Bank funding strategy and outcomes: views from around the world

In November 2019, KangaNews spoke to bank funders from Asia, Australia, Europe, Japan and North America – all of them active in the Australian dollar market – about market conditions, executing more diverse funding plans, sustainable debt and the role of noncore currencies. The consensus is that issuance diversity will play a greater role now new regulatory capital settings are largely bedded in.

PARTICIPANTS

Brooke Hales Associate Vice President, Treasury and Balance Sheet Management TD
Mostyn Kau Head of Group Funding ANZ
Franz-Josef Kaufmann Deputy Head of Capital Management and Funding COMMERZBANK
Ryosuke Kobayashi Vice President, Office of the CFO MITSUBISHI UFJ FINANCIAL GROUP

Hiroya Tanaka Vice President, ALM Department MIZUHO BANK
Junse Yamada Vice President, Office of the CFO MITSUBISHI UFJ FINANCIAL GROUP
Hong Nam Yeoh Head of Wholesale Funding DBS BANK

MODERATORS

Chris Rich Staff Writer KANGANEWS

Matt Zaunmayr Senior Staff Writer KANGANEWS

GLOBAL MARKET CONDITIONS

Rich The past year has been largely benign for global bank wholesale funding, notwithstanding geopolitical noise and patches of volatility. How would you describe liquidity and pricing conditions this year?

HALES There was some market-wide nervousness coming out of Q4 2018. However, the volatility dissipated quickly as monetary conditions eased. Since then, the influx of money into bond funds has supported credit spreads despite the late stage of the credit cycle.

KAU As you point out, it has been very benign. Liquidity has been reasonably plentiful and pricing has been relatively favourable. We have had the benefit of choosing which markets we issue in.

At ANZ, we have taken a greater percentage than we normally would have out of our domestic market. This has created a ‘burden of choice’ for offshore issuance. Global conditions have been really good and we have experienced larger-than-expected domestic demand. It has been a double benefit.

KAUFMANN A year ago, there was uncertainty about how we could best access the market. But changes in central-bank policy throughout 2019 brought significant liquidity back to the market. Investors have been looking for yield and, generally speaking, issuers have been able to tap the market successfully.

For example, Commerzbank did its first additional tier-one (AT1) transaction just before the European summer break and we were able to generate well over US$10 billion in demand for a Reg S transaction, which is remarkable.

TANAKA Global market conditions for bond issuance remained generally stable in 2019, although a risk-off tone at the beginning of the year brought wider new-issue concessions and secondary spreads.

Due to a favourable market environment and robust investor demand, in the year to mid-November Mizuho has successfully issued US$6.3 billion equivalent of TLAC [total loss-absorbing capacity] bonds in US dollars and euros as well as A$1.7 billion (US$1.2 billion) of TCDs [transferrable certificates of deposit] with tight spreads.

YEOH Conditions have partly been determined by banks’ balance-sheet requirements. All banks have now figured out what their Basel 3.5 requirements are, have worked out their funding plans and have settled into an issuance routine.

At the same time, a slowdown has come about from the US-China trade tensions. These have caused us to revise down our loan-book forecasts. We had forecast 8-9 per cent loan growth in previous years, but this year we will likely be around mid-single-digit growth. Tension in Hong Kong means it could be at the lower end of mid-single-digit growth.

Loan-growth deceleration means we have a lower funding requirement. We want to avoid being overfunded so we have tuned down our funding activity. This leads to a more demand-oriented market because paper is scarcer, and as a result spreads have tightened.

Even so, we won’t fund if we don’t have a requirement. The yield on transactions would have to get to a ludicrously low level before we thought about taking on funding for which we didn’t have an immediate requirement. While we may pre-emptively fund to meet short-term forecasts, we don’t make a multiyear estimate and then take a view on spreads.

KOBAYASHI The 2019 fiscal year in Japan started in April. Conditions have been very good since then, allowing us to issue some large public offerings. For example, we successfully issued a US$6.5 billion deal across four tranches. This was the largest transaction we have issued and the deal had very successful pricing.

