Bank bond issuance could slow sharply
Banks issue bonds to fund their balance-sheet growth alongside funding they source from deposits. Bank treasury teams are notoriously poor at forecasting balance-sheet growth and tend to suffer periods of under- or over-issuing. We are both observing and projecting a dramatic slow-down in Aussie bank balance-sheet growth, which could materially reduce both their senior and Tier 2 bond issuance needs in the next few years.
There has been a striking slow-down in Aussie bank balance-sheet growth on a rolling, six month annualised basis from circa 10.6% per annum in April 2022, just before the RBA began to hike rates, to 4.2% per annum as at March 2023. The majors have been growing even more slowly at a 3.8% annualised pace over the half-year to March with Westpac only realising a sluggish 1.4% annualised lending growth over this same period.
Balance-sheet growth is likely to decelerate further to 2% per annum or less as the RBA's record 375bps of hikes begin to bite. There is also a real risk that the central bank continues to nudge-up rates given recent freedom of information disclosures that it considers a 3.8% cash rate (we are at 3.85% currently) to be the "neutral" cash rate that is unlikely to quell inflation sufficiently for it to meet its 2-3% CPI target by 2024 or 2025.
![](https://assets.livewiremarkets.com/rails/active_storage/blobs/proxy/eyJfcmFpbHMiOnsibWVzc2FnZSI6IkJBaHBBd1NEQlE9PSIsImV4cCI6bnVsbCwicHVyIjoiYmxvYl9pZCJ9fQ==--c73440d26bc6a25610911429cc255a1d14e95ed3/system2.png)
The question is what does this mean for the banks' bond issuance?
We model the banks wholesale funding needs, which includes all forms of debt issuance, and their Tier 2 bond requirements in particular. Our central case is that balance-sheet growth decelerates to 2'% per annum or less with the risk that we go through a period of no growth at all. The major banks are targeting holding Tier 2 capital worth about 6.5% of their risk-weighted assets. However, Tier 2 bonds are substitutable with hybrids or Additional Tier 1 (AT1) capital. And AT1 hybrid spreads are at historically low levels compared to Tier 2 bond spreads (ie, they are cheap for banks to issue whereas Tier 2 is expensive). The chart below shows the ratio of the spread of 5-year major bank hybrids compared to 5-year major bank Tier 2 bonds. It is normally around 1.8x. Today it is about 1.3 times.
![](https://assets.livewiremarkets.com/rails/active_storage/blobs/proxy/eyJfcmFpbHMiOnsibWVzc2FnZSI6IkJBaHBBeStEQlE9PSIsImV4cCI6bnVsbCwicHVyIjoiYmxvYl9pZCJ9fQ==--1c525258b5faac1017f62cdd6f5098e0e2f7e2a6/at1t2.png)
So one might expect the major banks to issue a little more AT1 hybrid capital in the next year and a little less Tier 2. Consider CBA's new hybrid deal, launched today at 3% over the bank bill swap rate (BBSW) for an all-in yield of about 6.9% per annum franked.
The current coupon on the new CBA hybrid is 6.9% per annum, of which 4.8% is a cash payment before franking credits, which are worth 2.1%. The 4.8% cash cost to CBA represents a spread of 0.9% per annum above BBSW, which is much cheaper than issuing a Tier 2 bond at 2.35% above BBSW, as ANZ recently did. Post-tax, the cost is of course different.
So banks are targeting raising Tier 2 capital worth about 6.5% of their risk-weighted assets (RWA) by January 2026. At 3% annual balance-sheet growth, that implies about $17.5bn of issuance each year, which is almost exactly their average issuance volumes over the last 3-4 years. But if we likely see a combination of 1/ much slower balance-sheet growth of 0-2% per annum and 2/ a marginal substitution towards more AT1 hybrid issuance (noting there are no major bank maturities on the ASX this year that will encourage a pivot from T2 to AT1), then we could see less Tier 2 bond issuance. This could range from as little as $10.4bn ($2.8bn net) per annum (0% RWA growth and 6% T2) to $16.3bn ($8.7bn net) per annum (2% RWA growth and 6.5% T2).
![Gross issuance](https://assets.livewiremarkets.com/rails/active_storage/blobs/proxy/eyJfcmFpbHMiOnsibWVzc2FnZSI6IkJBaHBBMCtEQlE9PSIsImV4cCI6bnVsbCwicHVyIjoiYmxvYl9pZCJ9fQ==--66dc703d7e90f180d1edb26baec9989ef0d2475e/tier%202z.png)
![Net issuance](https://assets.livewiremarkets.com/rails/active_storage/blobs/proxy/eyJfcmFpbHMiOnsibWVzc2FnZSI6IkJBaHBBMUNFQlE9PSIsImV4cCI6bnVsbCwicHVyIjoiYmxvYl9pZCJ9fQ==--21c9bd83178caac82910e0b1299694ba0abbe803/t24.png)
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