Will Australia’s debt markets ever provide the range of funding options for its corporates that is offered by other developed world debt markets? The answer is a familiar one: the situation is improving, but slowly.
The overall picture for corporate debt in Australia looks pretty good. “2012 was a healthy year in the corporate bond market,” says Ron Ross, executive director and head of bond origination Australia at ANZ Global Markets. “We had $11bn of issuance, 45-plus issuers and a number of offshore issuers coming to our market”, among them Korea Gas, Fonterra, BP, ABB and Holcim.
“Then there was the A$1bn deal from BHP. For many reasons, it was a fantastic year for the domestic corporate bond market.” For investment banks, too: ANZ was a lead on all of those deals.
The year 2013 kicked off looking just as strong, until hit by global worries over indications from the US Federal Reserve that it planned to reduce the pace of its quantitative easing if the US economy continued to recover.
“It only took [Fed chairman Ben] Bernanke to say QE will one day come to an end and it rattled the markets for the next seven weeks,” says Ross. “The feeling now is of cautious optimism.”
Dealogic data for Australian dollar domestic corporate bond issuance show issuance of A$2.18bn domestically and A$6.42bn internationally from the start of this year until August 12, compared to A$7.78bn and A$14.5bn, respectively, for the whole of 2012. That pattern suggests a full year with lower volumes than 2012 but better than the two years that preceded it.
The crucial point, beyond domestic volumes, is just how much of the total corporate funding is being done at home rather than overseas. “One statistic we look closely at is the total volume of bonds done by Aussie corporates,” Ross says. In 2011, he says, that total was $30bn — excluding BHP and Rio Tinto, which he considers multinational despite their Australian domicile. Of that total, only A$6bn was raised in the domestic markets, just 20% and a level that Ross describes as disappointing and unhealthy.
Last year showed a marked improvement, however, he says, with almost half of funding done domestically. This year is so far showing a similar picture.
Australian corporates resort to overseas markets chiefly because they can’t get the funding they need at home. Historically the main reason has been tenor, and for the bigger issuers, scale. It may also be rating, as Australia has no high yield market to speak of. But on all three grounds, there are signs of improvement.
On tenor, it was notable that the two deals that re-opened the Australian markets after the turmoil caused by Bernanke’s QE remarks were corporate, and seven years — for Port of Brisbane and Perth Airport.
Westpac was a lead manager on Perth Airport. Bankers there saw great significance in the deal. “Perth Airport re-opened the market,” says Mark Goddard, head of debt securities. “To my mind, that reflects a greater desire for the corporate sectors than for others. Perth Airport is BBB/Baa2 rated, and we are seeing domestic investors want to buy more of those BBB corporates to get yield.”
His colleague Gary Blix highlights tenor. “Perth Airport was a seven year transaction. What we are now seeing is an acceptance by the market to move further out along the curve. This year, ten corporate issuers have been able to print transactions for seven-plus years.”
There is a widespread sense that this improvement in tenor is here to stay. “Seven years is the new five years in the local market,” says Will Farrant, head of debt capital markets at Credit Suisse.
At ANZ, Edwin Waters, executive director, debt capital markets, says: “Five years in Australia is always the most liquid and largest part of the market. Six and seven are certainly open, and there have been highly successful transactions in 10 as well. Extending tenor is just a product of confidence in the market.”
He notes, though, that the absence of longer-tenor deals is not just because investors aren’t interested in them, but because issuers may not need them. “Remember that a lot of tenor decisions are driven by issuers and what they decide they need,” he says. “A lot, especially on the property side, don’t need 10 year funds.”
In terms of market depth, last year’s A$1bn deal for BHP Billiton was clearly a landmark, but the country’s biggest names, like Telstra, are likely to continue to get the bulk of their benchmark funding in dollars and euros, as they always have.
More risk, but not much
On ratings, there is clear evidence of an desire to go a little further down the curve than used to be the case. “There is a growing willingness to look at lower rated credits,” says Ross. “Lend Lease is BBB-, Qantas has come to market, Holcim is a BBB issuer from Switzerland, and Downer EDI is the lowest credit, at BBB- from Fitch. There is a good sprinkling of BBB credits.
“Obviously when we’ve had this period of very low base rates, it’s encouraged investors to find incremental yield by going down the credit curve. I wouldn’t say we’ve been knocked over in the rush by BBB issuance, but there is more confidence in the market.”
