Next step for Australian capital

The Australian Prudential Regulation Authority (APRA) made its first official pronouncement on a potential Australian equivalent of total loss-absorbing capacity (TLAC) rules in November 2018. Local market participants are still assessing the potential consequences.

Davison APRA’s TLAC focus is on tier-two capital. What might the market consequences be if the big-four banks each have to do an extra A$3-4 billion (US$2.2-2.9 billion) of tier-two funding every year?

WHETTON They will do that much less in senior funding. Senior pricing will come in and tier-two will go a bit wider. This is whether the banks do 10-year non-call five years in Australian dollars or bullets in the US supplemented by euro issuance.

If anything, there may be more of a bid to the cross-currency basis in that environment because there is a larger amount of issuance to be done.
Investors in senior debt will have a larger buffer under them, which is good. It is not as good on the equity side, perhaps.

GOODMAN We are talking about big numbers and the issuance will come at the expense of senior. It remains to be seen whether the domestic investor base wants or has capacity for this much subordinated debt.

BROWN Mandates are quite important here. Investors can’t just substitute into subordinated debt because their mandates won’t let them buy it. The general rule of thumb is that a lot of subordinated debt will have to go offshore to find investors that can buy it.

STANLEY Australian dollar investors have been able to buy holdco US paper, though. Our credit analysts have been saying it may require some education for the Australian investor base, but they are broadly comfortable that the increase can be absorbed.

GOODMAN We are all calculating volume without balance-sheet growth, as well. Throw in some credit growth and there will be some big numbers. Our first reaction was that there would be a switch out of senior, but I agree that mandates become an issue.

It is a lot for the domestic investor base to absorb, so the banks probably will have to go offshore. It will present a fairly good proposition for European investors, as what will be offered will be traditional tier-two bank debt rather than a tier-three product.

I think the Australian proposal is appealing for offshore investors. Having an asset class they are already comfortable with and have done their credit work on – rather than a new, untested regime – is probably a good thing.

DAVID GOODMAN WESTPAC INSTITUTIONAL BANK

Davison Would the same mandate issues apply for potential investors if Australia was looking to implement a tier-three regime?

BROWN They would. The market will get there eventually because mandates will have to change if investors want to buy bank paper. But it won’t happen quickly. There will likely be a widening in tier-two initially and then investors will consider buying it because, even though it is subordinated debt, it is unlikely any of the big-four banks will go under any time soon.

It will likely become an attractive asset class as banks begin borrowing and spreads widen, but that is likely a 2-3 year process.

Davison Australia seems to be going out on its own in the sense that most other jurisdictions globally have introduced a tier-three security for their banks. Does this difference of approach fundamentally matter?

GOODMAN I think the Australian proposal is appealing for offshore investors. Having an asset class they are already comfortable with and have done their credit work on – rather than a new, untested regime – is probably a good thing.

BROWN I think, though, that Australia will come to be a large proportion of tier-two issuance globally and that this will come to be a problem. The numbers we have looked at suggest 30-50 per cent of global tier-two issuance would be coming from Australia.

WHETTON It could be like 2007/08, when the Australian banks were among the top-10 borrowers in the world by volume.

BROWN Something that has occurred to me, though to be fair only as a fairly vague notion, is that APRA may have acted as it has specifically because once a security is identified as subject to bail-in questions start being asked as to the reliability of government support.

The reason we may have this very exceptional, unique structure is precisely to avoid anyone being able to put the government on the spot about whether it would step in to protect a security that is subject to bail-in.

Perhaps the regulator and government didn’t want to have bail-in securities because they didn’t want to answer this question, so they picked a different route. I’m happy to admit I have no evidence for this theory, but it does fit the facts as we know them.