TFF means Credit Margins will Continue to Contract

As part of its package to support Australian banks and the economy, the RBA introduced a Term Funding Facility (TFF) whereby it will lend to ADIs at a rate of 0.25% with a maturity of 3 years. The purpose of the facility is three-fold: firstly, to ensure all banks have access to term funding so their liquidity ratios can be maintained; secondly, to be consistent with other measures the RBA is taking to bring down medium term interest rates (such as targeting the 3 year government bond rate at 0.25%); and thirdly, to encourage the banks to lend to customers, particularly small businesses.

The facility is limited to a maximum of 3% of any ADI’s domestic credit loans and the ADI has to post suitable collateral with the RBA as security for the loan.  Draw downs must be made before 30 September 2020, but there is the capacity for additional funding to be made available up until March 2021 if the ADI has increased its business lending over the period; particularly to small business. The TFF loans are repayable at the ADI’s discretion at any point during their term without penalty.

The response of the major banks, who dominate the market for term funding, has been to not draw on the facility immediately, but rather to tacitly agree with the RBA they will use the facility to replace existing bonds as they mature.  This has led to a dearth of new issuance from the major banks (as per the graph above) which in turn has caused secondary market pricing for existing major bank FRNs to contract. 

Consequently, this has caused a general reduction in credit margins for both major bank subordinated debt and regional bank senior debt as both these asset classes are priced relative to major bank senior debt.  Additionally, confidence has grown there is not going to be a short-term financial crisis as measures taken both globally and locally by governments and central banks seem to have been effective, contributing to a more optimistic outlook for financial institution risk and a resultant contraction in credit margins.

A further factor is an influx of money into the term deposit market which in turn has led to a contraction of margins in that market.  Similarly, much of the money from the early withdrawal from super of the maximum $10K per account has gone into mortgage offset accounts.  In July, the RBA cited these as reasons for the slow take up in the TFF in that many banks have also had an influx of funds into zero interest chequing accounts that has provided them with a cheaper source of funds than the 0.25% offered by the TFF albeit on a short term basis.  

The take-up of the TFF is shown above.  The RBA is expecting a rush before the end of September when the initial phase of the facility closes.  The RBA postulates many ADIs are waiting until the last possible moment as the term of the facility runs for three years from the draw down date so the later the draw down the longer the borrower will have the monies.  Many ADI’s such as Westpac have publicly stated it will use their full allocation under the TFF before the September deadline. As per the graph above if this is the case the take-up of the TFF will accelerate rapidly over the next five weeks and no no issuance of bonds into the private markets by domestic ADI’s is to be expected.

The current trends will likely continue at least in the short term and therefore Amicus expects credit margins to contract even further.  There may be some reversal post 30 September 2020 when the RBA decides to curtail the facility, although we doubt this will be significant as if it were, the RBA would likely extend the facility or replace the TFF with an alternative to ensure credit margins do not widen again as they did earlier in the year.

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