Sydney seeks financial-centre status
Australian domestic bond issues 1999 Month Issuer Amount (A$m) Credit rating Jan GMAC 50 A Jan AMP Bank 200 AA/A2 Jan Suncorp Metway 250 A- Jan Newcourt 75 BBB Feb CommonwealthBank 185 + 115 A+ Feb Case Credit 125 + 50 A Feb ANZ 300 AA- Feb Westpac (sub) 215 + 85 A+ Mar Schroders Property Fund 100 A- Mar St George 300 A Mar Ford Credit 100 A Mar Sydney AirportCorp 400 A+ Mar National Australia Bank 350 AA In the gold rush of 19th-century Australia, it seemed as if the country was made of money: one person squatting by a river would pan some gold and within weeks an industry of prospectors had set up camp. The 1999 corporate bond market in Australia has some similarities: as if from nowhere a thriving capital market has arisen and every week a pioneering issue is made that others quickly follow.
March’s A$3.6 billion ($2.3 billion) of corporate-bond issuance was a record. The volume of issuance so far this year is greater than the entire year’s in either 1998 or 1997. In April came the rare spectacle of foreign issuers roadshowing, and an influx of triple-B paper, both highly unusual in the Australian market. Moreover, such corporates as Coca-Cola Amatil and Western Mining Corporation are proposing to come back to the local market for the first time in over a decade.
Australia is the most active market in the Asia-Pacific region at the moment but it will never be more than marginal, in size terms, on the world scene. However, some permanent structural shifts have occurred that make it likely that the dormancy of the early 1990s is over.
Turning away from loans
One of the reasons for the increase in bond issuance is that bank lending has become more expensive. “The corporates were hit by the banks with higher loan pricing,” says Commonwealth Bank of Australia’s head of capital markets, Wayne Hoy, “and by the markets with higher commercial paper pricing, and they decided it was time to lock in some longer-term funding, and the best way to do that was via the capital markets.”
Merrill Lynch Australia’s director of debt capital markets, Brett Cairns, agrees: “There’s been a greater acceptance on the issuer side that they should relieve their dependence on bank financing.”
And investor demand for corporate paper has been rising. During the 1990s Australia’s compulsory superannuation system has resulted in an explosive growth of funds under management: recent annual growth rates have been close to 20%. With nearly a quarter of funds allocated to debt investments, the funds available for investment in debt securities should grow by A$55 billion over the next six years.
Most of the demand to date, however, has been for government bonds. In Australia fund managers generally slavishly follow the indices, and the index for fixed income has ben over 90% dominated by government and semi-government securities.
But the federal government has been running a budget surplus for several years. So as government debt matures it is not being replaced. The managed pension funds need to find new places to invest.
They have been enthusiastic about many of this year’s deals and that has given more corporates the signal that it’s an appropriate time to issue. That in turn lifts the proportion of corporate bonds in the index, creating more demand for corporate paper among the index followers. The percentage allocation to corporate bonds in the benchmark Warburg Dillon Read index has climbed this year from 9.4% to 11.3%.
“The fund managers have got money, and they still have to spend it,” says ABN Amro Australia’s director of debt capital markets, Graham Metcalf. “They stay in a corridor of about 14% to 18% invested in fixed income. If you assume they’re always going to be around that level, they have to buy stuff. And if they ignore corporate bonds, they’re really taking a very significant underweight position versus the indexes.”
Australia took a bit more time to recover from the credit shock prompted by last year’s Russian crisis than Europe, but took heart from Europe’s buoyancy as 1999 progressed. The banks led the way back, with Westpac Banking Corp, Commonwealth Bank, Suncorp-Metway and AMP Bank issuing bonds in January and February, along with some finance companies. But the pace picked up markedly through March and shows no signs of abating. Recent deals have featured three BBB+ rated corporates, and a foreign bank’s Australian subsidiary. In the pipeline are a slew of Australian corporate deals, and a growing list of triple-A rated German banks.
Australia is still a conservative market, however, and the most successful issues this year have been the safest, highest-rated paper. An A$530 million issue from triple-A rated Australia Post, the government-owned postal monopoly, and a A$400 million issue from single-A rated Sydney Airports Corporation, also a government-owned corporation, are generally cited as two of the most successful deals of the early part of this year.
But there are signs of Australian investors moving down the credit curve. One recent deal, an issue from triple-B rated newspaper publisher John Fairfax Holdings in mid-April, was heavily subscribed and increased from A$125 million to A$150 million. The triple-B rated Colonial State Bank and Southcorp deals were also successful and priced well.
