The big news out of the Commonwealth Bank’s result last Wednesday wasn’t that it ticked all the boxes with positive jaws (rate of revenue growth faster than expense growth), improved productivity, higher net interest margins and a fall in provisions. The big news was that that CBA is no longer going to play the “retail deposit game” and that deposit rates are coming down.
The market gave the result and the news the “thumbs up”, with CBA hitting a new all time high and rising from $64.83 to $67.03 over the week – an increase of 3.4%.
Post GFC – we have had it pretty good with deposit rates
In the aftermath of the GFC, wholesale funding markets dried up. Banks were forced to aggressively seek funds from “retail” investors such as SMSFs. Prior to the GFC, the term deposit “blackboard special” was being issued at a margin of around 50 basis points (0.50%) below the bank bill rate. Today, it sits at a margin of around 130 basis points over – with a 90-day term deposit paying 4.3% compared to the 90-day bank bill rate at 3.0%.
Looking at the whole retail market, CBA says that in an aggregate sense, retail deposits have “increased” in cost by 1.96% over this period. The increase they are referring to is the margin or spread to the benchmark rate the banks pay. Of course over this period, the actual rates we received on our deposits have fallen as the RBA has reduced the cash rate from 6.25% to 3.0%.
[1]Wholesale funding costs are falling
The cost of wholesale funding, which is effectively the spread over the benchmark rate that banks pay to borrow from domestic and offshore institutional investors, is also falling. This reflects the return of less-stressed credit markets. According to CBA, the spread has fallen by around 50 basis points over the last six months. For example, three-year funds in June 2012 were being raised from wholesale investors at an average of 137 basis points over the swap rate – in Dec 2012, this was down to 74 basis points.
With wholesale rates on the way down and an improvement in sentiment in the credit markets, CBA signalled last Wednesday that is not going to aggressively chase retail deposits. CBA is the leader in this market with a share of 25.2% – so its actions are likely to be matched by the other major players.
[2]What are the implications?
Firstly, term deposit rates are going to fall. Not only in a spread sense, but also the nominal rate (at least up to the one-year term) will fall, as the RBA has indicated that it is still on an easing bias. If you are not persuaded by the share market, or are just managing the liquidity component of your SMSF portfolio, lock the rates in now.
Secondly, an out-of-cycle cut in lending rates, including home loan rates, may be on the cards. We have seen some movement on fixed rates already – it is possible that a cut in the variable rate might happen without an RBA Board meeting being the trigger. This would be good for the property market.
Finally, lower interest rates are usually good for the share market as yield-hungry investors chase high dividend yielding stocks. Also, it should see increased demand from investors for hybrid issues.
NAB launches a new hybrid
Following Westpac’s lead with its ‘Capital Notes’ issue [3], NAB has followed and launched an almost identical hybrid securities issue. It is raising at least $750m from the issue of NAB Convertible Preference Shares.
Like Westpac’s Capital Notes, CBA’s PERLS VI and issues from Suncorp, BOQ and Bendigo, the NAB Convertible Preference Shares (CPS) will qualify as Additional Tier 1 capital for NAB and contain similar regulatory terms. These are:
- while perpetual, they are due to be converted into ordinary NAB shares in seven years’ time (22 March 2021);
- NAB can, at its option, redeem the CPS for cash or convert them into ordinary shares in five years’ time (20 March 2019);
- there are capital (common equity) and non-viability triggers;
- dividend payments are discretionary and non-cumulative; and
- they rank ahead of ordinary shares, equal with NABHA, however below NABHB, other subordinated issues, secured creditors and of course, depositors.
Pricing is indicated at a margin of 3.20% to 3.40% over the 90-day bill rate, paid quarterly. As the dividend will be fully franked, the actual dividend paid in cash will be 70% of the gross amount (90-day bill rate plus 3.2%, then multiplied by 0.70).
A book build on Wednesday will set the final margin. The Westpac Capital Notes issue was priced at 3.20% and size increased from $500m to at least $1.25bn – the NAB issue should also attract a strong level of interest. With margins coming in and term deposits set to become less attractive, this issue is worth considering – particularly as part of a diversification strategy.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.