Australian banks return to bond market to drive up costs and squeeze margins

Australian banks will face increased pressure on their margins in the coming years as they will have to replace around A$190 billion of central bank subsidized funding with more expensive funds raised in the bond market.

The three-year Term Funding Facility, or TFF, provided by the Reserve Bank of Australia to help local banks with cheaper money weather the pandemic, will mature between March 2023 and June 2024. banks will then have to rely more on bond markets after two years of relatively weak debt issuance. With interest rates expected to rise, banks will have to pay more for new financing.

“I expect further margin compression unless they can recoup the costs of rising mortgage rates, which they are trying right now,” said Martin North, director of Digital Finance Analytics. Banks must repay the TFF over the next two years, North noted.

The TFF has helped to cushion some of the impact of the pandemic on banks’ net interest margins, which have trended lower for Australia’s major lenders in recent years as the key interest rate fell at a record high. For example, Commonwealth Bank of Australia, the country’s largest bank by assets, saw its NIM fall to 2.03% in the financial year ending June 2021, from 2.15% three years earlier. .

Even when the benchmark spot rate begins to rise, banks may not be able to charge customers higher interest as home buying has begun to subside after house prices rise. at a record pace in 2021.

Cheap funds

“Banks have been able to fund loan growth and replace maturing debt with customer deposits and the term funding facility in recent years,” Morningstar equity analyst Nathan Zaia told S&P Global Market Intelligence. This may not change significantly in 2022, but “banks are likely to be even more active from 2023 and into 2024 as they begin to refinance drawdowns on the Term Funding Facility,” he said. Zaia said.

Funds under the TFF were initially made available at a fixed rate of 0.25% when it was introduced in 2020. As the The Reserve Bank of Australia, or RBA, lowered the cash rate to 0.1% during the pandemic to support the economy, the TFF rate was also lowered in line with the benchmark. The TFF was closed to new draws in June 2021.

The Commonwealth Bank of Australia saw its issuance in the debt market fall to 2.16 billion Australian dollars in 2021, from AU$8.50 billion in 2019.

Higher issuance costs can impact banks’ funding costs over time as banks issue more new debt, as this issuance is more expensive than maturing or existing funding.” , the RBA said in a March 17 report. Overall, bank lending rates have fallen more than funding costs in 2021, partly due to competition in home loans, as well as a shift to lower-margin products, a- he declared.

Big banks have not issued new bonds, which account for the bulk of their wholesale funding, until the first quarter of 2021, the RBA said. However, as banks started issuing more bonds in the second half of 2021, their costs also started to rise.

Australia’s banks’ overall funding cost had already risen by around 100 basis points as some lenders tapped bond markets in the second half of 2021, analysts said.

Normal levels

Australia and New Zealand Banking Group Ltd., or ANZ, the country’s second largest bank by assets, expects financial institutions to return to more normal levels of debt market issuance in 2022. The bank expects the issuance level of financial institutions to reach 53 Australian dollars. billion, up from A$28 billion in 2021, ANZ’s head of capital markets, Paul White, told the Australian Financial Review.

ANZ’s own debt issuance in 2020 was A$1.86 billion, up from A$5.06 billion in 2019. In 2021, the bank’s debt issuance increased to 2, 22 billion Australian dollars.

Australian lenders may be able to borrow overseas unless their access to offshore funding is disrupted by a dislocation in global financial markets, for example due to geopolitical tensions, said Sharad Jain, analyst at S&P Global Ratings. “We expect banks will not face major challenges in their funding task, based on recent trends as well as track record,” Jain said.

Australian bonds will also be attractive to investors looking for capital stability, as the economy of the commodity-supplying country could pick up speed in 2022.

“Australian bond yields are likely to be the most sought after and will see a surge in demand as interest rates rise for the first time in 14 years,” said Jessica Amir, Australian market strategist at Saxo Markets. This would support returns as investors seek better yields, Amir told Market Intelligence.

Admittedly, Australian banks do not need to raise funds for their capital requirements, as their common Tier 1 capital ratios remain well above the minimum regulatory requirement of 8%.

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Julio V. Miller