blackstock, head of debt capital markets at UBS in Sydney. "Everyone will maintain a slight buffer inside that, which brings it down to about $120 billion. Most issuers are probably going to try to build up to that and not do it all at once, but you could still expect to see about A$5 billion per major bank per annum."
For banks, there is every reason to participate in this market as fully as they can. "Covered bonds will form a core part of funding," says Blackstock. "They will still do senior deals and RMBS, but covered bonds will be another string to the bow."
Blackstock, having worked on the ANZ deal, attributes the reception to the fact "the markets were tough and just getting tougher. We were pleased with the way the ANZ transaction went: the initial primary subscription was strong, we were oversubscribed with $1.45 billion in the book, and the performance immediately on the break was pretty strong. But then the market deteriorated."
In his view, all regular comparables issuers – the Scandinavians, the Canadians – were under similar pressure. "Timing was unfortunate," he says. "Legislation came through at the point when markets were really turning, and ANZ managed to hit what turned out to be a very small window."
Blackstock accepts that "with the underperformance of the initial bonds, we need to make sure, as the market stabilizes, that performance can come back. New deals will have a chance to perform in a better market and put the product back on track." However, he adds: "There’s not a material hole in the covered bond product that needs addressing."
Is it realistic to expect a group of banks that compete vigorously among themselves to collaborate in building a successful funding market? Lord points to Germany, Sweden and the UK as examples of places where this has happened.
When markets stabilize and shelved deals return, it will be interesting to see whether issuers are prepared to leave a little more on the table for the greater good. It is in their interests to have happy investors – and not just because of the established European and US buyers.
"Several Asian central banks are now finalizing plans to invest in covered bonds for the first time," says Lord. "Australian issuers will probably enhance that, because Asian investors – whether banks, pension funds, insurers or central banks – have a good and comfortable knowledge of Australia."
As another banker, not involved in the first two trades, succinctly puts it: "It would be nice if they don’t screw up the market before it has even started."
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