Fri Oct 10, 2014 4:36am EDT
* Aussie majors await bail-in news
* Canberra under pressure to adopt a new regime for rescue of troubled banks
By John Weavers
LONDON, Oct 10 (IFR) - A review of the government's exposure to Australia's biggest banks has knocked share prices and prompted warnings of ratings downgrades, even as credit markets see little reason to fear.
Shares in ANZ, Commonwealth Bank of Australia, National Australia Bank and Westpac have fallen around 8% since the start of September on speculation that an independent inquiry may recommend limits to the use of public funds in the event of a banking crisis.
The Financial System Inquiry is due to release its report in November, the same month that Australia hosts the G20 Leaders summit in Brisbane, and may recommend the introduction of a new bail-in framework that would shift the burden of bank resolutions away from taxpayers and towards bank creditors, including senior bondholders.
Although both the Reserve Bank of Australia and the Australian Prudential Regulatory Authority have adopted a cautious approach to the idea, the government's G20 role puts it under some pressure to adopt such a system. Australia is a member of the Financial Stability Board, an international body that has called for G20 countries to establish bail-in regimes.
Conceptually, a statutory bail-in framework will force professional investors to take losses before any taxpayer money is used to rescue a troubled bank. That puts the four major banks' identical Aa3/AA-/AA- ratings under threat, since implicit government support is a key factor in the Double A standing.
Standard & Poor's rates these four lenders two notches lower at A on a standalone basis, and has warned that bail-in powers will be likely to change its assessment of government support.
Similarly, Moody's said last month that "a credible bail-in regime could result in a transfer of risk towards banks' creditors and a reduction in our support assumptions underpinning the banks' senior debt ratings".
However, market participants do not expect a repricing of Australian bank credit even if the measures are introduced and ratings are lowered.
TOO BIG TO FAIL
In Australia's case, a bail-in framework will not necessarily end expectations of government support, given the dominance of the four major lenders, and the fact that similar steps elsewhere have had little impact on credit spreads.
Moody's also expects the government to step in to prevent senior creditor losses due to the high level of interconnectedness within Australia's banking system and its reliance on foreign borrowings, which represent around two-thirds of the Big Four's total annual wholesale funding needs.
These factors "raise the likelihood that government support would be forthcoming in order to prevent the occurrence of a disorderly bank failure or broader contagion", said Moody's in its September report.
"Consequently, even if Australia ultimately introduces a bail-in regime, we would need to evaluate the likelihood that it would be used as the primary policy tool to resolve a troubled bank," the report said.
A Sydney-based syndication manager said it was difficult to make any definitive judgements on market prices until further details were revealed, but, overall, he anticipated little change.
One key detail is whether bail-ins would be introduced retrospectively like in Europe or only applied to future deals like the Canadian regulator is proposing. In either scenario, banks could print more Tier 2 paper to protect their senior bonds, the banker said.
"The Canadian outlook downgrades, after the government announced bail-in plans, have made no impact on secondary levels, while Lloyds' US dollar five-year print on September 3 also suggests minimal investors concerns. This could, of course, change if the clouds darken again over the financial sector," he said.
The European Union last year agreed on a bail-in framework that would come into force in 2018, while Canada launched a public consultation period for bail-in proposals on August 1.
Both Moody's and S&P cut their ratings outlooks for Canada's largest banks to negative from stable, in direct response to Ottawa's plans to create a bail-in regime for troubled lenders.
UK lender Lloyds Bank highlighted the bail-in regime in its prospectus for the US$1bn senior bond, but this did not prevent it pricing in line with CBA's five-year deal issued on the same day, at 67bp over Treasuries.
Although Lloyds benefited from some scarcity value, each of the three main rating agencies rated the lender two notches lower at A1/A/A.
Even if ANZ, CBA, NAB and Westpac do suffer downgrades in the event of local bail-in legislation, their fundamental performances remain very sound in both absolute and relative terms.
After early problems, related to their huge external and internal wholesale borrowing needs, the four banks emerged from the global financial crisis in very good shape with strong local commercial arms accounting for a vast majority of their combined annual profits in excess of A$30bn (US$26.5bn). (Reporting by John Weavers, Editing by Steve Garton)
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