In the six weeks after the CEBS stress tests, offshore banks raised A$8bn in the Australian dollar bond market, making August the best ever month for offshore issuers. Investors lapped up issues from banks of all credit qualities, from Rabobank to Royal Bank of Scotland, with spreads on offer running from 75bp to 245bp.
"The Australian dollar market is rapidly maturing, offering tremendous depth of liquidity and we at Lloyds are big fans of it," said Simon White, head of senior issuance at Lloyds Banking Group in London. "We are fans in terms of funding our Australian business, but also of the way it has developed over the last several years. It is a very responsible market many other currency sectors pale into insignificance in terms of the liquidity and flows it offers."
However, since the first week in September, the tone has been more muted while the European market has roared back after the summer. But there is plenty of life left, say leading syndicate bankers.
"Theres been a pause after the European summer but conditions are still good," says Mark Goddard, head of syndicate and frequent borrowers at Westpac in Sydney. "Markets go in phases. Weve seen the first names come in over the last month or so, but other borrowers will get comfortable with the market and investors globally are still paying attention to Australian dollars."
The countrys economy has made a robust recovery from the global financial crisis, so much so that the Reserve Bank of Australia started raising rates in October 2009. With short term rates now at 4.5%, Australia has the highest yields of any triple-A country, which has led to international investors allocating larger portions of their portfolios to Australian dollars. The Australian market also benefits from its accessibility to Asian private bank investors.
"The major development this year has been increased appetite from offshore investors," says Paul White, global head of syndicate at ANZ in Sydney. "Demand isnt just from Asia, although there is a clear trend of demand for Australian dollar product from the region investors globally are starting to pay attention to the Australian market."
Enrico Massi, head of DCM at RBC Capital Markets in Sydney, agrees. "We are seeing more and more Asian private bank accounts participating in these trades in both primary and secondary," he says, "and we expect this to become a more sizeable investor base in time."
Aussie investors still key
Westpacs Goddard says that, although offshore investors helped deals to get done, domestic demand is still the cornerstone of the market, based on large institutional accounts and bank liquidity books.
"Domestic real money is the foundation of the market," says Tim Galt, fixed income syndicate at UBS in Sydney. "Weve had some pan-Asian support and some European support, but there are significant Australian dollar funds under management in Australia and theyve been driving the big transactions from foreign financials."
The leading Australian banks are succeeding in attracting more retail deposits and so need to maintain large positions in liquid assets to meet demand for withdrawals. Deals from Australian subsidiary institutions are repo-eligible at the Reserve Bank of Australia, so meet liquidity book requirements for liquid assets that offer some spread.
Liquidity book orders for bank paper are typically large but they are matched by big orders from domestic fund managers. "Liquidity books can sometimes be cornerstone orders," said one Sydney-based head of DCM. "But there are at least two really major orders from domestic real money investors in the deals from offshore financials. Not the same two investors in every deal, but the pool of investors is not very wide. Its a concentrated, professional market like the sterling market."
Big orders from Australian domestic buyers and abundant private bank demand has allowed offshore banks to issue large sizes in the market. Barclays Bank (Australia) and Royal Bank of Scotland (Australia) issued A$1.5bn and BNP Paribas (Australia) issued A$1.25bn in August.
"The market isnt deep enough to take US-style A$3bn-A$5bn size trades," says ANZs White. "But a market of A$1bn-A$2bn deals two or three times a year is sustainable, and theres no reason why it should be any smaller than that."
The vulnerability of the cross-currency basis swap could hinder issuance by offshore banks. However, there are good reasons to think that the basis will remain favourable, among them Australian banks issuing offshore.
Indeed, the big four Australia & New Zealand Bank, Commonwealth Bank of Australia, National Australia Bank, Westpac have such high funding needs that they have no choice but to look at international markets. The quartet have raised 42% of their funding in dollars this year and 16% in euros, against 24% in Australian dollars, according to Dealogic. Australian corporates, including the supermarket chain Woolworths, have also issued large deals offshore this year.
When Australian issuers swap the proceeds of their dollar or euro transactions into their local currency, that creates demand for someone willing to swap Australian dollars for core currencies, creating an opportunity for offshore issuers to issue in the Australian market.
ANZs White emphasises that the Australian market is not dependent on basis swap arbitrage. Pricing for the recent surge of FIG deals was in line with or up to 5bp inside global comparables, but not astonishingly cheap.
Galt says: "The basis actually moved 5bp or 6bp against offshore issuers at the beginning of August versus late July, but the general tone of the market continued to improve, and particularly confidence in offshore financials."
Because Australian investors are typically large institutional accounts, they tend to demand pricing close to global comparables on a swapped basis, capturing most of the arbitrage benefit.
Massi agrees. "While pricing needs to be competitive relative to other markets, a sustainable, growing investor base that buys Australian dollars is worthwhile pursuing," he says. "At some stage we expect to see this translate to financial institution clients."
This does not mean that the swap back to core currencies is not important though. Uncertainty in core markets means volatility in the basis swap and execution risk for borrowers. Because of Australias timezone and the number of international investors involved during the recent flowering of the offshore FIG market, books on all the offshore financial deals in August were left open overnight. Only Bank of Scotland (Australia)s A$500m deal, which was led by ANZ and RBS and was largely sold domestically, closed in one day.
The Australian market offers FIG issuers not only an opportunity pick up a few basis points on the swap, but also diversity of investors. While the economic story in Australia stays strong and rates stay high, prospects for the market are bright.But as this summer shows, the Australian market is just as vulnerable to jitters about bank and sovereign solvency as the dollar and euro markets, with the added complications of currency swaps and an awkward timezone for European banks. Treasurers are realising that the Australian market is a great complement to core currencies, but its no substitute.