We have also been active in euros and Australian dollars, for a total of three global deals so far this fiscal year. We have seen very good demand from investors for each transaction and have been able to issue at very good pricing – even tighter than our expectations.

YAMADA Central-bank policy has completely changed in the last 12 months. In 2018, we were in a tightening phase being led by the Fed [US Federal Reserve]. This year the policy has changed completely and moved to an easing cycle.

This policy change has had a positive effect on the fixed-income market, which has performed very well. We have captured these good conditions by issuing large transactions in US dollars and we have also seen other names able to print very large volume.

Zaunmayr We have gone from globally synchronised growth in 2017 to rates heading towards zero across the board in 2019. How are ultra-low rates and spreads affecting demand patterns?

YEOH With rates at this level, there is more likely to be a significant move back up to higher spreads than there is to be another significant move tighter. Spreads could grind tighter but, on balance, any large move is likely to be up rather than down.

If this is the case, investors should be looking to hold short-duration products and higher-grade products such as covered bonds. In a spread-widening environment these will probably move less than senior notes. Investors can then liquidate covered bonds and take on the senior notes at a wider spread, assuming they can find them.

YAMADA On the other hand, investors’ hunt for yield has accelerated since the beginning of 2019. The Fed moving into easing territory has completely changed buy-side behaviour and investors are looking for yield all over the world.

KOBAYASHI The US dollar and euro markets have seen very good demand for longer-tenor deals from investors. We had strong demand for the 10- and 20-year tranches of our US dollar deal, for instance. We also had very good demand for a 10-year euro transaction. This was the first time we have been able to issue euros at this tenor.

“One could say that no local reference [for Australian nonpreferred senior] makes it more challenging to find pricing points for a foreign issuer. Or you could argue that investors will have a lack of investment opportunities and may be more receptive to invest in the nonpreferred-senior instruments offered by offshore issuers.”

TANAKA Demand for longer-tenor bonds was strong in 2019 as investors preferred higher yields. In our transactions we have seen stronger demand for the 10-year part of the curve than at five years.

KAUFMANN It is important to differentiate between spread-based and yield-based investors. Absolute return is of lesser importance for the first group than it is for the second. Yield investors realised in the second half of 2019 that a lot of investments went into negative-yield territory in absolute terms, which they tried to mitigate by going for longer duration and for other investments that still offered positive yield.

HALES It’s worth noting that rates in Canada have not changed materially since Q1, so 2019 has been more business-as-usual as Canadian banks work towards meeting their TLAC requirements.

In the US dollar market, lower-for-longer has prompted investors to reach for yield either in credit or structure. As a result, we have seen strong support for our bail-in notes. In euros, we have seen broad-based support for bail-in notes and also for longer-dated covered bonds.

“I think it would be helpful to have consistency between peers and to have industries working towards common goals. Companies can take different approaches but they should also be comparable by investors.”

ISSUANCE INSTRUMENTS

Zaunmayr The makeup of bank funding has evolved in response to capital rules, most recently TLAC, and what was once a very senior-unsecured-focused market now features a lot more diversity up and down the capital stack. How has this affected funding strategies? Do banks target particular types of issuance at specific markets or are they happy to respond to demand?

KAU It is always demand-led. However, it is true that our TLAC requirement means a transformational change in the way we access offshore markets. It is going to be a big change going forward as the regulatory-capital developments in Australia mean we will be required to increase our issuance of tier-two securities quite dramatically.

While it will still be demand-led, and while liquidity conditions are currently favourable, we will need to use more of our offshore options. There will be a price effect associated with this.

When I say issuance will be demand-led it is also worth pointing out that generally speaking demand goes hand-in-hand with the economics of a trade. We certainly have less optionality around tier-two issuance than we do in normal unsecured issuance – because of the increase in size of our issuance now relative to the recent past.

