Surge in deposits drives the cost of borrowing down

Borrowing costs for banks in Australia tumbled to the lowest in nearly a year after a climb in deposits to a 14-year high allowed them to limit bond sales.

The extra yield investors demand to hold Australian currency financial debt instead of government bonds fell 46 basis points this quarter to 241, the lowest since last September, Bank of America Merrill Lynch indexes show. Global bank debt spreads narrowed 37 to 236, according to the indexes.

The four biggest Australian banks have $373.5 billion of bonds outstanding, down by $67.2 billion from the third quarter of 2010, according to data compiled by Bloomberg.

Deposits swelled to 53 per cent of funding this year, the biggest share since 1998, as investors shunned stocks in favour of more stable assets, central bank data shows.

Commonwealth Bank of Australia, the nation's biggest lender, reported record profit this week and said it reduced bond offerings by 46 per cent to $29 billion in the 12 months to June 30, compared with two years earlier.

"Banks have rejigged their funding sources and have a lot more domestic term deposits, which will probably be more sticky than they used to be because of the shift in retail investor sentiment away from equities," said Warren Bird, co-head of global fixed interest and credit at Colonial First State.

"The world generally perceives that the Australian economy is doing all right, as are the banks, which have record profits, very low non-performing loans and are very cost conscious."

Credit default swaps on Australia's four biggest banks - CBA, National Australia Bank, Westpac and ANZ - fell to 135 basis points this week, the lowest since April, according to data compiled by Bloomberg.

An index of contracts on US banks was at 191 basis points and a gauge for European lenders was at 412 basis points.

Australian banks have been adding deposits at a pace that outstrips lending growth by about 4 percentage points, the Reserve Bank of Australia said in its Statement on Monetary Policy, released last week.

"The strength in deposit funding has limited the need for banks to issue wholesale debt in large volumes," the RBA said.

"Notwithstanding the global turmoil, appetite for Australian bank paper has remained strong."

CBA reported a record $7.09 billion annual profit on August 15 and said retail deposits rose 10 per cent to $183 billion. NAB posted third-quarter cash profit of $1.4 billion a day earlier. ANZ said nine-month profit rose 10 per cent to $4.4 billion after the lender increased market share at home and earned more from overseas units.

"Domestic bank bonds have performed well, the sector's credit quality continues to be sound and their funding dynamics continue to disappoint sceptics," said Greg Stock, who helps manage $4.5 billion at Perpetual Ltd. "The rationale for allocations to this sector still stack up despite the recent rally."

Elsewhere in Australian credit markets, benchmark 10-year government bond yields were little changed at 3.48 per cent yesterday in Sydney, or 165 basis points more than similar maturity treasuries.

The gap between yields on 10-year sovereign bonds and inflation-linked debt of similar maturity, a measure of forecast consumer-price increases over the next decade, was at 2.58 per cent.

Interest-rate swaps data compiled by Bloomberg shows a 67 per cent chance the RBA will leave borrowing costs unchanged next month. The RBA's benchmark of 3.5 per cent is the highest in the developed world as it seeks to prevent a record mining boom from spurring inflation.

The Markit iTraxx Australia index of the cost of bond insurance on 25 of the nation's biggest companies was little changed at 157 basis points yesterday, according to data provider CMA.

Australian dollar-denominated bonds sold by offshore lenders have also rallied as the Chancellor of Germany, Angela Merkel, softened her stance towards the rescue plan for Spain and Italy put forward by the president of the European Central Bank, Mario Draghi.

Spreads on securities sold by BNP Paribas SA narrowed 113 basis points this quarter to 258, the Bank of America Merrill Lynch index data shows. Royal Bank of Scotland Group Plc's yield premium dropped 69 to 452.

CBA thinks slow loan growth will continue as consumer confidence remains weak in Australia, the chief executive, Ian Narev, said in results briefing documents this week.

NAB analyst Ken Hanton wrote in a note to clients after CBA released its earnings: "From a credit investor and credit ratings perspective, things are appearing pretty steady with asset quality, the composition of funding and capital continuing to strengthen."

The relative yield on Commonwealth Bank's $1 billion of 6.5 per cent bonds due in July 2015 fell as low as 91 basis points more than the swap rate this month, from 143 in February, according to ANZ prices.

The nation's residential mortgage-backed securities market is unlikely to have a cut in ratings even if home prices plunge, unemployment doubles and interest rates surge, according to a stress test published by Fitch Ratings this week.

Australia is "one of the more robust countries in the world", Fitch analysts led by Ben Newey wrote in the report.