Euroweek Australia report: corporate issuers

Euroweek, August 2013

Standfirst: Australia’s corporate bond market still doesn’t serve all the funding needs of the country’s corporations: there is no high yield, and scarce availability of tenor beyond seven years. But there are signs of investors becoming more enthusiastic about longer tenor and credit further down the curve than in the past. While it develops, many needs are met in the US. By Chris Wright

Will Australia’s debt markets ever provide the range of funding options to its corporates that other developed-world debt markets around the world do? The answer is a familiar one: the situation is improving, but slowly.

The overall picture for corporate debt in Australia looks pretty good. “2012 was a healthy year in the corporate bond market,” says Ron Ross, executive director and head of bond origination Australia at ANZ Global Markets. “We had $11 billion of issuance, 45-plus issuers, and a number of offshore issuers coming to our market”, among them Korea Gas, Fonterra, BP, ABB and Holcim. “Then there was the A$1 billion deal from BHP. For many reasons, it was a fantastic year for the domestic corporate bond market.” For investment banks, too: ANZ was a lead on all of those deals.

2013 kicked off looking just as strong, until global sentiment got in the way. “The year kicked off robustly, but it only took Bernanke to say QE will one day come to an end and it rattled the markets for the next seven weeks,” Ross says. “The feeling now is of cautious optimism.” Dealogic data for Australian dollar domestic corporate bond issuance – whose definitions may differ slightly from Ross’s – show issuance of A$2.18 billion domestically and A$6.42 billion internationally marketed in the year to August 12, compared to A$7.78 billion and A$14.5 billion respectively for the whole of 2012; the pattern suggests a full year with lower volumes than 2012 but better than the two years that preceded it.

The crucial point, beyond domestic volumes, is just how much of total corporate funding is being done at home rather than overseas. “One statistic we look closely at is the total volume of bonds done by Aussie corporates,” Ross says. In 2011, he says, that total was $30 billion – excluding BHP and Rio Tinto, which he considers multinational despite their Australian domicile – and of that, only A$6 billion was raised in the domestic markets. “In other words, of the total volume of bonds raised by Australian corporates, only 20% was done domestically. That was disappointing and unhealthy.” Last year showed a marked improvement. “Almost 50% was being done domestically: a much healthier balance.” 2013 so far is showing a similar picture.

Why do Australian corporates go overseas at all? Chiefly because they can’t get the funding they need at home. Historically the main reason has been tenor, and for the bigger issuers, scale; it may also be rating, as Australia has nothing like a high yield market. But on all three grounds, there are signs of improvement.

Firstly, on tenor, it was notable that the two deals that re-opened the Australian markets after the turmoil caused by Bernanke’s tapering remarks were corporate, and were seven-year deals: for Port of Brisbane and Perth Airport.

Westpac was a lead manager on Perth Airport, and its bankers saw great significance in the deal. “Perth Airport re-opened the market,” says Mark Goddard, head of debt securities. “To my mind, that reflects a greater desire for the corporate sectors than for others. Perth Airport is BBB/Baa2 rated, and we are seeing domestic investors want to buy more of those BBB corporates to get yield.” Goddard’s colleague Gary Blix focuses on the tenor. “Perth Airport was a seven year transaction. What we are now seeing is an acceptance by the market to move further out the curve. This year ten corporate issuers have been able to print transactions for seven-plus years.”

There is a widespread sense that this improvement in tenor is here to stay. “Seven years is the new five years in the local market,” says Will Farrant, head of debt capital markets at Credit Suisse. At ANZ, Edwin Waters, executive director, debt capital markets, says: “Five years in Australia is always the most liquid and largest part of the market. Six and seven are certainly open, and there have been highly successful transactions in 10 as well. Extending tenor is just a product of confidence in the market.” He notes, though, that an absence of longer-tenor deals is not just because investors aren’t there, but because issuers may not need them. “It’s fair to remember that a lot of tenor decisions are driven by issuers and what they decide they need,” he says. “A lot, especially on the property side, don’t need 10 year funds.”

In terms of market depth, last year’s A$1 billion deal for BHP Billiton was clearly a landmark, but the country’s biggest names, like Telstra, are likely to continue to get the bulk of their benchmark funding in dollars and euros as they always have.

On ratings, there’s clear evidence of an eagerness to look a little further down the curve than used to be the case. “There is a growing willingness to look at lower rated credits,” says Ross. “Lend Lease is BBB-, Qantas has come to market, Holcim is a BBB issuer from Switzerland, and Downer EDI is the lowest credit, at BBB- from Fitch. There is a good sprinkling of BBB credits.” Why? “Obviously when we’ve had this period of very low base rates, it’s encouraged investors to find incremental yield by going down the credit curve. I wouldn’t say we’ve been knocked over in the rush by BBB issuance, but there is more confidence in the market.”

