Australian banks: Growing demand for capital will boost overseas issuance and possibly in euro

• Australian banks are facing an uncharted era. Lower domestic rates, weaker economic growth and tougher regulations are all posing more challenges. Among all uncertainties, the Australian Prudential Regulation Authority (APRA) has announced the introduction of the total loss absorbing capacity (TLAC) for the four domestic systemically important banks (D-SIBs). This means Australian large banks need to raise additional capital. In this note, we look into the impact of such announcement on potential options for issuance.
• In the last decade, Australian banks have taken advantages of lower overseas funding costs to support domestic activities. Despite the growing share of deposits, overseas markets contribute to a quarter of total funding. However, Australian banks are insulated from currency risks as most of the forex positions are hedged as there is a strong demand for Australian assets from non-residents.
• With the reliance on foreign funding, the question is how Australian banks will meet the capital requirements. The regulation announced in August 2019 by the APRA means banks will need to strengthen their Tier 2 capital ratio by three percentage points from 2% to 5% by 1 Jan 2024. Based on the assumption on the growth of risk weighted assets (RWA) ranging from 0% to 2% per annum, the big four Australian banks need to raise AUD 50-61 billion of Tier-2 capital by 2024.
• Australian banks currently have a currency mix in Tier 2 bonds with 43% in USD, 30% in AUD and 15% in EUR. Although the funding cost for Tier 2 bonds in the USD is higher than the domestic currency, the advantage is the depth of the US bond market with longer maturity and higher issuance. Despite lower domestic rates, Australian banks still need overseas funding due to the still shallow domestic capital market, the low saving rate and the volatile current account balance.
• Due to the high funding needs and the limited bond market size domestically, we expect continuous overseas issuance of Tier 2 bonds. Australian banks have lower funding cost than global peers within the same rating spectrum thanks to the strong demand from investors. The pursuit of cheaper liquidity means EUR-denominated Tier 2 bond could offer an alternative for lower cost funding as rates remain low in Europe and hedging costs have come down aggressively comparing to a few years ago, which can help to achieve a more diversified funding composition given the reliance on the USD.
• All in all, the new capital requirement will boost the issuance of Tier 2 bonds by Australian banks. Although domestic rates are getting lower, overseas issuance demand will surge due to the depth and funding structure. Asides from the USD, issuance in the EUR could provide an attractive alternative given the low rate environment and cheaper funding costs in the Eurozone.

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