Time to review the government guarantee on bank bonds

The first quarter of 2009 has one week to run and issuance in the domestic corporate bond market is already greater than in any other quarter, at $22.8 billion.

The largest quarterly issuance seen previously was in the first quarter of 2007, with total issuance of $21.1 billion. This was when markets were still booming.

No doubt, the record breaking bond issuance of this quarter is the result of the government guarantee for bank bond issuance. All but $1.5 billion of bonds issued have been in this form.

This tells us that the government guarantee has been successful. But it also points to the fact that there is a great deal of money in the hands of investors, looking for a home.

Not all the investors that have participated in the government guaranteed bank bond issues have been real money investors. A proportion of them have been triple A-only buyers and some have been from offshore.

Nevertheless, there is evidence now of strong investor demand and that real money investors are looking for diversity, as last week's Australia Post and RBS deals demonstrate.

It is time to review the application of the government guarantee scheme.

Australia's scheme is a particularly generous one, being put in place for a period of three years and providing guarantees for bond issues with maturities out to five years.

The UK scheme was put in place initially for only six months, although this was subsequently extended to the end of this year. It only covers maturities out to three years but rollovers can be negotiated.

The US scheme is due to end on June 30, although there is talk of extending it. The US guarantee covers maturities out to three years.

There is talk of increasing the US guarantee fee. This would act to wean banks off the guarantee.
 
With the Australian scheme being under on-going review, perhaps consideration should now be given to also increasing the guarantee fee levied by the government. This would allow the banks still to use the guarantee in international markets, where it is probably still essential, but provide the incentive to consider more non-guaranteed issuance in the domestic market.

Such a move would be welcomed by the state governments. They would see it taking the pressure off their own credit spreads. It may also provide the opportunity to consider the use of a government guarantee elsewhere in the credit market.

For example, the Australian Office of Financial Management's support of the RMBS market seems to have been particularly ineffective in re-starting that market.

Without AOFM-bought deals being brought to market, there would be no RMBS issuance at all.

If the government were to guarantee the senior tranches of RMBS issues, it is a certainty that there would be considerable investor demand and it would relieve any mounting pressure on the government's own balance sheet.

It seems a better idea than giving concessional loans to investors to buy securitised assets.