The Asian Development Bank wowed the Kangaroo market in early July with a A$1.1bn (US$1.125bn) dual tranche deal that ended up nearly four times larger than its original size.
The Asian supras deal shows that non-European names are well on their way to rebuilding their presence in the market, after a quiet second half of 2011 during which they stepped back to keep clear of the eurozone debt crisis. However, European issuers have found it much harder to win back the attention of the domestic Australian investor base.
Kangaroo issuance was nearly US$10bn lower in the first six months of this year, at US$13.9bn equivalent, than the first six months of 2011, when US$23.2bn of Kangaroo bonds were issued by borrowers globally, according to Dealogic.
Eurozone issuers were hit particularly hard. Supply in the first half of this year was more than 40% down on volumes in the same period last year. The European Investment Bank, usually a regular Kangaroo supplier, has printed just two non benchmark-sized deals this year.
The Australian Prudential Regulation Authority (APRA) dealt Kangaroo issuers a blow in February last year, ruling that SSA Kangaroo bonds would count as neither level one nor level two eligible liquid assets as part of its implementation of the Basle III liquidity coverage ratio. The decision hit the bank bid for the asset class hard.
But this has not completely stemmed demand a plethora of non-European supranational issuers are understood to be lining up deals in the wake of the ADBs trade.
However, while the International Finance Corp, the Inter-American Development Bank and the World Bank are all guaranteed a rapturous response from investors should they decide to print, the outlook for European borrowers is nowhere near as positive the sovereign debt crisis that has gripped the Continent for getting on for a year remains fixed in Kangaroo investors minds.
One way in which European issuers could start to rebuild their presence would be to treat the market as a core part of their funding, and not just as an arbitrage opportunity.
Issuers say that they want to diversify their funding sources, but many Europeans only print Kangaroos when the basis swap arbitrage works and offers them an attractive level.
This approach has annoyed some Australian buyers and added to their suspicion of European issuers following the Eurozone debt crisis.
Lack of presence
One of the problems for many European borrowers is they are not present often enough in the market to ensure their banks support their deals.
"The key issues are around liquidity, its about being here when things get tough," says Tony Adams, co-head of global fixed interest and credit at Colonial First State Global Asset Management in Sydney. "We want banks to provide liquidity on the deals they do, provide buy-back options, to support their deals."
When things do get tough as they did late last year when the eurozone crisis intensified many deals from European issuers have not had the support that investors required.
"Weve had many occasions where the lead manager of a deal, particularly the lead manager on a foreign deal, has just walked away," says Adams. "If the lead manager of an Australian issuers deal doesnt support it then we ring the issuer. But if a European issuers Australian bonds are not being supported what are they going to do about it? Its an opportunistic market for them."
In the second half of last year the spreads of several European borrowers gapped out to unprecedented levels as the Eurozone sovereign debt crisis worsened.
The secondary trading levels of the EIB, for example, gapped out sharply and have remained highly volatile. Its 6.125% January 2017s were trading at about 200bp over semi-quarterly swaps in late November 2011, tightened to 75bp in late January before moving out to 145bp over in April. By late June they had tightened back to 95bp over.
While the spreads of European issuers widened across the board, the lack of liquidity in Kangaroo bonds made these moves more intense.
By contrast, the EIBs euro curve has experienced less violent swings. The EIBs 2.875% July 2017s traded out from a low of asset swaps less around 0.5bp in early September to 75bp over in late November, and had returned to close to Septembers levels by July this year.
"There were some liquidity problems with some outstanding Kangaroo issues from European borrowers late last year, where spreads moved out sharply," says Adams. "One large foreign buyer reduced their holdings of several hundred million dollars and that skewed spreads tremendously."
This liquidity shortage in Kangaroo bonds has led some Kangaroo investors many of whom can buy bonds in euros, dollars or sterling to question why they should buy foreign issuers bonds in the Kangaroo market, rather than buying issuers deals in their core currencies.
"Id rather buy a European name in euros and then deal with European banks to buy or sell the deal," says Adams. "If you do that, then you can get out easily, or switch your portfolio weightings easily."