YAMADA The instruments we issue depend on our risk-weighted-asset volume and how much TLAC funding we need to meet requirements. In this fiscal year, we need roughly US$8-10 billion of TLAC issuance to maintain our TLAC ratio at a sustainable level.

However, we also have a large Australian dollar balance sheet in Oceania. We will continue to look to fund this balance sheet through local opco issuance as well as future Australian dollar TLAC deals when they suit.

TANAKA In order to meet Basel III and TLAC requirements, we have been issuing AT1, tier-two and TLAC notes in accordance with our annual capital-funding plan. We determine in which markets, currencies and issuing formats to raise capital mainly by considering issuing costs and investor demand.

In recent years, we have focused issuance of AT1 and tier-two notes in the Japanese domestic market while issuing foreign-currency denominated TLAC notes in global markets.

HALES In 2019, TD issued bail-in notes in Canadian, US and Australian dollars as well as in euros. Unlike other jurisdictions – where banks may issue various types of senior debt – Canadian domestic and global systemically important banks cannot elect to issue non-bail-in unsecured senior debt. We have heard from investors that the Canadian bail-in regime provides clarity and we have generally been comfortable with transition to the bail-in regime.

KAUFMANN We have to roll over our maturing unsecured debt, either in nonpreferred or preferred format. You might be aware that German banking legislation was amended whereby outstanding vanilla senior-unsecured debt became nonpreferred senior. Then a further amendment was made in 2018, allowing banks also to issue plain-vanilla preferred senior bonds.

Commerzbank is an MREL [minimum requirement for own funds and eligible liabilities] issuer, so we are not affected by TLAC – but there is clearly a differentiation between nonpreferred senior and preferred senior.

We look at what proportion of issuance we need between nonpreferred senior and preferred senior to fulfil MREL on a rolling basis. In addition, we try to diversify our funding base into other markets, currencies and investors.

The role of Australian dollars in global funding portfolios

At face value, a lower cash rate might be expected to reduce investor – and thus issuer – interest in Australian dollar bonds. Global bank funders beg to differ, saying they expect Australian dollar issuance to increase, if anything – with domestic investor participation a key goal.

ZAUNMAYR Has the declining Australian cash rate changed demand for the currency among international investors?

HALES The decline in the Australian dollar cash rate has not had a major impact on our issuance strategy as we have generally issued shorter-duration tenors in floating-rate format. We continue to see strong demand for our Australian dollar issuance.

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Rich Has there been any progress from the Singaporean regulator on a TLAC regime?

YEOH The regulator has told us that it views nonviability and bail-in as virtually synonymous, which makes sense. It has also given guidance on qualifying instruments. Other than this, there has not been much movement. The regulator has certainly not given us a TLAC target to meet. It has told us senior debt and covered bonds will not be subject to bail-in but it has not given us a ratio to apply.

Zaunmayr Australia now has a TLAC-equivalent regime but not a ‘tier-three’ asset class. How will this affect the shape of the Australian market?

KAUFMANN I believe this is a key question, to which I do not have a definite answer right now. Nevertheless, it will be interesting to see the market reaction to having the Australian major banks increase their issuance of tier-two without issuing nonpreferred senior.

Nonpreferred senior is a very important instrument for the rest of the world. Therefore, you could argue along two lines regarding investor engagement.

One could say that no local reference makes it more challenging to find pricing points for a foreign issuer. Or you could argue that investors will have a lack of investment opportunities and may be more receptive to investing in the nonpreferred-senior instruments offered by offshore issuers. Clearly it will be very interesting to see which behaviour will lead investment decisions.

KAU Time will tell, but the initial response to the two deals issued after the TLAC requirements introduced by APRA [the Australian Prudential Regulation Authority] have been extremely positive. They exceeded expectations. Going forward, once domestic investors are comfortable with a credit they are generally not at all averse to moving down the credit structure in order to obtain greater yield. The initial signs are very positive.