“We have such relatively flat yields,” says Hoy. “The market’s looking for anything that gives them a leg-up in yield. The funds have got a lot of government and semi-government and finance sector credits, and they’re looking very tight to bills, either just under or over. They need something cheap they can use to flesh out the yield in their portfolio, and they’ve realized they’re not going to get that at single-A, they’ll have to go to the triple-Bs.”
For the moment many fund managers are still prevented from venturing below single-A but the numbers allowed to buy below that threshold are growing. “There are now a reasonable amount who are prepared to go below single A,” says Warburg Dillon Read Australia’s head of debt capital markets, Mark Langsworth. “And that’s allowing some smaller-volume stuff to come to market.”
Another reason investors have been cautious about domestic corporate-bond issues is a concern about their liquidity. But that too is starting to change. “Liquidity in the secondary market has contributed to the growth in issue size we’ve seen,” says Merrill Lynch Australia’s head of debt syndicate, Cynthia Whalen. “Last year we would have told a corporate borrower to look at an issue size of A$150 million. Now we’re saying to them they can do a minimum of A$200 to A$250 million, and the ideal size should be A$350 to A400 million. But of course, that presents a bit of a problem for some corporates, which just can’t afford an issue of that size.”
ABN Amro’s Metcalf says that he has seen secondary trading volumes at his bank increase markedly. “It’s been a self-fulfilling prophecy,” he says. “People didn’t believe there was any liquidity, so nothing was happening. With all the issuing that’s happened recently, there has been a reasonable amount of rebalancing of portfolios, and we are getting more investors looking at assets on a relative-value basis. So we do get more switching going on if people want to be on a particular part of the curve.”
Liquidity is still a major problem in the longer-term issues, however, where the secondary market is very thin. This is why Australian corporates must still usually go offshore for maturities of more than five years. But some market participants, such as Merrill’s Whelan, are optimistic that even this supposed axiom of the Australian marketplace may change. “When we were advising issuers 12 months ago, or foreign borrowers were looking here, we said the market was two to four years. Now, four to six years is really on the radar, so I’d expect to see benchmark seven- and 10-year deals over the next six months, and corporates may look at that too. But we’re certainly behind the rest of the world.”
Retail demand
The head of capital-raising at Westpac, Cathryn Carver, says longer-term issues could also be given a kick from the demand side. “Retail’s gone a long way on the equity side,” she says. You’ve seen a huge appetite from retail investors for the floats of the last few years. But that hasn’t extended into the debt market: these people are recent entrants, they haven’t seen a negative equity market, so they haven’t felt the need to play it safe and go into the debt side. It’ll take a few more years.”
But the greater demand for Australian dollar paper has already attracted the attention of international borrowers. The market smells good, and currency convergence in Europe makes Aussie dollar debt a good way to diversify. Some foreign financial institutions are considering an issue. But the latest foreign issuer to-date remains the Asian Development Bank, whose A$1 billion issue last September struggled to get away.
German development bank KfW is proposing a A$500 million MTN programme from a A$3 billion facility, Nordic Investment Bank A$500 million from a A$2 billion facility, and Inter-American Development Bank is planning a facility with a limit of A$5 billion. Others, not yet named publicly, are also on the road in Sydney and Melbourne.
Some have argued that with A$7.3 billion of government bonds maturing in the next six months without being replaced, these triple-A credits will be a good substitute.
Paul Umbrazunas, Deutsche Bank’s head of public markets, says that there is no way domestic corporates could satisfy the heavy demand for highly rated paper from fund managers. And there is room for the right kind of foreign issuers. “The trick is to pick the right issuers,” he says. “There’s no point bringing someone in who does deals at Libor minus 30 or 40. With semi-governments trading at 20 under, that’s not going to happen. We’re looking for the ones that have priced in an international context on an equivalent basis at between semi-government and swap.”
League-table tussles
Deutsche and the other foreign banks in Australia believe they will be the winners from this growing international interest in Australia. So far this year, though, the domestic banks are winning hands down in the tightly fought contest to win the local capital market underwriting mandates.
Part of the reason the domestic banks lead the league table is that they arrange their own issues. But even if self-led issues are excluded, Commonwealth Bank and Westpac are still head and shoulders above the pack in terms of deals led, at A$1.18 billion and A$962.5 million respectively. Below them are Deutsche with A$300 million, ABN Amro with A$237.5 million, Salomon Smith Barney with A$175 million and Warburg Dillon Read with A$150 million. Notable by its absence so far is Merrill Lynch, although it was involved as a sub-arranger or manager in eight of the nine deals in March.
Clearly, the locals are doing an effective job of leveraging their commercial banking relationships into investment banking relationships. Some domestic corporates admit they give the first right of rejection to their relationship bank.
