SSAs benefit from Kangaroo bounce
What a difference a few months makes. Last summer, Kangaroo bond specialists were lamenting the decline of issuance from high grade European and supranational borrowers. But the global credit crunch and a new Australian interest rate cycle have turned the market on its head and created almost perfect conditions on every front for issuance from sovereigns, supranationals and agencies (SSAs).
Enrico Massi, head of Asia Pacific debt capital markets at RBC Capital Markets in Sydney, notes several reasons for the surge in demand. "Activity picked up late in 2007, when market volatility started to cause a flight to quality in Australian dollars," he says. "General concerns about markets, combined with optically attractive spreads due to wider swap markets, laid the foundation for the re-emergence of this bid. The economic backdrop that is leading to higher yields and an appreciating currency have also been contributors to the market."
The Kangaroo market had picked up by the turn of the year but the breakthrough month was January, when A$2.375bn ($2.19bn) of Kangaroo paper was priced, according to data company Dealogic.
There was a similar level of issuance in February and March has also been a bumper month, with deals from Nordic Investment Bank, Landwirtschaftliche Rentenbank, the European Investment Bank and many other SSA borrowers.
Australias separate economic cycle, compared with the rest of the developed world, has been a prime factor in driving the market.
While the US Federal Reserve has been aggressively cutting interest rates in an increasingly desperate attempt to keep its banking system liquid and the economy out of recession, the Reserve Bank of Australia has been moving in the opposite direction, trying to contain inflationary pressures. It has raised rates by 25bp four times in August, November, February and March. The RBAs Cash Rate is now 7.25%, the highest it has been since December 2004 and well above US, European and UK levels.
A strong currency, boosted by high commodity prices, faster economic growth and the interest rate differential, has helped to make Kangaroo bonds attractive to international investors.
And while swap spreads have been on a widening trend globally, the effect has been even more pronounced in Australia, as the bid for the safety net of government securities has intensified (see chart).
Swap spread widening extra-steep
Issuers that a year ago were offering a 40bp or 50bp pick-up over Australian government bonds are now pricing at as much as 130bp over even while achieving tighter funding against Euribor.
"Swap spreads have widened amazingly, which is increasing headline spreads over governments, but our transactions are trading very stable or tighter versus swaps," says Stefan Goebel, co-head of funding/assets at Rentenbank in Frankfurt.
"The overall cost of funding versus Euribor has decreased and we align our Aussie dollar target in line with that level."
Outright yields and headline coupons have been enticing global investors into Australian dollar debt generally, and Kangaroo bonds in particular. The Asian bid has been particularly strong, dealers note.
Meanwhile, wider swap spreads make the product more attractive to domestic investors, relative to government and semi-government debt.
"There are Asian investors that remain motivated by outright yields, so the recent rally has temporarily reduced their appetite," explains Alf Costanzo, head of European syndication and origination at TD Securities in London. "Conversely, the widening in EFP [exchange of futures for physical] levels has encouraged domestic investors to switch into high grade Kangaroos versus governments and semi-governments."
And Massi at RBC says the Kangaroos status as a global product helps drive sales: "The Asian bid has been a recurrent theme for many years, Japan remains a key driver of followthrough demand, and European investors have always been active in this currency. This is complemented by a growing domestic bid, which has been modest for a good while."
That leads to one of the most striking aspects of the Kangaroo market in recent months the wide fluctuations between similar deals in the split of order books between domestic and offshore investors.
"We have seen bookbuildings with an extraordinary bid from residentials, but also the opposite," says Alexander Lieberthal, vice-president of capital markets at KfW in Frankfurt. "In the past the domestic participation varied. We feel more comfortable in having non-domestic and domestic investors buying a new Kangaroo and a good mix is crucial for a successful transaction. The domestic bid is not subject to FX fluctuations to the same extent and therefore guarantees stability, whereas non-residentials help to increase liquidity of our bonds."
Other borrowers agree that having a complementary mix of investor types in their transactions helps the deals to perform.
"Its important to us to have domestic investors participate for diversification, but its also good to have Asian investors because if swap spreads widen and domestic investors want to get out, the Asians will stay in. For that reason we aim for a good mix, and we dont have a specific target," says Jens Hellerup, a funding executive at Nordic Investment Bank in Helsinki.
High grade issuers are enthusiastic about the bounce in demand for Aussie dollars, even if the outright cost of funds in US dollar Libor or Euribor terms is not yet quite as good as the global dollar benchmark market.
"This year the best funding is available to us through the dollar benchmark market but we still want to be in the Kangaroo and other markets," says Hellerup at NIB. "Right now the costs are probably flat, but sometimes it [Kangaroo funding costs] has been wider. As a relatively small borrower we have to compare costs across different markets and cant have different targets in different currencies."
