The depth, tenor and pricing available in the US private placement market are very attractive to Australian borrowers. But bankers at home are increasingly desperate to overcome this obstacle and develop a more liquid and active domestic corporate bond market.
"One of the key continuing trends in the Australian market is that there are fewer and fewer issues from industrial borrowers as opposed to financials, which has been a source of frustration for investors and intermediaries alike," says Peter Christie, head of corporate securities origination at Commonwealth Bank of Australia in Sydney.
"Companies that do need to borrow often find the US private placement (USPP) market a more attractive source of funding than the domestic market, which means we find ourselves overweight with financials, property trusts and credit-wrapped deals in the infrastructure space."
Part of the reason for this lack of supply is that after 17 years of continuous economic growth, few Australian companies need to raise funding for operational reasons, although some are gearing up their balance sheets to fend off the advances of private equity predators. "Aside from the top half a dozen or so companies, if an Australian corporate is raising A$1bn a year in the bond market thats a pretty big number," says Mark Langsworth, head of debt capital markets at Royal Bank of Scotland in Sydney.
Conventional wisdom is that there would be no shortage of investor appetite if more corporate supply was made available to them. "There would be demand for more single-A and triple-B issuance, but there is no supply," says Simon Maidment, head of fixed income at UBS in Sydney. "The bank market is very efficient and for borrowers in that rating zone, the offshore capital markets are more competitive on price, volume and tenor. So most Australian corporates will barbell their strategy by having three to five year bank facilities with full flexibility and by going to the USPP or Eurobond market for their 10 or 15 year funding."
Where Australian borrowers have chosen to fund themselves offshore rather than domestically, say some bankers, there have often been sound strategic reasons behind the choice. "Weve seen a number of the property trusts buying companies in Europe and the US, and in those cases it makes sense for them to fund in the currency of their acquisition," says Fergus Blackstock, executive director of debt capital markets at UBS in Sydney.
International gain, domestic loss
Whatever their reason for funding themselves in the international market, a series of recent corporate transactions appear to have been international investors gain and domestic investors loss. In March, for example, Telstras 10 year Eu1bn transaction via Barclays Capital, BNP Paribas, Deutsche Bank and JP Morgan, offered at 62bp over swaps, was five times oversubscribed. "Telstra has been a regular issue in the euro market, where it is very well supported," says Natalie Vanstone, head of debt capital markets at JP Morgan in Sydney.
More recently, in June, Australias largest media company, the BBB- rated Fairfax, also saw its debut euro denominated transaction very solidly received. ABN Amro and Merrill Lynch led the Eu350m five year deal, which was priced at 58bp over swaps, compared with guidance of 60bp over.
In the Reg S/144A market, meanwhile, the strength of international demand for exposure to higher yielding Australian corporate borrowers was illustrated in June, when the Ba3/B+ rated mining company, Bemax Resources, launched a $175m five year transaction via Morgan Stanley. Marketed into an increasingly edgy credit market, the Bemax deal was priced in line with guidance, at a coupon of 9.375%, and was 2-1/2 times covered, with investors in the US and Asia each taking 40% of the transaction and Europe the balance.
For lower rated Australian corporates, it has not been exclusively a one-way street leading towards offshore markets, especially for shorter dated transactions. Take the example of a company like General Property Trust (GPT), which first accessed the local corporate bond market with a seven year issue as a AA- rated credit in 1999, but has since managed its rating down to BBB+.
Since its initial seven year transaction, GPT has raised 10 year funding once in the domestic market, but all its other deals have been for five years or below. Those included a A$700m three year issue in March 2006, led by nabCapital and CBA, which was Australias largest ever triple-B corporate deal. It was launched into a very appreciative market in which just 5% of supply in the previous year had been from borrowers outside the financial sector. Some 81% of the deal was allocated to investors in Australasia, with the balance going to Asia, according to nabCapital.
"Having first tapped this market as a double-A minus issuer, we found that once we had done the necessary documentation and presented ourselves to the investor base it was relatively easy for us to go back to the market," explains GPTs chief financial officer, Kieran Pryke. "Yes, it would have been nice to have issued more longer dated bonds, but this is a small market and it has been positive that a reasonably robust market has evolved for transactions of up to five years. To the best of my knowledge no corporate has borrowed beyond 10 years in the plain vanilla market.
"Weve looked at alternatives like the USPP market and others, which clearly offer the benefits of diversification and longer tenor," says Pryke. "But weve been pretty comfortable with the way the domestic bond market functions, although it is now 18 months since we were last in the market." GPTs next deal, however, will likley be offshore. It has begun meeting investors in Europe.
Despite GPTs success, views on the outlook for the Australian corporate bond market are mixed, with bankers saying that the local investor base appears to have something of a contradictory approach to corporate credit.
"Domestic investors talk about how theyd love to see more issuance into Australia rather than offshore," says Maidment at UBS. "But even when weve seen Aussie dollar tranches added to USPP deals with an opportunity for Australian investors to participate, they have tended to knock them back on the basis of price, because the bid out of the US is so much stronger."
Looking to the short term, bankers think it likely that the local investor base will become more rather than less picky about corporate exposure, principally because event risk has reared its head so conspicuously in Australia.
