Wednesday, 19 December 2018

Bouncing back

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SSAs’ return to the Kangaroo market en masse, but Basel III rules restrict local demand and chances of return to previous peaks

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Kangaroo issuance from SSA borrowers sprang back to life in late February 2012 ending months of inactivity for many bankers.

Tightening spreads, a much improved currency basis swap and growing overseas demand sparked the upturn. But things are not all on the up. Basel III liquidity rules and new capital requirements are likely to prevent a return to the market’s previous heights.

The dramatic revival showed how issuers had been lined up waiting during the market freeze of late 2011. Kicking off the revival, the European Investment Bank returned to the Australian dollar market after a nine-month absence on February 23 2012.

Just five days later, the International Bank for Reconstruction and Development printed its first transaction in 13 months with a dual-tranche A$1.05bn deal – the largest Kangaroo since summer 2011.

Before the IBRD and EIB, the only SSA to issue Kangaroos in 2012 was market leader KfW, in fact the top German credit was the only name that had been a consistent issuer throughout the preceding months.

By March 28 KfW was already making its sixth, and largest, visit of the year for a A$700m addition to the 5.50% July 25 2016s. This took its 2012 sales up to A$2.55bn, underlining KfW’s position as the world’s largest issuer of Kangaroo bonds with A$20.75bn outstanding.

The consistency of issuance from KfW showed the attractiveness of the Aussie market, but, by representing the entire SSA sector, also illustrated that for a long time only the best credit could tap investors. The EIB and IBRD then cracked it open for many others to follow.

The IBRD’s success provided the fillip the market needed as Asian Development Bank, Rentenbank, International Finance Corporation, Kommunalbanken, FMS Wertmanagement, African Development Bank, Eurofima and Inter-American Development Bank all followed in its footsteps by the end of March.

Consequently, first-quarter 2011 issuance ended up totalling an impressive A$8.1bn, a significant downturn from the bumper A$11.5bn of SSA’s Kangaroo supply in the first three months of 2011, but a strong positive considering the limited activity until late February.

Despite a strong start, 2011 had not followed through on the initial promise as Kangaroo volumes subsequently fell off a cliff during 2011 as investors grew more risk-averse. SSA sales declined to just A$4.8bn between July and December. This compares with the A$16.8bn printed in the first half of 2011.

A surge in spreads and concurrent basis collapse curtailed supra supply since spring/summer 2011 when the deepening eurozone crisis coupled with disappointing US growth figures triggered a sustained bout of safe haven switching.

Paul White, global head of debt syndicate at ANZ – which was joint lead manager for nine of the first quarter’s 20 SSA Kangaroo deals – cited three reasons for the market’s revival:

“The improvement in global sentiment following the LTRO boosted liquidity and compressed spreads, thereby reopening capital markets globally. More specifically, as far as Australia is concerned, the basis pushed out to attractive levels following a bout of foreign currency covered bond issuance by the major banks, whilst overseas appetite for high quality Australian dollar assets increased significantly.”

Spreads began narrowing globally at the start of 2012 as cash-rich investors derived comfort from an easing of European banks’ liquidity problems after LTRO’s introduction just as the US recovery began to surprise on the upside.

The basis swap became compelling again as Australia’s four major banks again issued offshore in vast size, with almost US$10bn printed in the US in the first quarter of 2012 in covered bond format alone.

This helped the Australian dollar/US dollar five-year basis move out sharply, to 35bp by late February/early March versus 15bp at the start of the year and as low as 6bp on September 12 2011. It has subsequently traded within a 25bp–35bp range.

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Demand for SSA paper slumped in 2011 when it was excluded in Australia from the list of eligible Liquid 1 and 2 assets for Basel III. This triggered an inevitable decline in local bank balance sheet demand when APRA announced its preliminary list in March 2011.

SSA Kangaroos became the most expensive assets (and lowest-yielding) allowable in the RBA’s committed liquidity facility, where banks can repo eligible securities with the central bank in return for a flat fee of 15bp.

Bank balance sheet demand for IBRD’s 2012 deal was hit hard as it amounted to just 30% of allocations for the five-year tranche and just 8% of the 10-year.

Coming in to replace that demand are foreign central banks and insurance companies. They are keen to boost their Australian dollar exposure and attracted by the pickup SSAs offer over sovereign Commonwealth paper.

“Demand had been historically split very roughly around 50:50 between local and overseas investors but since the preliminary APRA ruling it has shifted to around two thirds to one third in favour of foreign accounts, depending upon which SSA is coming to market and the tenor,” said ANZ syndication manager Apoorva Tandon.

“Domestic investors are generally seeking diversification within the sector and have in recent times had greater appetite for less frequent SSA’s with additional scarcity value, whereas offshore Australian dollar investors have recently dominated the order books for frequent borrowers that tap the Australian dollar market more actively,” he said.

However, another longer-term problem for Kangaroo supply is the introduction of new regulatory rules that require banks to hold much more capital against derivative positions including the cross-currency swap contracts they provide for SSAs.

“The banks will pass these higher costs on to the borrowers which thereby increases the issuers’ costs of raising funds in the Kangaroo market,” said one local DCM banker.

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