HALES We do not expect the absence of equivalent bail-in notes for Australian banks to affect investor engagement for Canadian bail-in notes. In our experience, investors in Australia are well-informed on the global regimes and understand the nuances of each of them.

TANAKA The regulation requires the domestic big-four banks to issue large amounts of tier-two bonds, and the Australian dollar market is still expected to be their main source of funding.

When local big-four banks are issuing a large amount of tier-two bonds, we expect investor demand for TLAC bonds issued by foreign financial institutions might be affected – because yield on these instruments is generally lower than tier-two bonds. We still expect demand for TLAC bonds will be sufficient to maintain current yield and spread levels, though.

“Investors’ hunt for yield has accelerated since the beginning of 2019. The Fed moving into easing territory has completely changed buy-side behaviour and investors are looking for yield all over the world.”

DIVERSIFICATION BENEFITS

Rich Which currencies worked best for banks in 2019 and which were more challenging – in particular relative to 2017 and 2018?

YAMADA In public markets, the only currencies MUFG holdco has issued are US dollars, euros and Australian dollars. In addition, the local opcos have issued Australian and New Zealand dollar TCDs.

We conducted inaugural transactions in New Zealand dollar opco and Australian dollar TLAC in 2019 and can say these markets worked well for us. We also issued a number of successful US dollar and euro TLAC transactions. These markets also continue to work for us.

KOBOYASHI MUFG holdco has also found other currencies for private issuance, such as Hong Kong dollars.

HALES Euros remains a stable source of funding for covered bonds as ECB [European Central Bank] QE has provided support for the market. We have consistently seen strong support for senior debt and capital issuance in our two home markets of Canadian dollars and US dollars, and this continued in 2019.

We were also pleased to access bail-in funding in euros and Australian dollars in 2019, executing the first bail-in issuance by a Canadian bank in both these markets.

KAUFMANN For the past two years we have been looking into other markets. Following the merger with Dresdner Bank we did not have a significant funding need for some time – so we were able to raise everything in our home market. We did so as it was the most cost-efficient way to raise funding at the time.

Now we have more funding to do as the bank grows on the asset side and we still have maturing debt. We are therefore looking more closely into other markets.

We have done so very successfully with three tier-two transactions into Asian markets in the last couple of years. We did our first Singapore dollar trade in 2017 followed by a second Singapore dollar tier-two and an Australian dollar tier-two in 2018.

In 2019, we also issued our inaugural US dollar, Reg S AT1. This deal enjoyed significant support from Asia: we were able to allocate 25 per cent of the bonds to Asian investors – with interest in the orderbook that was significantly greater than 25 per cent.

These are our first steps into the Asian region. Clearly we want to continue on our way – to issue instruments in other markets such as preferred senior and nonpreferred senior.

TANAKA We are active and issuing notes in all the major global financial markets across a range of currencies, products, tenors and capital types. In 2019, US dollar denominated bonds continued to be the largest funding source for Mizuho from an asset-liability management and market-capacity perspective.

However, Mizuho has issued more euro-denominated bonds in 2019 than previous years due to the funding-cost efficiency that has been evident in the market.

For Australian dollars, Mizuho Bank Sydney Branch (Mizuho Sydney) has issued a certain amount of TCDs because the funding cost was much more attractive than TLAC. This is the first time Mizuho Sydney has issued two benchmark deals in the same year and it was also able to increase the amount issued, number of participating investors and domestic participation to higher levels than ever before.

“Going forward, once domestic investors are comfortable with a credit, they are generally not at all averse to moving down the credit structure in order to obtain greater yield. The initial signs are very positive.”

KAU We took nearly two-thirds of our funding out of the Australian market in 2019. Our need for foreign-currency issuance has not been great at all as we experienced very limited balance-sheet growth and a funding gap that hasn’t grown in any material way.

