Australia's small banks set to feel funding pinch

* Majors' big covered bond programmes hurts non-majors funding options

* NAB's latest deal suggests non-majors' unsecured spreads could double

* Lenders unlikely to pass on RBA rate cuts

By John Weavers

LONDON, Feb 1 (IFR) - Australia's non-major banks could end up paying more than twice the spread for raising senior unsecured debt that they incurred last year, if the new five-year bond from National Australia Bank prices in line with guidance.

And its not just Australia's smaller banks, known locally as non-majors, that are faced with the situation -- funding costs are rising across the entire sector because senior debt has re-priced as investors seek the protection of collateralized paper.

The NAB issue will effectively determine the benchmark for senior unsecured bonds, and preliminary guidance was heard last week at 200bp-210bp over swaps.

Take the 175-185bp over swaps recently seen for CBA's August 2016 floating-rate notes, add more yield for the extra six months in tenor, top it off with a new-issue premium, and 200bp-210bp sounds about right.

But in January 2011, NAB and CBA paid just 75bp and 105bp over swaps respectively for their jumbo three-year and four-year issues.

Suncorp Metway, one of the best regarded of the non-majors, printed a three-year floating rate note last June at 110bp over three-month BBSW, the local benchmark rate.

This was 30bp more than the majors were then paying for similar debt. The premium has probably now widened out to 40bp-50bp.

NOT ACCORDING TO PLAN

The situation isn't exactly what the government had in mind when it decided last year to allow covered bonds; that move was intended to make it cheaper for Australia's banks to borrow.

But instead those bonds have transformed wholesale funding costs, which some analysts believe could slash profits at the big four by as much as a third.

Again, it will be even harder on the non-majors, who are hampered still further because they are unlikely to hit the covered bond market individually.

Because they are backed by mortgages that are kept on a bank's balance sheet and can be reached in the event of a default, covered bonds are normally AAA rated.

The much-smaller non-majors do not have enough assets to create sizeable and liquid bonds, and would anyway have to pledge significant assets to collateral pools to secure Triple A status -- making the structure inaccessible for them.

Meanwhile, the higher funding costs are likely to be passed down to homebuyers; there are doubts whether mortgage borrowers will fully see lower rates even after the next RBA rate cut, expected on February 7.

Indeed, the majors have already indicated that they may not match a future 25bp RBA cut, which has led some to predict only an average 15bp reduction in mortgage rates next time around.

The banks can defend this strategy by pointing to the situation in the UK, where several banks were badly caught out by tracker mortgages that matched base rate moves -- and subsequently undermined profits when the Bank of England slashed its rate to 0.5%, where it remains today.

RMBS COMPELLING?

To compensate for the sharp rise in wholesale funding costs, non-majors will have to shift their revenue raising efforts towards the retail markets by offering generous rates to savers.

But that only limits their room for manoeuvre in the mortgage market, and compromises their ability to compete for Australia's shrinking pool of new mortgage business (which also keeps them from having enough loans to create a covered bond).

So for now they will have to stay with the senior unsecured and residential mortgage-backed securities markets -- and RMBS may be more compelling.

Suncorp impressed with a deal last November that came at 135bp over one-month BBSW, though syndicate managers say any new offering now would almost certainly come in above 175bp.

Just as it did when the global financial crisis kicked in, the Australian Office of Financial management (AOFM) could come to the rescue and pick up RMBS paper from non-majors at below market levels.

But some wonder who the other investors could possibly be.

"A lot of people got burned last time around by buying at artificially low levels alongside the AOFM," one securitisation banker said.

"I don't see them repeating that mistake. These deals need to be priced at the new market clearing levels," he said. (Reporting by Alex Chambers)