Euroweek Australia report: domestic debt capital markets

Euroweek, August 2013

Standfirst: Tenor, depth and diversity of credit are all improving in Australia’s domestic capital markets. But local bankers and issuers would like it to be able to do more, starting with longer-term benchmarks and a hint of a high yield market.

Every year, it appears, one can do more in the Australian domestic debt capital markets than the year before; and every year, one feels it still isn’t enough. Australia’s markets are deeper and offer greater tenor than ever before, but still practitioners wonder: why can’t it do more?

First, the positive view. “A$ is a market that has taken a lot of people by surprise,” says Luke Gersbach, director, debt securities at Westpac. “We have started to see further demand for longer-dated tenor, something the A$ market hasn’t seen for a while. The Aussie market has become more robust in the last couple of years and is prepared to look at issues it wasn’t in the past.”

All of this is demonstrably true. As the corporate issuance chapter explains, the Australian market will now take an issue from a company rated BBB- by Fitch and unrated by the other agencies (Downer EDI); will re-open after a volatile patch not with a three-year bank floater but with seven-year corporate issues  (Port of Brisbane and Perth Airport); will take 10-year funding for the right name; and will absorb a billion dollars of issuance in one hit (from BHP Billiton).

This is all promising. “Borrowers and investors’ willingness to extend duration is definitely growing, despite recent volatility in long end rates,” says Tim Galt, executive director in fixed income syndicate at UBS. “The lead is coming from the sovereign and semi-government borrowers, and more recently corporate borrowers. The AOFM [Australian Office of Financial Management, Australia’s debt management office] have printed 2029 and 2025 maturities in the last 12 months.” Semi-governments have in some cases, notably Victoria, gone even further out, and correspondingly it is now commonplace to see seven-year corporate deals and occasional 10s.

But is that enough? Even at the sovereign end, a 16-year deal is not so impressive. There’s a reason for that – Australia, lacking the debt load of other developed world countries, doesn’t really need the money – but it doesn’t help the development of a longer curve. “There is no 30 year government bond in this country because of the size and preferred financing structure of the government’s debt,” says Steve Black, in debt capital markets at Credit Suisse. “This lack of a benchmark makes it more difficult for issuers to raise very long date financing.” That, in turn, holds back infrastructure financing, which in a country as big as Australia, with such mighty infrastructure needs, is a big deal.

At the other end of the credit spectrum, although lower-rated issuers like EDI Downer are getting a reception now where perhaps they never would have done in the past, there’s still no high yield market, and issuers who want one have to go to the USA to get it.

So what to do about the domestic market from here? “This question has been heavily debated and most participants have a view,” says Will Farrant, head of debt capital markets at Credit Suisse. “I believe that the macro conditions of the last few years are as good as they’ve ever been to break the current cycle, and the market has indeed improved in depth and tenor, a trend we hope continues.” By the current cycle, he means the fact that long-dated and sub-investment grade deals don’t exist because people won’t invest in them; but then again they might not be investing in them because they aren’t there to be invested in – a circular arrangement that is especially irksome in a country with a vast A$1.5 trillion retirement savings industry looking for investments.

“My own view is that offshore demand for AUD paper, particularly private bank demand for higher yielding corporate paper, has been a big factor in spurring that growth, but the general rates environment has definitely assisted in pushing demand into longer tenors to pick up yield,” Farrant says. “If these conditions persist for long enough to establish more diversity in the market, the vicious circle can perhaps be turned into a virtuous one.”

Farrant’s point about the offshore bid in domestic markets is one that is echoed throughout this report from sovereign to corporate paper. “A key development in the Australian dollar market has been the incremental bid out of Asia,” says Gersbach. “In fact, where it was incremental, it is now becoming more of a cornerstone.” Australian issuers will now sometimes take their roadshows not only to Sydney and Melbourne but to Hong Kong and Singapore – Mirvac was a recent example. And this is for genuinely local names, rather than those that are Australia domiciled but foreign-linked. “We often see issuers like Coca-Cola Amatil issuing in Australian dollars off an international EMTN programme,” says Gersbach. “But with all three factors – Australian credit, Australian dollars, off Australian law A$MTN documentation – you would have historically seen the liquidity out of Asia be visibly diminished.” Not anymore: Melbourne Airport, for example, had one third of its order book from offshore on recent deals.

And what of the so-called great rotation? As investors move back into equities, will domestic debt capital markets be able to continue their improvement, or will their funds be drawn away in search of risk and return? Bankers are optimistic. “Rather than characterise this liquidity in terms of a great rotation from fixed interest to equities I think a better context might be that central banks are printing liquidity which is ending up with fund managers,” says Paul Donnelly, global head of equity capital markets and debt capital markets for Macquarie Capital. “Rather than a rotation out of bonds into equities, we are seeing a deployment of cash into equities.” In which case, there should be no shortage of capital to be deployed into Australia’s debt markets; if it can only be coaxed to go into the areas where issuers can’t yet find it.