While SSA borrowers have undoubtedly benefited in the Kangaroo market since the credit crunch began, the reverse has been true for almost every other issuer. The flotilla of US financial institutions that crossed the Pacific in 2006 to 2007 has been turned back by the global credit crunch, and will not be back in the foreseeable future. Kangaroo sales reached A$6.1bn in February 2007, for instance, driven by US bank issuance, but there has not been a single non-triple-A rated issue since the credit crisis began last June.
"At this stage, it appears more than unlikely that certain sectors will appear in the Kangaroo market in 2008," says Massi. "Investors will be biased towards high grade and/or issuers that are closer to home."
Corporate borrowers, too, are having a hard time, though some dealers say demand may return later in the year. "Im slightly more optimistic than many others that in September we can get a few more things done," says Fergus Kiely, head of debt capital market origination at nabCapital in London. "The economy is strong, which means investors have cash to put to work, and I hope theyll be looking for opportunistic deals from European credits later in the year."
Global players gobble market share
Market instability has concentrated Kangaroo deal flow in the hands of the biggest houses. So far this year, RBC and TD have a market share of over 80%, against less than 40% last year. Domestic banks without global distribution networks have languished, according to Dealogic.
"At this stage, Australian dollars is not a fully subscribed market on day one," says Massi. "To get a successful deal done you need to have confidence on followthrough demand and managing residual risk to ensure the transaction performs. If as a dealer you do not see and are not able to service secondary flow, it is very difficult to execute successful deals."
The difficulties of lead managing a Kangaroo issue in current conditions were illustrated in February when ANZ Bank pulled out of partnering TD on a benchmark tap for Cades, the French social security financing agency. The deal came at the end of a flurry of issuance, which had pressurised the basis swap into euros, and ANZ said it advised the borrower to postpone the transaction. But with orders already in the book, Cades was reluctant to pull it so TD ended up as sole lead.
Kangaroos are not the only Australian dollar product available to international investors, and in Europe the preferred format tends to be Eurobonds. General Electric, Nestlé and Toyota Motor Credit Corp are among the issuers that have sold such deals this year. Europeans are looking more at higher-yielding, but strong and familiar corporate names.
Meanwhile, Japanese retail buyers remain eager for Uridashi bonds from top-rated borrowers.
Market participants remain bullish on the outlook for the Kangaroo and Australian dollar Eurobond markets as yield differentials widen even further.
"Keep a close focus on outright yields," says Costanzo. "Aussie dollars in general, both Eurobond and Kangaroo formats, have been extremely busy and are some of the most sought-after bonds in secondary at the moment. When investors see an 8.5% coupon for a triple-A issuer, such as the recent GE deal, it is extremely attractive and drives a significant flow in secondary activity."Massi argues that secular trends are working in the markets favour. "Structural growth of demand due to superannuation [i.e. pension savings] will continue to fuel demand in the markets," he says. "We have been through similar teething pains as the Maple and Kauri markets are going through, but Kangaroos are now displaying longevity and sustainability."
Kauri follows Kangaroos route to maturity
New Zealands domestic Kauri bond market came of age in the last year as many foreign borrowers bonds became eligible as repo collateral with the central bank. But relative to its Kangaroo cousin, the Kauri market remains a tiddler.
However, many of the trends in the Kangaroo market have also favoured Kauris.
"Domestically, the sovereigns and supranationals are a play on swap spreads," says Fergus Kiely, head of debt capital market origination at nabCapital in London. "Deals become attractive to investors when absolute spreads to underlying government bonds are high. Banks liquidity books are big buyers and that drives most transactions, while other institutional buyers tend to be smaller than, for instance, in Australia."
Besides that, Kiely says Asian central banks have big lines for the New Zealand dollar; European private banks have played in it, though not necessarily in Kauri format; and there is European demand for the currency and interest rate plays.
So far in 2008, six Kauri bonds have been issued, totalling NZ$1.35bn ($1.09bn).
"With all new markets you tend to have a bit of a gallop to begin with, and then it calms down, but theres continuous demand for Kauris, even on a private placement basis," says Kiely. "For instance, weve just placed a NZ$200m trade in a single shot for a supranational borrower, so demand is obviously still strong."
However, the markets development still has a long way to go as many issuers have not yet established a presence in the currency. KfW is a notable absentee so far, though it is expected to arrive shortly.
"We wish to be in the Kauri market it is on our agenda and were confident that we can join our triple-A peers soon in that market," says Alexander Lieberthal, vice-president of funding at KfW in Frankfurt.But Kauris are not just open to SSA borrowers, says Kiely there are opportunities for high profile credits from other sectors. "Household names fly very well in New Zealand," he says. "Weve been trying to couple Australian roadshows with a New Zealand add-on. Wed caution issuers on the size available but for the right names there would be a strong chance for a deal."