Euroweek Australia report: corporate hybrids

Euroweek, August 2013

Chris Wright

Euroweek Australia report

Corporate hybrid issuance (1 page)

Standfirst: Hybrid securities have been a retail mainstay in Australia for seven years, and are increasingly fuelled by Asia-based investors and the changing dynamics of an income-hungry, retirement-age Australia. Why, then, asks Chris Wright, have corporate hybrids been almost completely edged out by complex financials?

Australia has long been a market where the odd marriage of complex hybrid securities and ordinary mum-and-dad retail investors has thrived against the odds. The popularity of these instruments – listed on the Australian Securities Exchange but paying a steady bond-like yield – continues to grow, and the dynamics are in place for them to gain still greater traction.

“The last two years in particular have been prolific for listed debt and hybrid issuance,” says Allan O’Sullivan, director, retail syndicate, at Westpac Institutional Bank. 2012 saw over A$13 billion of issuance from 18 transactions; by late July, the year to date total in 2013 was A$6.4 billion. “I don’t think we will surpass last year’s A$13 billion, but we’re on course for A$10 billion plus.”

In recent years, though, issuance has been dominated heavily by financial institutions, with corporate issuance largely dormant. In 2006, for example, half of all hybrid issuance was corporate. In 2012, only A$3.5 billion of the $13 billion was, and in 2013 there has been just one deal: a A$305 million subordinated notes issue from Healthscope in March. “Issuance has continued apace, but with not a lot of diversity: it has been almost completely dominated by prudentially regulated borrowers, largely banks or insurers, with almost no corporate issuance,” says O’Sullivan. “That’s the only negative.” Financial deals, including the first Basel III compliant issues, are covered in the chapter on financial institutions.

Healthscope didn’t want for appetite. “On a deal where some were worried about whether we could print $125 million, we ended up printing $305 million and could have printed more,” says Will Farrant, head of debt capital markets for Australia for Credit Suisse, a bookrunner on the deal. It had to pay up to do it – a fixed annual 10.25% – but was in considerable demand.

One tends to think of Australian corporate hybrids as being purely a domestic yield-hungry retiree phenomenon, but with Healthscope that wasn’t the case. “What was interesting about that deal was that we have seen increasing interest in that sort of product from offshore private banking clients, partly because investors in Asia look at Australia as a sophisticated economy with a strong legal system,” Farrant says. “Healthscope is also in the right sector, which is very well followed in Asia.”

There are, though, many reasons to expect the domestic buyer base to continue to grow too. “The growth in the hybrid market really started in the last quarter of 2011 with the increasing retail bid,” says Steve Lambert, executive general manager, global capital markets at National Australia Bank. “We think it’s because there has been a lot of deposit raising activity from the banks, whose big focus is on the balance sheet and loan to deposit ratio.” But now, as yields have started to fall on those deposits, “retail investors have looked to buy other things.”

“Some people think that is just a case of rotating back out of cash or fixed interest into equity, and that may be true, but there has also been a structural change in Australia,” Lambert adds. “A large chunk of Australians have just retired, and there are going to be more people who want fixed income as part of their retirement investment. That is a genuine driver for these retail fixed income products domestically.”

Lambert is not alone in this view. “Term deposit rates have fallen while investors remain risk averse and are still focused on yield,” says Andrew Buchanan, head of hybrid capital at UBS, which has led corporate hybrids for issuers including Woolworths, Origin, Tabcorp and Crown in the last two years. “Hybrids strike the balance between higher yield, and greater capital stability than equities.” In particular, they appeal to self-managed super funds, the go-it-alone retirement vehicles which now account for one third of the A$1.5 trillion superannuation industry. O’Sullivan explains: “There is a great weight of money to be reallocated into higher yielding asset classes.”

So why aren’t there more corporate deals? Why is it only the banks who are issuing? Perhaps the main reason is a controversial review by Standard & Poor’s on its hybrid capital methodology around equity content and credit assignment, long awaited and eventually published in April 2013 – with action that applied retrospectively, throwing a spanner in the works of some existing issues (particularly Santos). “We were all gobsmacked that S&P came out and did what they did, after issuers had paid hundreds of thousands of dollars to get confirmation that their structures were OK,” says one banker. According to Rupert Daly, head of hybrid capital at Deutsche, only two broad types of instruments will now qualify for high equity content under S&P methodology: short-dated mandatory convertibles, which “you rarely ever see because they price and trade like equities and don’t appeal to fixed income investors”, and true perpetuals. “The Australian retail investor base stopped buying true perpetuals 10-plus years ago.”

Still, others feel S&P’s changes will have a mild lasting impact. “While achieving 100% equity credit is now more difficult, we don’t think the changes will materially affect hybrid supply,” says Buchanan at UBS, who notes that APA, Caltex and Crown have all issued 50% hybrid securities in the last 12 months. Bankers hope that, with clarity re-established, new corporate issuers will return.

A separate, related theme involves bringing more vanilla senior bonds to the listed market. Government listed bonds appeared on the ASX in May and some bankers believe that listed corporate bonds are the future. “We think we see a tipping point here, where deposits are no longer the disincentive they once were,” O’Sullivan says. “The ability to bring vanilla senior bonds to the listed market is where many of us put our faith.”