The Downer deal he mentions has been widely remarked upon in Australia, partly because of the BBB- rating, but in particular because it is only rated by one agency, and the least widely followed of the three, Fitch. Some find this more interesting than the headline heavyweight deals of 2012. “This year we haven’t seen as many jumbo trades from the corporate side like Telstra and BP last year, but we have seen trades getting away for names that might not have succeeded in previous years, particularly for BBB corporates,” says Sean Henderson, head of debt capital markets for Australia at HSBC. “Our deal for Downer, for example, had eight domestic investors and 32 accounts from offshore, for a BBB- name.”

This last point is crucial: it wasn’t, by and large, Australians who bought that deal. International participation appears vital for further progress down the curve. “There are multiple pockets of demand in Australia, but for corporate credits like Downer you need the institutional bid to come to the fore, and historically that hasn’t been deep or consistent enough for many corporates to rely on with the notable exception of the largest names,” says Henderson. “The big development in recent years has been the growth of the A$ bid from offshore – Japan, Asian private and commercial banks, central banks and into Europe. Many recent issuers with name recognition offshore have seen 50% plus going to these offshore accounts.”

Downer EDI is an engineering and infrastructure service provider, Australian but with significant Asia Pacific business. In some other names, the Asia connection is easier to see: a deal earlier this year for SP Ausnet, in seven and 10 year maturities, saw over 50% placed offshore. That’s partly because although the company operates in the state of Victoria, it is owned by Singapore Power.

“The Asian bid has been critical on many trades, providing great size and price tension, and filling order books out from 10 to 20 investors, up to 40 or 50,” Henderson says. Ross at ANZ says that “every deal we bring to market sees a certain level of Asian participation” and that 10 to 30% of books will typically now come from Asia, especially on BBB deals which appeal to the private bank space. Blix at Westpac cites the same range, 10 to 30%, as Ross. “The domestic investor base is still the driver, but the addition of the investor base from Asia can provide price tension,” Blix says. And Waters at ANZ suggests that visiting Asia will pay dividends. “Those issuers who have travelled to Asia and conducted investor updates have found their transactions have been successful and well supported.”

So what about the next logical step – a notch below Downer, to a high yield market? Few people seem to have much faith in that. “Taking one step further to a sub-investment grade market here? I wouldn’t be holding my breath for that,” says Ross.

An interesting but rather circular debate takes place about why this is: is it because Australia’s big institutions won’t buy high yield paper, or do they not buy it because it doesn’t exist in the first place? Waters at ANZ takes the first view. “A lot of that is governed by the mandates from investors and super funds that don’t allow them to buy sub-investment grade.”

But Mark Goddard at Westpac thinks there are long-entrenched factors at play in the institutional market. “Would fund managers buy more sub-investment grade paper if it was available? Perhaps, but other factors, including the low allocation to fixed income, is also a factor in further development.

“A move into sub-investment grade paper doesn’t happen overnight. It may need mandate changes as well as a cultural shift. In the same way as the local market is built on an overall investment culture that has an equity bias, the fixed income market is built around an investment grade bias.”

Some are more positive. “We can see the buds of an A$-denominated high yield or unrated wholesale market,” says Farrant, pointing to his Healthscope deal, covered in the corporate hybrids section of this report, as a first sign. “We feel that the globalization of the Aussie dollar as an investable currency will drive this and it is likely that Australian dollar high yield will initially be mostly an offshore phenomenon.” Meanwhile issuers who can’t meet their needs at home head for US private placements, US high yield or the term B loan market, all covered in other articles.

If retail want to participate in vanilla corporate debt, the process has historically not been easy. “For retail investors we barely have an investment grade corporate bond market in Australia that they can readily access,” says Paul Donnelly, global head of equity capital markets and debt capital markets for Macquarie Capital. Instead they have bought more complex listed structured hybrids, dominated by bank hybrid capital (see financial institutions article).

But the inaccessibility Donnelly complains of may be about to change. “There is definitely a move from the government, treasury and ASIC to make it easier to issue to retail investors in listed form,” says Andrew Buchanan, head of hybrid capital for Australia at UBS. The legislation is already through, but there is a challenge in creating demand, “as investors will assess a corporate bond return against a government guaranteed term deposit, and therefore a bond will need to offer a premium to attract attention.”

It will take time to find a level at which issuers and retail can meet, but the idea has potential. As John Chauvel, head of debt capital markets at Westpac, says: “Retail corporate debt is definitely an area we want to see growing. There would theoretically be huge demand there.”