We haven’t really had a hard job of filling that gap and there have been no real challenges in individual markets. It is just that some appear better than others at times. In particular, the euro market is performing quite well right now. This is why we were able, in November, to print a tier-two transaction in Europe – which is something we hadn’t done in a decade.

Hopefully the timing works well in that our increased tier-two need dovetails with demand in the euro market. With a bit of luck, the fact that we have spent a lot of time in Europe over the years maintaining close contact with investors will pay off.

Rich How important is currency diversity beyond the G3 to banks’ funding tasks?

KAU It is not necessarily currency that determines diversity per se, although it can be an indicator. It is more about what type of investor we are looking at and, to a lesser extent, where they are located. Different product types also play a key role in any issuance programme.

In the past year, diversity may not have been crucial but it is in the years where we come across comprised liquidity conditions that our diversity comes into play. The cost of maintaining diversity during the good times eventually gets repaid during the challenging times.

As an example, we recently increased our RMBS [residential mortgage-backed securities] issuance and the investor base for this product has had a large offshore component even though our issuance is in Australian dollars. Although it doesn’t appear on the surface to offer diversification, the investor base is strongly represented offshore – particularly in Japan and other parts of Asia.

We use a materiality process to map sustainability risks across industries. We do a lot of impact reporting to understand the use of proceeds from GSS bonds and can look at things like specifically how much carbon an investment has saved.

We also align our reporting with the SDGs, looking at what companies are saying they have aligned to. A lot of impact reporting is driving discussion with clients and some of it is a collaboration with clients as well.

KAUFMANN When we go to Asian markets, as I mentioned before, we gain access to investors we might not typically reach with issuance in our home currency, euros. Therefore, I would argue that currency diversification and investor diversification very often go hand-in-hand.

TANAKA For long-term funding other than US dollars, euros and Australian dollars, currency swap is one of the main sources of funding for Mizuho – in addition to client deposits. However, Mizuho issues local-currency bonds if it is significantly cheaper than currency swaps or is suitable for of local regulations.

Other than bonds, TCDs and cross-currency repo are also funding measures Mizuho uses effectively to reduce the liquidity costs of local-currency funding.

“If local banks issue a large amount of tier-two bonds in the Australian dollar market, we expect investor demand for TLAC bonds issued by foreign financial institutions might be affected as yield on these instruments is generally lower than tier-two bonds.”

HALES We are focused on diversification across investors and markets. TD currently issues in Canadian, US and Australian dollars, euros and sterling.

YAMADA Our target is mostly in US dollars because 70 per cent of our non-yen loan balance sheet is denominated in this currency. This is why we print large amounts in the US dollar market. The next most important currency is euros. For other currencies, it depends on the market. If it is cheaper than US dollars or euros we will consider it.

Currency diversification is very important for us. Next fiscal year we will consider again whether Australian dollars is appropriate for our issuance.

YEOH Even with a lower overall funding requirement we are still focused on currency diversity. However, we have been less diverse in 2019 than previously. The only currencies we have issued are US and Australian dollars, and sterling.

GSS issuance and the growth of qualifying assets

International banks are keen to increase their activity in sustainable debt markets. Whether this means more green, social and sustainability (GSS) bonds depends on the scale of their qualifying asset books and how demand for labelled product evolves.

RICH How active are banks as issuers of green, social and sustainability (GSS) bonds? How much issuance is there and in which currencies – and what are the aspirations for growth?

KOBAYASHI We had very good demand from domestic investors for our Australian dollar green bond. We need to consider our green-bond issuance from an economic point of view, though, because we have limited eligible green assets. This means we need to consider the currencies that will be most effective for demand and which markets will be most suited to our ESG [environmental, social and governance] approach.

If we think issuing an Australian dollar TLAC green bond will give us the best outcome, we will do so. But US dollars and euros are also very good markets for green bonds.

We also understand that Australian domestic investors tend to prefer Australian domestic assets to back green-bond issuance. So we need to be conscious of the projects we have in Australian dollars.

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