Australia Bank Bonds Punished on Bubble Concern: Credit Markets

Aug. 31 (Bloomberg) -- Investors in U.S. dollar-denominated bonds issued by Australian banks are demanding higher relative yields on concern the country’s property market is overheating.

The spread between Westpac Banking Corp.’s $2 billion of five-year notes and similar-maturity Treasuries widened to 144 basis points yesterday from 137 basis points when sold on July 26, Citadel Securities prices show. The cost of credit-default swaps tied to Sydney-based Westpac and its three largest peers jumped at least 59 percent this year, outpacing the benchmark Australia Markit iTraxx index’s 47 percent increase.

House values in Australia surged 18.4 percent in 2010, causing Nobel-winning economist Joseph Stiglitz to say this month that the nation’s property inflation gives “cause for concern.” Westpac, National Australia Bank Ltd., Commonwealth Bank of Australia and Australia & New Zealand Banking Group Ltd. accumulated A$798 billion ($713.5 billion) of mortgage debt, almost 66 percent of their combined loans, according to their banking regulator.

“We don’t have the same type of bets on we would have had four years ago,” said Tom Farina, a director at Deutsche Insurance Asset Management in New York, who helps manage $188 billion. While Australian homeowners may not be facing a U.S.- style meltdown, “we’re certainly hitting some lofty leverage levels from a valuation perspective,” he said.

Four Pillar Banks

The so-called Four Pillar banks, named for a law that forbids them from merging with each other, have raised more than $102.5 billion from bonds in the U.S. currency since the start of 2008, or about 46 percent of their total sales, Bloomberg data including issues by units show.

The lenders, facing regulatory reforms that favor long-term capital over short-dated funding, may need to sell A$162 billion of bonds in the 2011 financial year, 80 percent more than their annual average for the five years to 2007, Morgan Stanley analysts led by Viktor Hjort said last month.

Elsewhere in credit markets, the extra yield investors demand to own corporate bonds worldwide rather than government debt rose amid increasing concern U.S. growth is decelerating. Emerging market debentures weakened and government-backed mortgage bonds are poised for their worst monthly performance relative to Treasuries since November 2008. Sara Lee Corp. sold $800 million of bonds, the day’s biggest offering in the U.S.

Global company bond spreads widened 1 basis point to 179 basis points according to Bank of America Merrill Lynch’s Global Broad Market Corporate index. The gap increased 2 basis points this month and is 3 basis points higher from Dec. 31. Yields fell to 3.478 percent from 3.751 percent on July 31.

Slowing Economy

The bonds returned 1.96 percent in August, the best monthly performance since July 2009, according to Bank of America Merrill Lynch index data, as equity markets faltered amid signs the economic recovery may be stuttering. The debt gained 1.47 percent in July, according to the index.

Commerce Department data yesterday showed that disposable incomes, or the money left over after taxes, dropped for the first time since January after adjusting for inflation, showing how the lack of jobs may prevent consumer spending from strengthening further after purchases rose 0.4 percent in July.

For the year, corporate bonds have returned 8.63 percent, versus 6.17 percent for global government debt. The MSCI World Index has lost 5.5 percent including reinvested dividends.

Sara Lee, the maker of Ball Park hot dogs and Hillshire Farm meat products, sold bonds in the U.S. for the first time since 2003, Bloomberg data show.

Debt Offerings

The Downers Grove, Illinois-based company issued $800 million evenly split between 5- and 10-year debt, the data show. The 5-year notes yield 137 basis points more than similar- maturity Treasuries and $400 million of 10-year debt pays a 157 basis-point spread, Bloomberg data show.

That helped U.S. debt offerings reach $97.3 billion this month, a 37 percent increase from the similar period last year, and the busiest August since 2007, Bloomberg data show. Companies from Johnson & Johnson to Southern California Edison Co. took advantage of the lowest rates on record as declining Treasury yields encouraged investors to buy corporate debt.

Sales rose to the most since March, when issuance was about $140 billion, the data show.

High-yield, high-risk debt offerings reached $23.2 billion, the most for an August on record even as issuance halted after Aug. 20 amid mounting concern the economic recovery is slowing.

The debt returned 0.2 percent this month, the worst performance since May, when Bank of America Merrill Lynch’s U.S. High Yield Master II index lost 3.5 percent.