The Downer deal he mentions has been widely remarked upon in Australia, partly because of the BBB- rating, but in particular because it is only rated by one agency, and the least widely followed of the three — Fitch. Some find this more interesting than the headline heavyweight deals of 2012.
“This year we haven’t seen as many jumbo trades from the corporate side like Telstra and BP last year, but we have seen trades getting away for names that might not have succeeded in previous years, particularly for BBB corporates,” says Sean Henderson, head of debt capital markets for Australia at HSBC. “Our deal for Downer, for example, had eight domestic investors and 32 accounts from offshore, for a BBB- name.”
This last point is crucial: it wasn’t, by and large, Australians who bought that deal. International participation appears vital for further progress down the curve.
“There are multiple pockets of demand in Australia, but for corporate credits like Downer you need the institutional bid to come to the fore, and historically that hasn’t been deep or consistent enough for many corporates to rely on, with the notable exception of the largest names,” says Henderson.
“The big development in recent years has been the growth of the A$ bid from offshore — Japan, Asian private and commercial banks, central banks and Europe. Many recent issuers with name recognition offshore have seen 50% plus going to these offshore accounts.”
Downer EDI is an engineering and infrastructure service provider, Australian but with significant Asia Pacific business. In some other names, the Asia connection is easier to see: a deal earlier this year for SP Ausnet, in seven and 10 year maturities, saw more than 50% placed offshore. That’s partly because, although the company operates in the state of Victoria, it is owned by Singapore Power.
“The Asian bid has been critical on many trades, providing great size and price tension, and filling order books out from 10 to 20 investors up to 40 or 50,” Henderson says.
Ross at ANZ says that “every deal we bring to market sees a certain level of Asian participation” and that 10%-30% of books will typically now come from Asia, especially on BBB deals which appeal to the private bank space.
Westpac’s Blix cites the same range. “The domestic investor base is still the driver, but the addition of the investor base from Asia can provide price tension,” he says.
And Waters at ANZ suggests that visiting Asia will pay dividends. “Those issuers who have travelled to Asia and conducted investor updates have found their transactions have been successful and well supported.”
High yield, anyone?
Whatever the progress represented by Downer’s deal, however, few people seem to have much faith in a high yield market. “Taking one step further to a sub-investment grade market here? I wouldn’t be holding my breath for that,” says Ross.
There is a circular debate about why this is. Some argue that Australia’s big institutions won’t buy high yield paper, some that they don’t because it doesn’t exist. Waters at ANZ takes the first view. “A lot of that is governed by the mandates from investors and super funds that don’t allow them to buy sub-investment grade.”
But Mark Goddard at Westpac thinks there are long-entrenched factors at play in the institutional market. “Would fund managers buy more sub-investment grade paper if it was available? Perhaps, but other factors, including the low allocation to fixed income, are also a factor in further development.
“A move into sub-investment grade paper doesn’t happen overnight. It may need mandate changes as well as a cultural shift. In the same way as the local market is built on an overall investment culture that has an equity bias, the fixed income market is built around an investment grade bias.”
Some are more positive, though. “We can see the buds of an A$-denominated high yield or unrated wholesale market,” says Farrant, pointing to his Healthscope deal, covered in the corporate hybrids section of this report, as a first sign. “We feel that the globalisation of the Aussie dollar as an investable currency will drive this and it is likely that Australian dollar high yield will initially be mostly an offshore phenomenon.”
Meanwhile, issuers who cannot meet their needs at home head for US private placements, US high yield or the term B loan market (see elsewhere in this report).
If retail investors want to participate in vanilla corporate debt, the process has historically not been easy. “For retail investors we barely have an investment grade corporate bond market in Australia that they can readily access,” says Paul Donnelly, global head of equity capital markets and debt capital markets for Macquarie Capital.
Instead, they have bought more complex listed structured hybrids, dominated by bank hybrid capital (see separate article on financial institutions).
But the inaccessibility Donnelly complains of may be about to change. “There is definitely a move from the government, treasury and ASIC to make it easier to issue to retail investors in listed form,” says Andrew Buchanan, head of hybrid capital for Australia at UBS. The legislation is already through, but there is a challenge in creating demand, he says. “Investors will assess a corporate bond return against a government guaranteed term deposit, and therefore a bond will need to offer a premium to attract attention.”
It will take time to find a level at which issuers and retail can meet, but the idea has potential. As John Chauvel, head of debt capital markets at Westpac, says: “Retail corporate debt is definitely an area we want to see growing. There would theoretically be huge demand there.”