Weak NAB pays a tier two premium in the Euromarket

National Australia Bank last week became only the second bank of the four majors to issue Basel III compliant tier two subordinated debt in an international market.

The bank sold €750 million from the sale of ten year non-call five, subordinated bonds in the Euromarket and paid 165 basis points over mid-swaps to do so.

In March, ANZ sold US$750 million of ten-year non-call five, subordinated bonds in the US s144A market, at a spread of 180 bps over US Treasury bonds. The proceeds from the ANZ issue are understood to have swapped back into Australian dollars at a spread of 218 bps over bank bills.

ANZ's US subordinated bond issue came less than a week after Westpac had sold subordinated bonds in the domestic wholesale market at a spread of just 205 bps over bank bills. ANZ paid a premium of 13 bps to get its deal done in the US.

The week before last Commonwealth Bank became the third of the four major banks to issue the new style subordinated debt in the domestic market. CBA raised A$1 billion at a margin of 195 bps over bank bills.

Perhaps, in deciding to go to the Euromarket last week, NAB felt it would be unable to raise the volume required in the domestic market coming so soon after CBA.

The €750 million raised equates to almost A$1.1 billion but the swapped back cost comes out 235 bps over bank bills, according to a report in the International Financing Review.

NAB paid a massive 40 bps premium to go to the Euromarket. It is highly likely that domestic investors would have snapped-up a second A$1.0 billion subordinated debt issue in a week, for a premium of just 20 bps, and probably even less.

Of course this would have set an unwanted precedent in the domestic market. But then NAB has set an unwanted precedent in the Euromarket, which should ensure that none of the major banks will go there any time soon to issue Basel III compliant subordinated debt.

This raises the question: why did NAB choose to go to the Euromarket, when the pricing achieved by the ANZ in the US 144A market, earlier in the year, did not incorporate such a premium? Perhaps conditions in the US have changed but, according to the International Financing Review, NAB had to pay-up in Europe because of uncertainty over the operation of the non-viability conversion trigger in the bonds.

The operation of the non-viability trigger in subordinated bonds and Additional Tier 1 capital is covered by legislation in the euro-zone. The legislation specifically gives the ECB and local banking regulators authority to act at the point of non-viability and force the conversion or write-off of the bonds.

There is no such legislation in Australia. APRA simply has the discretion to act at the point of non-viability, which it has refused to define.

The difference between the two systems is referred to as statutory non-viability and contractual non-viability.

The intention of both systems is the same - subordinated debt subject to non-viability conversion or write-off is gone concern capital. It is there to provide additional loss-absorption capacity at the time of resolving a failing bank.

It is not going concern capital that can be converted to equity before a bank fails.

This, however, brings us to the nub of European investor concerns - seemingly they don't trust APRA.

As long as non-viability remains undefined by APRA, the Europeans don't trust APRA not to pull the non-viability trigger before the point of non-viability has been reached - thereby treating their gone concern capital as going concern capital.

This may be misplaced. The legislation dealing with non-viability also leaves a lot of discretion with the ECB and local regulators.

This is simply a case of European investors exploiting NAB's position of weakness.