Bloomberg News

Lenders Turn Global Favorite in Default Swaps: Australia Credit

September 29, 2011

Sept. 29 (Bloomberg) -- Australian banks increased their advantage in credit-default swaps over global peers this quarter by the most in two years as bad loans fell and lenders led by Commonwealth Bank of Australia cut overseas borrowings.

While the average cost to insure the bonds of Australia’s four biggest banks rose to 216 basis points yesterday from 129 on June 30, the global average jumped to 378 from 236, according to data from Bloomberg and CMA. The Australian lenders’ discount grew 55 basis points, the largest such increase since at least 2009, and their advantage over six major U.S. banks is at the largest since May 2010.

Australia’s top four banks avoided state bailouts when funding froze worldwide in 2008 and posted a 17 percent jump in profits in their most-recent half-year reports. The lenders cut reliance on overseas debt markets to the lowest since August 2009 after Moody’s Investors Service cited that dependence when lowering their ratings in May. That’s allowed the banks to avoid debt sales during the latest European debt crisis.

“They’re well capitalized, their asset quality is sound, they’re profitable and they’ve reduced their dependence on wholesale funding,” said Michael Korber, who manages A$6 billion ($5.9 billion) in cash and fixed-income assets as head of credit at Perpetual Ltd. in Sydney. “Aussie banks’ credit quality is quite robust.”

The extra yield investors demand to hold Commonwealth Bank’s $1.75 billion of 3.5 percent notes due in March 2015 instead of government debt jumped 64 basis points this quarter to 200, Royal Bank of Scotland Group Plc and Bloomberg prices show. The notes were issued at a 120 basis-point spread in March 2010, according to Bloomberg data.

Yield Premiums

The yield premium on Bank of America Corp.’s $2.5 billion of 4.5 percent securities due April 2015 surged 273 basis points to 501 in the same period, RBS and Bloomberg prices show.

Corporate spreads have expanded as concerns that Europe won’t contain the fiscal crisis that started in Greece spurred rallies in U.S. Treasuries and Australian government debt. The benchmark Australian 10-year yield fell two basis points, or 0.02 percentage point, to 4.26 percent as of 4:35 p.m. in Sydney, paring its decline since Aug. 31 to 11 basis points. The premium over similar-dated Treasuries narrowed four basis points to 232.

The Australian yields are poised for a ninth month of declines, the longest stretch of declines since at least 1978.

The Australian dollar is weakening for a second month, trading at 98.15 U.S. cents as of 4:40 p.m. in Sydney. The so- called Aussie, the world’s fifth-most traded currency, reached a post-float record of $1.1081 on July 27.

Traders are betting the Reserve Bank of Australia will lower its benchmark interest rate from 4.75 percent to 4.08 percent by year-end, as concern that Greece will default roils global financial markets.

Greece-Resistant

Australian banks have no investments in Greece, compared with $56.7 billion owed to French banks, according to data from the Bank for International Settlements as of the end of 2010. Meanwhile, Australia’s economy grew 1.2 percent in the second quarter, the most in four years, driving earnings at the biggest banks and making defaults by customers on bank loans less likely.

“It’s a combination of the macro and the micro,” said Mark Mitchell, head of credit at Sydney-based Kapstream Capital, which manages A$4.2 billion of assets. “Australian banks have negligible exposure to mainland Europe, the Australian economy is doing quite well and the triple-A rating is not at all under threat. But it also comes down to the quality of their assets.”

Profits Climbing

The four biggest lenders -- Commonwealth Bank, Westpac Banking Corp., National Australia Bank Ltd. and Australia & New Zealand Banking Group Ltd. -- reported aggregate profits of A$12.4 billion in their latest half-yearly results, the central bank said in its financial stability review on Sept. 23. That’s about A$1.6 billion higher than a year earlier, mainly due to declines in bad and doubtful debt charges, the RBA said.

The biggest mining boom since the 1850s and interest-rate increases by Australia’s central bank have helped drive up the nation’s currency 13 percent against the U.S. dollar in the past two years.

As global equity markets sink and soar by unprecedented margins, Australian consumers are saving the most ever, lured by the developed world’s highest benchmark interest rate. Term deposits surged to a record A$469.5 billion in July, the most relative to offshore bank debt in data going back to 1984.

Growing Deposits

Ralph Norris, chief executive officer of Commonwealth Bank, said in Sydney on Sept. 26 that the lender was so well funded it wouldn’t have to raise financing in wholesale debt markets until next year.

“Over the last 12 months or so, the growth of lending in Australia has largely been covered by internal deposits,” Norris told reporters that day. “That means we’ve been overfunded in deposits, which means we’ve been able to pay down some of our wholesale and offshore debt. We are strongly placed to weather any storm that may occur as a result of what’s happening in Europe.”

The spread between the interest Australian banks pay when borrowing from each other for three months and swaps tracking expectations for the RBA’s benchmark expanded three basis points to 38 basis points. The gap, a gauge of banks’ difficulty in accessing funds, closed at 61 on Aug. 8, the highest since January 2009.

Lack of Sales

Westpac’s sale of 100 billion yen ($1.3 billion) of notes on Aug. 4 was the last benchmark offering by one of the top four lenders, data compiled by Bloomberg show.

On existing debt, the spread on Australian-dollar bonds sold by financial companies was the lowest relative to global peers since July 2009 on Sept. 23, according to Bank of America Merrill Lynch data. While Australian yield premiums increased 19 basis points to 248 this month, those on global financial debt have climbed 53 basis points to 346, the data show.

Australian lenders’ outstanding borrowings from overseas dropped to A$314.1 billion in July, the least since August 2009, according to data from the RBA. Still, banks will have to return to debt markets at some stage, and that reliance remains their biggest potential weakness, according to Mitchell at Kapstream.

“The most significant threat is the funding pressure,” he said. “To the extent that their funding ever dries up, they are going to struggle. To date, that hasn’t been an issue.”

--With assistance from Sarah McDonald in Sydney. Editors: Malcolm Scott, Garfield Reynolds

To contact the reporter on this story: Angus Whitley in Sydney at awhitley1@bloomberg.net

To contact the editors responsible for this story: Shelley Smith at ssmith118@bloomberg.net; Philip Lagerkranser at lagerkranser@bloomberg.net


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