Analysis: NAB paid a realistic price for three-year debt

Philip Bayley
In January, National Australia Bank raised A$1.0 billion for three years in the domestic bond market at a credit spread of 75 basis points over bank bills.

That 75 bps now seems cheap. That fact illustrates how the cost of funds has changed for the major banks both since the global financial crisis and now we are in the midst of a eurozone sovereign debt crisis. Five years ago, before the GFC, funds were cheaper still: in March 2006, NAB paid just six bps over bank bills for three-year funds in the domestic market.

On Tuesday, NAB paid 130 bps over bank bills to raise A$800 million for three years.

But the NAB did not pay too much. Yes, the credit spread was above comparable secondary market levels of around 110 bps, but is this really representative of where the market is, when secondary market trading is so thin?

It should be noted that NAB's issue was priced exactly in line with where Australian Rail Track Corporation priced two issues of three-year floating rate notes over the prior two weeks. Both issuers are rated Aa2 by Moody's Investors Service and this year real corporates have been able to raise debt at better rates than the banks.

Lastly, three-year credit default swaps for the major banks were at 137 bps on Tuesday. NAB paid what it needed to raise A$800 million.

Bank CDS spreads

Bank CDS spreads

It is presently being widely said that wholesale debt markets, both international and domestic, are closed - that the banks cannot issue bonds.

NAB's domestic floating-rate note issue shows that the domestic debt market is not closed and that investors are there, ready to take up issues as they come. The same is true of the international markets as well, especially for bank issuers of the quality of the major Australian banks.

The determining factor for whether the banks issue into wholesale debt markets is the price that they are willing to pay. This is why there has effectively been a drought of issuance during the second half of 2011.

The cost of debt for the banks in wholesale markets has again widened dramatically to levels beyond what the banks were paying at the height of the GFC.

In December 2008, when the Australian government guarantee of the banks' wholesale debt was first used, the major banks were able to raise five-year debt at a spread of 190 bps over the benchmark rate (swap or bank bills). This price included the 70 bps guarantee fee.

Pricing on the recent covered bond issues of ANZ and Westpac translates into an effective cost for five-year unsecured debt of around 220 bps over the benchmark rate.

In the first half of 2011 the banks issued just under A$15 billion of bonds in the domestic market, putting them on track for a total issuance of A$30 billion for the year. This would have aligned closely with the A$31.5 billion of issuance seen in 2010.

Similarly, in international markets, the banks raised more than A$42 billion of debt in the first half of the year and this should have resulted in a total of, say, A$84 billion for the year. For 2010, the total was A$81.2 billion.

In the second half of this year, issuance has fallen away to A$7.1 billion in the domestic market and A$13 billion in international markets. This issuance has been opportunistic, based on what market conditions have allowed, and much has been in the form of private placements in international markets.

Some traditional pools of buyers will still buy term paper. That's the case in Japan, where Commonwealth Bank is marketing a ¥50 billion (A$647 million) five-year bond this week, as Bloomberg reported yesterday.

As Ric Battelino, the deputy governor of the Reserve Bank of Australia, noted in a speech yesterday, "the main effect of the European crisis on Australian banks is through the increased cost of funds in global markets. As debt has become more expensive, Australian banks have reduced their issues of long-term debt sharply."

Battelino rightly noted that "short-term debt remains more readily available, particularly in the United States, where money market funds have shifted their investments from European banks to Australian, Canadian and Japanese banks".

The volatility evident in the chart of five-year credit default swap spreads for ANZ, illustrates why debt issuance by the major banks will continue to be opportunistic for some time to come. In the meantime, the relative cost of borrowing from the banks can be expected to increase.