Loan Returns

Loan prices fell for the month, with the Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index declining 0.31 cent to 89.34 cents on the dollar. Loans have returned 3.85 percent in 2010, based on the index, which tracks the 100 largest dollar- denominated first-lien leveraged loans.

Leveraged loans and junk bonds are typically rated below Baa3 by Moody’s Investors Service and lower than BBB- by S&P.

Fannie Mae, Freddie Mac and Ginnie Mae securities have returned 35 basis points less than U.S. debt this month through Aug. 27, even after narrowing the gap by 19 basis points last week, Barclays Capital indexes show.

That’s the worst relative performance since November 2008, when the securities underperformed U.S. debt by 68 basis points amid the depths of the global financial crisis. Last month, the bonds returned 44 basis points more than Treasuries.

Home Prices

In emerging markets, the extra yield investors demand to own corporate bonds rather than government debentures rose 13 basis points to 296 basis points, the highest since July 22, according to index data from JPMorgan Chase & Co. Spreads for the month rose 11 basis points after declining 53 basis points in July, index data show.

Spreads on bonds issues by Australian financial companies have widened to 215 basis points on average from 209 on June 11, while the gap for bonds issued by similar borrowers around the world have narrowed to 224 from 256, according to Bank of America Merrill Lynch index data.

Home prices in the most populous cities of Melbourne and Sydney climbed 24 percent and 21 percent in the year to June as Australia continued almost two decades of uninterrupted economic growth, statistics bureau data show.

Australia’s ratio of household debt to disposable income was 157 percent as of March 31, central bank data show. It was 133 percent in the U.S. before the housing collapse began in 2007, according to the Federal Reserve Bank of San Francisco.

‘Collateral Damage’

“I’m not persuaded by arguments that houses are sustainably priced, I’m not persuaded by the view that debt is not a problem, and I’m not persuaded that policy-makers could prevent collateral damage to banks,” Gerard Minack, chief strategist for global developed markets at Morgan Stanley’s Australian unit, wrote in an Aug. 17 report. “Dodging the worst of the global financial crisis didn’t demonstrate that there’s no bubble, in my view it just showed we dodged the prick.”

Rising borrowing costs are a “revenue headwind” and may remain inflated for 18 months, Gail Kelly, the chief executive officer of Sydney-based Westpac, said when the lender reported quarterly earnings this month. They will be “permanently” higher, said Mike Smith, ANZ’s Melbourne-based CEO.

Omega Global Investors Pty Ltd., a fund management firm based in Melbourne, bought Macquarie Group Ltd. bonds in July and August from U.S. and European investors concerned about a housing slowdown, according to Investment Director Mat McCrum.

“Australia’s increasing population and limited supply make the market very different from the U.S. and Europe,” McCrum said in a telephone interview.

Housing Shortage

Australia, a nation of 22.4 million, faces a housing shortage and needs to build about 420,000 more homes in the next decade than it did in the last, according to Harley Dale, chief economist at the Canberra-based Housing Industry Association.

The median cost of an urban home was A$465,000 in July, research by real estate monitoring company RP Data show. The median price of a new home sold in the U.S. that month was $204,000, while sales unexpectedly dropped to the lowest on record, according to Commerce Department data published Aug. 25.

National Australia Bank priced $1.25 billion of three-year bonds in January to yield 87.5 basis points more than Treasuries, the data show. The spread has since widened to 126 basis points, according to HSBC Holdings Plc.

Credit Swaps

Investor demand for corporate debt globally will support Australian bank bonds, said Mark Kiesel, global head of corporate bond portfolio management at Pacific Investment Management Co. The Newport Beach, California-based firm oversees the world’s biggest bond fund and is among the largest holders of Australian bank debt.

While that may benefit the securities, “when we look around the world, the most attractive banks from a valuation perspective are U.S. and U.K. banks,” he said.

Investors have allocated $480.2 billion into debt mutual funds in the two years ending in June, according to data compiled by Bloomberg and the Washington-based Investment Company Institute.

Bank of America Corp., rated three grades lower than ANZ at A by Standard & Poor’s, priced $1.5 billion of five-year bonds on Aug. 17 to yield 230 basis points more than Treasuries, according to Bloomberg data.

Similarly-rated Royal Bank of Scotland Group Plc, the U.K.’s biggest state-owned bank, sold $1.5 billion of 2013 notes at a 265 basis point spread, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.