Why ‘goose eggs’ are a big problem for Australia’s big four banks

Issuers into the US corporate debt market call them “goose egg” days — the days when no one is able or willing to raise funds. There have been more of those days this year than even at the height of the 2008 financial crisis.

In fact, there have been 44 days this year when there have been no issues in the world’s largest and usually deepest market for investment-grade debt. In 2008, during the worst of the global financial crisis, there were 25. Since 2007, the average number of goose eggs laid has been 20 and the median 18.5.

The number of days when the market is effectively closed is even greater than it might appear because the data excludes Fridays (historically, there has been minimal activity on Fridays) and public holidays. Taking those into account, the market has been closed to new issues nearly one in every four trading days so far this year.

For issuers, the impact is amplified by their need to be able to provide current financials to investors. There are only limited windows each year when companies both have their up-to-date accounts and are lawfully able to provide them to a discrete group of investors.

The unusual behaviour of that market is of significance to the larger Australian companies that access the US debt markets for their borrowings and is of particular relevance for Australia’s big four banks.

Beyond their normal appetite for longer-term wholesale debt, the major banks face a wall of refinancing over the next 18 months as they replace the cheap funding extended to them by the Reserve Bank in response to the pandemic with higher-cost, market-sourced funds.

The RBA provided $188 billion to Australian financial institutions through its term funding facility at an interest rate as low as 0.10 per cent (it was initially 0.25 per cent) with the four major banks accounting for about $137 billion of those funds. The banks have until mid-2024 to repay the RBA, with a major repayment window in September next year.

Their experience in the US debt market says that it has become harder and more expensive to raise funds, and the funding is for shorter terms than used to be available even for some of the most highly rated banks in the world.

Not only have the terms available shrunk but reference rates – US government bond yields or, in this market, the bank bill swap rate (BBSW) – have risen sharply and the spreads, or margins over those rates, have also blown out. The BBSW is just above 3 per cent and the banks are paying about 150 basis points over BBSW for their funds. There’s a lot more risk being priced into corporate debt.

If the Australian banks are experiencing challenges and increased costs raising funds then lesser-rated corporate borrowers – or European banks with far less pristine balance sheets – would be having even more difficulty and/or paying higher premia for their funds.

The behaviour of the corporate debt market is an exaggerated version of what’s happened in the US Treasuries market – the market for US government debt – which has been far more volatile and illiquid than usual despite the market’s reputation as the global haven for investors in uncertain or “risk-off” times.

The explanation for what’s driving that volatility — illiquidity and, in the case of the markets for corporate debt, occasional seizure — seems relatively straightforward.

For most of the period since the financial crisis (apart from a brief bout of volatility in late 2018), inflation has been almost non-existent and interest rates low. Periodic releases of economic data barely caused a ripple.

Since March this year, when the Fed suddenly started hiking US interest rates aggressively in response to 40-year highs in US inflation, each release of an inflation number and each meeting of the Federal Reserve Board’s Open Market Committee (which determines US monetary policy) has generated volatility and affected liquidity in the government and corporate bond markets.

The Australian banks benefited greatly from the RBA’s provision of near-free money in response to the pandemic. Replacing those funds with wholesale debt that costs vastly more won’t, given the current condition  of debt markets, be cheap or straightforward.

It is the uncertainty about how far the Fed will go in raising US rates, how long those elevated rates will persist and what that might do to the macroeconomic outlook that is causing uncertainty and anxiety among investors who have had a horrible year.

Between them, the shift in US monetary policies, the legacies of the pandemic and the war in Ukraine have generated massive actual and market-to-market losses for bond investors after decades of a bull market in bonds.

As rates rise – and they’ve risen faster and further this year than any year since the 1980s – the prospect of defaults by companies and households also increases, which is another reason for bond investors to be more nervous and for them to demand greater yield compensation for the perceived increase in risk while shortening the periods in which they are exposed to risk by lending for shorter terms.

It’s little wonder that the investors are more nervous and risk-averse, or that issuers are more cautious about issuing into a market where there is reputational damage and potentially reduced access to the market in future if an issue bombs.

Earlier this year, an Australian bank had the misfortune of marketing a US dollar bond issue to investors on the morning when the US retail heavyweight, Target, reported a rather large and unexpected inventory problem.

The bank’s raising had been well received in Asia but Target’s shock announcement, which it attributed to the economic environment and inflated transportation costs, drove US debt investors to the sidelines.

The insight that the goose egg days provides into the fragile conditions in US debt markets is supported by harder data.

Issuance by non-financial companies with investment grade credit ratings was down about 28 per cent in the first 10 months of this year and, excluding 2020 when the onset of the pandemic froze activity, is likely to experience its worst decline in volumes since 2008. Issuance of high-yield debt – “junk” bonds – is down 80 per cent.

The Australian banks benefited greatly from the RBA’s provision of near-free money in response to the pandemic. Replacing those funds with wholesale debt that costs vastly more won’t, given the current condition of debt markets, be cheap or straightforward.

They’ll just have to hope that when they do go to the US market, their issues don’t coincide with one of those dreaded goose egg days.

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