Opinion: Here's eight reasons why funding costs aren't really hurting the big banks

By Gareth Vaughan

If any further evidence was needed that the much hyped funding cost rise faced by the big banks as 2012 dawned has turned into a damp squib, it was provided yesterday with confirmation of Westpac's NZ$750 million three-year bond issue.

Westpac's mammoth domestic debt issue, split into two tranches and priced at 155 basis points over the 90 day bank bill rate and the same margin over the three-year swap rate giving interest rates of about 4.30% and 4.86% respectively, may have looked on the generous side to some of the bank's competitors. And it was clearly embraced by institutional investors, given the maximum cap set on the issue of NZ$450 million was blown clean off.

But it's hard to believe New Zealand bank bosses are currently losing any sleep over fears of funding cost rises and here's eight reasons why.

1) As Westpac Treasurer Jim Reardon told interest.co.nz, the NZ$750 million is a "pretty big chunk" of what the bank needs to borrow during 2012 in order to fund its debt maturities and forecast lending growth, therefore reducing the prospects it'll need to go cap in hand to overseas wholesale lenders, potentially at a time of unfavourable market conditions.

2) ANZ last Friday raised NZ$250 million in a seven-year retail bond issue at 6.25%. That was after the bank called a separate NZ$250 million bond on March 2, that was paying 7.6%. Therefore it effectively replaced NZ$250 million of funding for 135 basis points less than it had been paying.

And there's more of this to come. Another NZ$1.32 billion worth of bank bonds are due to be called - or reset - this year. Issued in 2007 at margins over the five-year swap rate, the four issues are currently paying interest rates ranging from 8.23% to 10.04%. Given today's lower interest rate environment, if they're reset investor-lenders will start receiving interest rates hundreds of basis points lower than they're now getting, meaning the banks will be borrowing at cheaper rates. And if the banks plumb for new issues, they'll also be at lower rates.

3) Banks - and other corporates - are finding new markets from which to borrow money. ANZ recently issued covered bonds, secured by New Zealand residential mortgages, in Switzerland raising 500 million Swiss francs (about NZ$660 million) at a rate a spokesman declined to disclose. And Transpower is borrowing C$250 million (NZ$307 million) through a five-year Canadian private debt placement at 3%.

Given the interest rate environment in the likes of Europe and North America is even lower than New Zealand, and our relative economic solidity, there are plenty of investors in those countries attracted to solid looking kiwi banks and firms. Official interest rates in Switzerland are 0%, they're 1% in Canada, 0.25% in the United States and 1% in the Eurozone, compared with New Zealand's 2.5% Official Cash Rate.

4) In its Monetary Policy Statement last week the Reserve Bank noted banks pulled in NZ$7 billion more through the deposit door in 2011 than they emptied out the new lending door, thus reducing the need for banks to actively seek long-term wholesale funding at expensive levels.

Jason Wong, the Reserve Bank's head of financial markets intelligence, went as far as saying: "The banks can take all those deposits, fund any new credit growth, and actually pay off  debt when it comes up for maturity."

Now, granted the cost of converting the money borrowed overseas into the New Zealand dollar has gone up - something also highlighted by Wong - but the banks simply aren't currently raising much money in the much discussed offshore wholesale markets.

ANZ, the country's biggest bank with NZ$125.1 billion in assets including NZ$93.5 billion of net loans, has raised NZ$1.9 billion so far this year and BNZ issued a €500 million (about NZ$797 million) covered bond in January. ASB and Westpac are yet to tap overseas wholesale markets in 2012 and Kiwibank, whose euro denominated commercial paper programme was drawn down to the tune of NZ$385 million at December 31, says it's 87% funded through customer deposits.

5) Lending growth, where there is any, is  anaemic. The latest Reserve Bank sector credit data shows agricultural debt flat in the year to January at NZ$47.525 billion, business debt up 2% to NZ$74.215 billion, housing loans up 1.2% to NZ$173.375 billion and consumer debt down 0.2% to NZ$11.785 billion.

6) Term deposit rates haven't exactly been going through the roof. The average bank six month rate is up 13 basis points so far this year to 4.27%, the average one-year rate is up 8 basis points to 4.44%, with the average 90 day bank rate unchanged at 3.39%. The highest advertised rate is 6% for five years from RaboDirect and Kiwibank. See our bank averages chart at the bottom of this story. Also see all advertised bank term deposit rates from one to nine months here and all advertised bank term deposit rates for one to five years here.

7) The big banks have large stockpiles of emergency cash supply, should they be required. As of December 31, ANZ, ASB, BNZ and Westpac - between them - were sitting on liquid assets, the likes of cash, treasury bills, government securities, residential mortgage backed securities, bank bonds, and call deposits with the Reserve Bank, worth a combined NZ$41.489 billion. Chuck in Kiwibank's NZ$2.145 billion, and between them the big five had NZ$43.6 billion.

The idea is that this stock pile comprises either cash, or assets that can quickly be converted into cash, should the banks need money in a hurry if, for example, there was a sudden surge in demand from borrowers.

8) Last, but certainly not least, the European Central Bank's Long Term Refinancing Operation has seen it lend €1 trillion at 1% over three years to European banks since late December. This has calmed international financial markets, previously spooked by the Eurozone sovereign debt crisis, - at least for the time being.

Now, if the last few years have taught us anything about global financial markets it's to expect the unexpected and that there's likely to be more bad news around the corner. So later in the year the picture may change. Heck, our banks may even need to source more funding to cover a huge spike in demand from borrowers. But right now the much publicised fear of ramped up funding costs shouldn't be seeing any local bank bosses waking up in the middle of the night in a cold sweat.

This article was first published in our email for paid subscribers this morning. See here for more details and to subscribe.