According to a Moodys report released at the start of July, "of the 10 Asia Pacific ratings placed on review for downgrade in the second quarter [of 2007], seven were Australian, and most of these reviews were driven by M&A issues. Fully 25% of Australian issuers are now on review for downgrade or negative outlook, compared to 19% during Q1 2007."
Moodys sees no immediate signals to suggest a deceleration in this deterioration of credit quality. "Event risk continues to drive the credit trend in Australia and, going forward, the potential for mergers and acquisition activity to affect financial leverage will remain the key rating factor."
That has nothing to do with the intrinsic credit strengths of the Australian corporate sector. "Australia isnt a default-free country, but defaults have been very few and far between in this market," says Andrew Baume, director of cross-markets structuring at Deutsche Bank in Sydney. "As far as Im aware there are at present no stressed investment grade borrowers in Australia."
In the last year or so the positive earnings story has been overshadowed by tremors caused by private equity, with the bid for Qantas acting as an Australian mini-version of Barbarians at the Gate. "When the Qantas bid was announced its rating did not fall, but it was put on negative watch and the implication was that it was heading for non-investment grade territory," says Peter Bloomfield, joint head of debt capital markets at Westpac in Sydney. "Spreads blew out and although they eventually came back, investors were unnerved by the fact that there was nothing in the bond documentation to protect them."
While an increased focus on covenants will therefore be one feature of any expansion in the domestic corporate market, another area of continued growth, say some bankers, will be the hybrid sector. "Historically, Australia has had a highly developed corporate hybrid market, well in advance of the US and Europe," says Rupert Daly, head of hybrid capital at Deutsche Bank in Sydney.
"But it was generally seen as an avenue to tap a new investor base and broaden an issuers available funding sources, and hence used prominently in M&A activity. Now that the ratings agencies have changed their views on corporate hybrids and allowed for more equity credit, I think the rationale for issuing hybrids has been expanded, with borrowers likely to access the market purely for the ratings benefits they can derive."
|Offshore market key for banks|
If the domestic bond market is unable to provide corporate borrowers with what they need in terms of tenors, it is even less able to satisfy the voracious demands of Australian financial borrowers.
"Between them the Australian banks have an annual funding requirement of well over A$100bn, so investor diversification is absolutely critical for us," says Eric Williamson, head of group capital and funding at National Australia Bank in Melbourne.
"We generate most of our funding offshore, with the Australian market unlikely to provide more than 20% of our funding in any give year. So although there is a large domestic pool of money in Australia, you will continue to see us roadshowing in Europe, Asia and the US."
NAB itself raised about A$35bn through a mixture of term funding and securitisation in 2006, and much of the banks strategy in the last 18 months, says Williamson, has involved terming out its funding and enhancing the structure of its balance sheet. "We felt that the overall tenor of our funding mix was a touch too short," Williamson explains, "which we have rectified during 2006 and 2007."
That, says Williamson, has involved exploring some markets that NAB hadnt previously tapped, such as the Samurai and euro fixed rate markets. "We werent prepared to issue fixed rate euros at any cost," says Williamson, explaining that when NAB set out on its most recent non-deal roadshow in Europe it was careful to visit both fixed and floating rate accounts. "At the end of that roadshow it became clear to us that the fixed rate market was working well, which is why we took the opportunity to launch in fixed rate euros."
The result was an oversubscribed Eu650m five year deal via Deutsche Bank and nabCapital in June which was priced at the tight end of its guidance of mid-swaps plus 8bp-9bp and which attracted a well diversified range of investors, many of which were new to the NAB credit.
Following that roadshow, says Williamson, NAB spent a few days in London meeting a number of SIVs, many of which indicated that they would have a strong appetite for exposure to NAB in subordinated debt form. "So when we got back to Australia we took the opportunity of satisfying both that investor demand and our own requirement for tier two capital with a transaction that went very well," says Williamson.
That deal was an $850m 10 year non-call five issue via Citigroup, Deutsche and nabCapital which Williamson says generated sizeable demand. Pricing, meanwhile, came in at Libor plus 19bp, which was inside comparable deals the previous week. "Demand held up very well even at that tight pricing," says Williamson.
Strong credit story
In the global marketing process, bankers say that the Australian credit story in general and the banking industrys credentials in particular give them a very strong story to tell to investors. "Australian banks are great credits," says Edward McGuiness, co-head of debt financing at Nomura in Sydney. "The underlying default rates on their mortgage portfolios are extremely low by world standards, partly for cultural and partly for structural reasons."
That message was one that McGuiness and his team were eager to transmit on a recent roadshow to Japan preceding a ¥50bn five year Samurai transaction for NAB in July, which was the first of its kind for an Australian bank and was led by Nomura, Daiwa and Nikko-Citi.
A recent highlight for Australian banks in sterling, meanwhile, was the tightly priced and oversubscribed £450m issue of non-innovative tier one capital led in June by Citigroup, Deutsche and UBS for ANZ, priced at 96bp over the 2012 Gilt. "ANZs deal was the first non-innovative tier one transaction issued offshore by an Australian bank, although St George had done a domestic deal the previous year," says Fergus Blackstock, executive director of debt capital markets at UBS in Sydney.