Australian Banks buy over half in $13b government bond deal

The major banks have emerged as the biggest supporters of Australia’s record-breaking government bond deal, seizing more than half of the popular $13 billion offering, which Prime Minister Scott Morrison said reflected confidence the economy could pay off its debt.

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The banks’ oversized role in getting the deal away fuels optimism that the mounting deficit will not be financed by the Reserve Bank alone through its secondary market buying.

A motivated banking sector, which needs to hedge its interest rate exposure and add to reserves of top-quality assets to meet regulatory requirements, can help ease the funding burden.

The Australian Office of Financial Management attracted bids of $26 billion on Wednesday for the 4½-year bond, knocking back the equivalent of half of the final offer size.

Mr Morrison said the interest “should give Australians a sense of confidence that, the significant financial commitments we have made, we are being successful in raising those funds on markets”.

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Australian bonds “are well received, and that is because of the relative strength and the relative positive impression that markets have in relation to Australia”.

The Prime Minister highlighted the large domestic participation in the bond sale. The composition of the buyers was not revealed until Thursday by the AOFM. All up, 68.1 per cent of investors were domestic, and 17.6 per cent were from Asia.

Banks spoke for more than 50 per cent, investment managers 25 per cent, hedge funds more than 17 per cent and central banks 5 per cent. The bonds pay a yield of 0.47 per cent, at the upper end of the marketed range.

“The issuance was priced very attractively and bank balance sheets usually like that part of the curve,” said Su-Lin Ong at RBC Capital Markets, referring to how shorter-dated bonds are a natural fit for the replicating portfolios banks used to manage their interest rate risk.

Martin Whetton, head of fixed income and currency strategy at Commonwealth Bank, explained that the banks participated in two ways: through their trading desks and through their Treasury operations.

Treasury operations (“buy and hold”) are in the market for liquidity purposes. Trading desks can be big earners for the banks and will chase value where they see it. The Reserve Bank emerging as a buyer opens up opportunities traders can arbitrage.

The Reserve Bank declared in a historic move on March 19 that it would buy government and semi-government bonds to enforce market stability and keep the three-year bond yield around the same level as the cash rate (0.25 per cent), enabling cheap borrowing.

The banks’ trading desks got a large amount of the offer with 31.5 per cent, Mr Whetton said.

“I suspect that the dealers, because of where the RBA has been buying in the three- to five-year part of the curve, don’t have any paper to sell to clients, so by issuing [in the 4½-year part of the curve] dealers are getting paper and they can make markets.”

Probably the most important part of the Reserve Bank’s buying, Mr Whetton said, is that “they are getting rid of the dysfunction in the bond market, which saw the bid-offer spread as wide as 14 basis points”. It’s now 1 to 2 points, he said.

“There has to be a functioning bond market,” Mr Whetton said. “If there isn’t, companies and governments can’t raise money.”

Banks may top up liquid assets

Finally, a unique inadequacy of the Australian market makes the banks the natural owners of a greater number of bonds set to be issued. Up to $300 billion of government debt needs to find a home.

Regulatory demands require them to hold a large stock of high-quality liquid assets. However, the government’s previously modest debt position meant there was always an insufficient amount of bonds available. This resulted in the Reserve Bank devising a liquidity facility as a substitute.

With the supply of government bonds expected to expand materially, the banks are likely to be required to own more as part of their liquid assets.

Nomura strategist Andrew Ticehurst estimates this amounts to an additional $157 billion if regulators increase the proportion of liquid assets represented by government bonds from 25 to 35 per cent.

He said the record size and strong interest reflected that the November 2024 offer “represented very good value”.

The AOFM has already told the bond market that it would raise about $5 billion a week via bond auctions, sell about $4 billion of short-term Treasury notes, and conduct several syndicated offers.