Long term commitment
For those issuers that do want to have a regular presence in the market, Adams recommends they flag their issuance plans in advance as they would in dollars or euros and not just turn up when the basis looks particularly compelling.
"Wed prefer those issuers which want to be frequent borrowers to announce their funding plans in advance and make a long term commitment to the market," says Adams. "We want them to be transparent about what they intend to do."
So far this year, Europeans have had to look beyond Australia to Asian investors for additional support.
"The minute you mention Europe clients scramble," says Roger Bridges, head of fixed income at Tyndall Asset Management in Sydney. "Many Australian investors just dont want to hear. Anything European is a tall order to sell to the domestic investor base. Local demand for Europe even the top names is not very big. The recent deals from European names have gone to central bank balance sheets in Asia. "
This is even true of KfW. The German-guaranteed agency sold a A$600m five year note in January last year of which 72% was distributed to Australian banks. Its latest outing in the market was a A$300m tap of its 6% 2016s early in July. Two-thirds of that deal went to offshore buyers.
What Australian investors also want to see is some stability around spreads and for politicians to agree on a resolution to the debt crisis. Until that happens it will be difficult to convince them to bite.
"European policymakers are moving around the place," says Bridges. "Theres too much talk Im worried that no one knows the solution."
Spreads have begun to stabilise for some issuers. KfWs spreads began recovering in early 2012 in January its 2021s tightened from 120bp over three month BBSW to about 90bp over.
But those levels wont tempt all investors back in many are likely to remain cautious. "We look for stability in spreads but we base our investment decision on fundamental analysis," says Gerard Sheehan, investment manager at Aberdeen Asset Management. "A reverse in spread widening doesnt mean that we are jumping back on board."
Of those European credits, some are happy with top quality credits with explicit sovereign guarantees like KfW. Other attractive areas include the Nordic region.
"They have independent monetary policy and retain fiscal flexibility," says Sheehan. "They have the ability to control their own interest rates. Wed be more constructive on names like Kommunalbanken given the support from a strong sovereign such as Norway."
And then, of course, there are the supranationals. However, these issuers trade at ultra-tight levels. But they still get traction when the basis swap is in their favour.
"Some investors would say theres little value in buying from Washington supranationals like the IBRDs and IADBs at such low spreads" says Sheehan. "But we are still open to buying those names given their better fundamentals and lower price volatility in the current environment. We place more emphasis on these factors than simple spread or yield."
Other issuers are poised to fill the gap left by Europes borrowers. "Investors still want diversity away from Australian government and quasi-sovereign debt," says Bridges at Tyndall. "They used to look to European issuers for that diversification but now they are looking elsewhere."
Canadian banks have profited by printing covered bonds in Australian dollars, while other issuers considering the market include Asian corporate borrowers.
"Some Koreans, such as Kexim and Korea National Oil Corporation, have been doing roadshows in Australia, and some of the Hong Kong names such as MTR too," says Bridges. "These will be well received because of the natural demand for diversification which Australian buyers have. Plus a lot of Australian borrowers find it easy to print offshore, such as Telstra and BHP Billiton. It means there isnt too much corporate supply in Australian dollars."
The domestic investor base is happy hoovering up Washington supranational bonds but it is not short of top-rated alternatives, either. As well as Commonwealth bonds and a healthy supply of Australian municipal bonds, it also has the new attraction of Australian covered bonds to look to.
The Australian government passed legislation authorising issuance in October 2011. And the products are performing well.
"Commonwealth Bank of Australia issued covered bonds at 175bp over swaps at the beginning of the year, which are now trading at 100bp over swaps," says Sheehan. "From our perspective that is the deal of the year."But investors are well aware of their need to keep their holdings diverse which means Kangaroo bonds at least those issued by those outside of the Eurozone will continue to be popular investments. "Most Commonwealth government bonds are bought offshore by central banks and sovereign wealth funds," says Adams at Colonial First State. "Municipal governments have been issuing quite a bit lately, which has soaked up some of the demand, but that wont go on forever. We havent seen the death of the Kangaroo market by any means."