Westpac: Tier 2 opens ALAC test with a bang

On 9 July, APRA announced ALAC requirements under which Australia’s big four have to raise some A$50bn of additional Tier 2 by 2024. Less than a week later, Westpac opened the new subordinated innings with a US$2.25bn long-dated trade that attracted some US$15bn of orders. Westpac’s Guy Volpicella and Nicholas Cooper talked to Bank+Insurance Hybrid Capital about the bank’s stance vis-à-vis the new requirement as well as its pace-setting Tier 2 deal.

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When APRA in November 2018 published its initial proposals for Australian loss-absorbing capacity (ALAC), these envisaged lifting Australian D-SIBs’ Total Capital requirement by four to five percentage points of risk-weighted assets over four years. The regulator further proposed that the bulk of the requirement being met through an increase in Total Capital, expected to be Tier 2 capital – not via a senior non-preferred or HoldCo solution as in many other jurisdictions.

The combination of proposals met with opposition from certain stakeholders, including some among the country’s banks, who flagged the higher costs this would inflict on Australian issuers, particularly given that the magnitude of the extra issuance would more than double their amounts of Tier 2 outstanding.

When APRA on 9 July announced how it would proceed, it reduced the increase in Total Capital to three percentage points for now, but maintained its position whereby the additional requirement would be met with Tier 2. Longer term, an additional one to two percentage points may be required, but the question of how this should be met has been left open.

Westpac on 15 July moved quickly to begin fulfilling its extra needs, selling US$1.25bn 4.11% 15 year non-call 10 and US$1bn 4.421% 20 year bullet tranches in an SEC-registered trade, rated Baa1/BBB/A+, that attracted a combined $15bn book, allowing it to tighten pricing from IPTs of the Treasuries plus 230bp area for both tranches to 200bp and 180bp, respectively.

Australia & New Zealand Banking Corporation (ANZ) subsequently opened domestic issuance, on 19 July, with a A$1.75bn 10 non-call five Tier 2 paying BBSW+200bp.

Neil Day, Bank+Insurance Hybrid Capital: How did APRA’s decision compare with what you hoped for or expected?

Guy Volpicella, Head of Structured Funding and Capital, Westpac Banking Corporation: It was clear that APRA’s intent was for us to issue Tier 2 as part of a loss-absorption capital mechanism, even if some jurisdictions across the globe probably have more cost-effective structures to meet similar requirements.

The key thing for us is that when they put out their original paper they were looking to increase the capital requirement by 4%-5% of RWAs, but what they’ve now done is reduce that to 3%. So there has at least been a clear reduction in the amount of Tier 2 that will be needed to meet this ALAC requirement.

Day, BIHC: APRA only confirmed its decision on 9 July and you issued your new Tier 2 just a week later. What was the thinking behind moving quickly?

Volpicella, Westpac: Based on Westpac’s RWA levels today, we need to issue roughly A$13bn of Tier 2, equivalent to around US$9bn, and we wanted to get started on this as soon as possible and get some runs on the board. That target is probably going to mean one or two benchmark transactions a year, in addition to our normal refinancings, which are only around A$3.5bn (US$2.5bn) to the end of the transition period.

Our decision also reflected the constructive nature of the market. With the lower for longer interest rate environment that we’re in globally, and a relatively more benign geopolitical environment at the moment, it was clear that it was probably a good window to issue.

Day, BIHC: Why did you choose to go to the dollar market now?

Volpicella, Westpac: Tapping the US dollar market was important to us for two main reasons: the duration that’s available to us in the US dollar market, and the depth we see there. We are the only Aussie bank issuing both senior and Tier 2 in SEC-registered format in the US dollar market and the investors know us well. On top of that, since the introduction of Basel III, which is a number of years ago now, we had only issued one US dollar SEC Tier 2 transaction. So from that perspective, we knew we had the capacity to issue, and we were well aware that the duration was available to us, too, so we felt it was a good transaction to move ahead with.

Day, BIHC: How did spreads react to APRA’s moves?

Nicholas Cooper, Senior Associate, Global Funding, Westpac: The domestic market here clearly reacted more than offshore markets. On the day of the announcement, we saw spreads move about 15bp wider in the morning, but that was based on small-sized flow in the secondary market. Then through the afternoon as we started to move into Asia and the start of the European day, the price action in the domestic market, at least, saw those spreads retrace, ending up around 10bp wider on the day. That night in the US, on TRACE we only saw circa US$7m trade of any Australian Tier 2 lines, and spreads were maybe marked a handful of basis points wider. The offshore reaction was much more in line with the announcement, i.e. 3% of capital by 2024, which was less than what was originally proposed in the consultation late last year.

Day, BIHC: What was the thinking behind the choice of the different tranches?