In a recent survey, however, domestic companies rated the Australian arms of JP Morgan, Merrill Lynch and Salomon Smith Barney as the best relationship managers in the local market, ahead of the domestic banks.
Where the foreign banks are making headway is in syndicated lending. The lack of opportunities in Asia has driven big lenders towards Australia, including many German Landesbanken as evidenced in their participation in the A$900 million Sydney Airports Corporation deal, the A$1.9 billion Bunbury-Dampier gas pipeline last year, and the US$900 million Southern Cross Cable deal.
In 1998, syndicated-loan volumes fell 3.9%, from A$30.3 billion to A$29.1 billion. Demand has been strong in recent months, however, with around A$7 billion in loans arranged, largely from the energy, resources, infrastructure and telecommunications sectors. Moreover, the bank-debt market will continue to bubble over for a while thanks to the state government of Victoria. It is privatizing A$4 billion in gas assets and A$1 billion of public transport. The federal government is selling Australian Defence Industries for A$450 million and the recent privatization of Victorian Plantation Corp to the Hancock group has also added A$350 million.
Some of the recent deals have been for relatively short-term funds that the borrowers intend to refinance in the debt markets quite soon, which may provide another fillip to the capital market later in the year.
In project finance and syndicated debt, Chase is the clear market leader, last year arranging 12 loans for a total value of A$3.63 billion, a 19 per cent market share. Other top syndicated lenders include Westpac, which arranged 15 loans worth A$2.04 billion last year, National Australia Bank with four totalling A$1.82 billion, and Deutsche with seven worth a total of A$1.79 billion.
Asset-backed boost
Some bankers hope last year’s lending squeeze will boost Australia’s securitization market. Slowly, they say, corporates as well as banks are being persuaded that securitization is a realistic funding alternative. New issuance reached A$16.1 billion in the mortgage-backed, asset-backed and asset-backed commercial paper market, up 20% from the previous year.
The banks are the main issuers and most tend to stick to vanilla deals: fully insured, triple-A rated residential mortgage-backed deals are released on a regular basis.
But there has been a significant increase in innovation over the past year. Bankers Trust financed two aircraft leases worth A$199 million using an enhanced equipment trust certificate, which gives noteholders guarantees over the aircraft and allows the paper to be rated higher than the underlying airline that holds the lease. This is common practice in the US but a first for Australia.
Likewise, last year the first securitizations in the public market of credit-card receivables, car loans, and equipment leasing were done, again mostly by Bankers Trust. More recently, mortgage-backed securities without mortgage insurance using subordinated debt and/or a cash reserve have been issued.
In the traditional mortgage-backed arena, however, the market has slowed. There is some weakness in demand, largely because of concern about liquidity. There are also supply-side problems: spreads are still hovering at an average of 40bp over swap, making these deals expensive for issuers. Securitization flows from non-bank mortgage originators have declined. In 1998, issuance dropped sharply from A$8.1 billion the year before to A$4.7 billion, according to Standard & Poor’s.
Judging the lead players in the securitization is difficult: each institution produces its own league table, often with itself at the head. But at the top of most tables for last year were JP Morgan, Deutsche Bank, Bankers Trust, Warburg Dillon Read and Westpac. Australian specialist Macquarie is generally ranked just outside the top five.
Equity polarization
The energy and enthusiasm evident in Australia’s debt capital markets is not quite as visible in equities. “The market is divided between a few big deals and a lot of small ones,” says one bank’s head of equities. “In any bull market, you get a lot of small floats coming out. They’re speculative, and people are hoping to double their money on day one. That’s typical at the end of a bull market.”
No-one is quite sure where the big transactions will come from this year. There is the Austar Pay TV float, worth over A$1 billion, and Contact Energy at about the same value. The sale of the remainder of telecoms company Telstra, if it goes ahead in part or full, could make for a record year.
“You’ve seen a couple of shares held by corporates being sold into the market. There’s been that block-trade type of activity, there’s been some selective capital raising, and some property. But right now, the opportunities for capital raising are less obvious,” says Warburg Dillon Read’s managing director of equity capital markets, Brett Paton.
Paton says: “Where corporate-finance teams are spending an increasing amount of their time is probably looking at merger and acquisition activity. That may lead to fund raisings, which may involve equity, but it does draw down on the time available for banks to allocate resources to certain other tasks.”
Some players are hoping to develop niches for themselves in equity corporate finance, like Ord Minnett in telecoms and internet stocks. But the market is dominated by foreign names: Warburg Dillon Read, ABN Amro, JB Were, Deutsche, and Credit Suisse First Boston.