Volpicella, Westpac: Clearly the depth of the market and where we saw demand was key, but so too was the duration available. Given the overall amount of Tier 2 that we need to do over time, including our refinancing needs, it’s prudent to push out the tenor profile to somewhere between seven and 10 years. For example, an average issuance tenor of around 10 years means we’ll only need to refinance about A$2.5bn per annum.

We also wanted to make sure that we have a very manageable profile, and that’s what led us into a dual-tranche deal, so that we don’t end up having a significant amount maturing at one point in time. And we will continue to build our maturity profile in a way that creates a smoother outcome for refinancing purposes going forward.

Day, BIHC: The deal itself, judging by the book, seems to have gone very well. How do you feel about the outcome, and how did that compare with your expectations?

Volpicella, Westpac: It’s the sort of book that you hope to end up with; certainly not something that you would have expected going into the trade. That said, we were expecting to see investors feeling like this was a trade that they want to be investing in given how the factors I mentioned earlier lined up – the very constructive backdrop and relatively calm geopolitical environment; that we haven’t issued a lot of Tier 2 and only one previously in US dollars; and that we are the only SEC-registered Australian bank issuing either Tier 2 or senior in the US dollar market.

Cooper, Westpac: We were pleasantly surprised by the granularity and the quality of the book given how big it was. We weren’t seeing overinflated orders coming out of any particular region or investor type. And so what we ended up with was a really high quality but large book where we saw somewhere between 420 and 450 unique investors across the book – we had over 300 line items in each tranche, so over 600 line items across the two books, which speaks to the level of engagement and granularity we got, not only through the US, but right across the world.

Day, BIHC: You’ve explained your reasons for accessing the US dollar market, but how does it compare with what you could do domestically, where ANZ has since issued a 10 year non-call five Tier 2?

Volpicella, Westpac: When you compare the US dollar market to the Aussie market, the Australian dollar market tends to be a shorter dated market when it comes to Tier 2. Our desire here was not only to get a benchmark trade out in the marketplace, but also to get the tenor. If you actually compare the two markets, you’d say the US dollar market is certainly providing depth and duration, whereas the Aussie market provides us the depth, but not as much duration.

In terms of the relative pricing between one and the other, given the duration, it still stacks up. If you look at the two bookends, the 20 year bullet and the 10 non-call five, it’s probably not uncommon to see that sort of pricing differential for the additional 15 years in duration.

Day, BIHC: You’ve said quite a bit already about what you expect to be doing going forward in Tier 2 – is there anything else you wanted to add to that?

Volpicella, Westpac: When you look at Australian banks, any dollar amount we raise in respect of this ALAC requirement is completely offset against other funding we issue – it’s not like banks in other jurisdictions, where it becomes an accumulation of liquidity. There are two key aspects that come off the back of that. One is that we are not going to be changing what we do from the bank’s perspective – we’re not needing to go and find other assets to invest in; it’s going to be business as usual from our side. And the other element is that we are offsetting what we are doing in other forms of funding, such as senior unsecured, which is the main funding option that we will be looking to dial down. And then when you look at the type of senior unsecured that we will be reducing, there will probably be more focus on the longer dated senior than the shorter dated, given that we are issuing longer dated Tier 2 now.

Day, BIHC: Funding costs were a key topic in the debate about APRA’s proposals – what are the takeaways from where you ended up pricing?

Volpicella, Westpac: APRA has made it very clear that its view is that using Tier 2 as a form of ALAC for the additional capital requirement results in about 5bp in terms of additional cost. That’s not far away from where we’d see the ultimate cost – this deal is very much in line with that. But when you look at it from a dollar perspective, 5bp on our total asset book is actually quite significant. When you’ve got almost A$900bn of assets, 5bp across your whole NIM is about A$400m a year – that’s not a small number.

Day, BIHC: Does the success of your Tier 2 transaction show that fulfilling the additional ALAC requirement will be plain-sailing?

Volpicella, Westpac: Whilst there’s been a reduction in the amount of Tier 2 required, it’s still a substantial amount that we have to issue, and that still needs to be carefully managed. We got a bit of a tailwind on this one, where we issued against the backdrop of a really constructive market and the other elements I mentioned. But when you look through the number of years in which we need to issue this type of paper, it’s clear that we will need to traverse periods of volatility and heightened supply from Australian banks and the like. So while it certainly feels like it’s more manageable given the smaller size, there’s still a lot of work to be done.

Day, BIHC: APRA has left open how the incremental 1%-2% that would get to the 4%-5% level could be met in future. When do you expect to get some visibility on how that might play out?

Volpicella, Westpac: It’s going to be some time before we get visibility on that. One of the reasons APRA went down the Tier 2 route was apparently because they can’t control what the legislation may or may not be, and they wanted to make sure that something was done. So they’ve given us four years or thereabouts to try to work something out. I don’t anticipate any rush – it’s just going to be something we have to keep on working on over time.