Thursday, 24 January 2019

Narrow trajectory

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  • Narrow trajectory

Australian onshore accounts have traditionally only focused on the best-known SSA names. But as the market expands so too are their horizons.

The size of Australia’s Kangaroo market has grown significantly in recent years. Last year was a record for debt denominated in Australian dollars. By year-end, DCM volume stood at US$35.4bn, not only a record year but an increase in issuance of 34%.

More to the point, bankers called it a break-out year thanks to names such as National Bank of Abu Dhabi or German borrower Landeskreditbank Baden-Wuerttemberg-Foerderbank (L-Bank) that dipped their toes into the market either for the first time or for the first time in a long time.

If the start of the year is anything to go by, 2015 is going to be a record year. Half way through January, overall supply had comfortably exceeded whole-month figures for January 2013 A$4.025bn (US$3.3bn) and A$4.075bn for January 2014, according to figures from Reuters. Bankers are, not surprisingly, enthusiastic.

“This time last year we saw A$2.5bn of issuance. At the moment we are standing at A$4.9bn of issuance. That is a good sign that it will be another good year,” said Rod Everitt, head of Australian dollar bond syndicate, Deutsche Bank in Sydney.

In the week of January 12, there were five deals alone. Inter-American Development Bank tapped its 3.25% February 2020s for A$500m; Germany’s Rentenbank sold A$650m of 2.70% 2020s; KfW first tapped its 4.0% February 2025s for A$300m and then its 2.75% April 2020s for A$300m; L-Bank tapped its 3.75% January 2018s for A$150m; and Nederlandse Waterschapsbank sold A$150m of 3.4% July 2025s. All of the bonds were comfortably subscribed and all priced well.

There was little let-up for the rest of the month that followed, with deals, for example, from the African Development Bank, another from KfW and Nordic Investment Bank.

Family favourites

All good news, but there are well-recognised concerns that the majority of enthusiasm from investors, especially in the SSA space, comes for the same names. Indeed, with the exception of comparative newbie L-Bank, the issuers are all family favourites. It would be an exaggeration to say that the issuance calendar is so familiar that a clock could be set by it, but bankers in Sydney appear slightly out of sorts that the International Bank for Reconstruction and Development has yet to issue.

Is there any sign of change? Although there are hints that demand is changing slightly, it is doing so only very slowly.

“Existing names do tend to attract the most interest. As time goes by, there will be more interest in other names,” said Tom Irving, managing director, head of Asia Syndicate, TD Securities, the top-ranked Kangaroo bond underwriter last year.

Perhaps the biggest difficulty is not so much innate conservatism of buyers, rather it is the question of liquidity.

“Domestic investors are interested in the more liquid lines and the larger benchmarks – the KfWs, the IFCs, the Rentenbanks and ADBs,” said Deutsche’s Everitt.

The reason for this is that although domestic real money can be thought of as buy-and-hold investors and, for the most part, will hold paper to maturity, this does not mean that they will not look to trade. If they want to exit a position for any reason they need liquidity, indeed for the most part domestic accounts as a mandate have a need for liquidity.

There is, inevitably, a lack of liquidity, with the less frequent names that only appear in the primary market and don’t have the ability to come in week in week out. It is not a lack of interest, simply it is harder and more work for funds to buy occasional issuers.

As an example take Germany’s L-Bank, the state development bank for Baden-Wuerttemberg. In 2007, it sold A$200m of 6.3825% February 2011s; in January last year it sold A$350m of 3.75% January 2018s, which it then followed up later in the year with A$100m of 4.25% August 2025s. Both the 18s and the 25s have been tapped for A$150m and A$50m respectively.

L-Bank’s outstanding line of A$650m almost pales into insignificance compared with Germany’s Rentenbank. A long-standing issuer in Australian dollars (to the extent that about 14% of total funding is issued in this way), it sold A$2.85bn in 2013, A$2.2bn in 2014 and is expected to issue a similar volume this year.

But there are signs that Australian investors are beginning to look at the Kangaroo market in a slightly different manner. Bankers in Sydney speak of “a couple of new onshore real-money accounts looking at the SSA space”. This, they emphasise, is a change from the previous two years, when there was considerably more international money.

The hangover of that emphasis on international money can be seen most obviously of all in the preponderance of five-year SSA Kangaroo issuance that has been seen so far in the first quarter, specifically structured to attract central banks.

But tenor can be an advantage for new names. 2014 was, in many ways, the year of the Canadian Kangaroo. Not only the state of Manitoba – which has already tapped its 4.25% 2025s this year – but also Quebec, Ontario and British Columbia all raised debt last year in the market. Although not strictly speaking SSAs, with ratings that stretch from Aa2 (Moody’s) to A+ (S&P), they are looked at by the same accounts that focus on SSAs and treated in a similar manner. Significantly all came to the market with 10-year debt, which is of particular interest to Australian insurance and pension funds.

Perhaps the biggest driver for change has been the organic growth of the Kangaroo market itself. Whereas once it was a niche market with comparatively little action, nowadays not only is there a growing primary market, there is an active secondary market too.

“The reality is that the Australian dollar market is much, much bigger than it used to be. It is no longer dominated by Australian onshore accounts, there are central banks, Japanese accounts and European accounts. The market trades 24 hours a day,” said one DCM head in Sydney.

Fortunately, too, it is unlikely to change any time soon. From an issuer perspective, the driver for much Kangaroo issuance is the favourable basis swap. As Rogier Everwijn, head of capital markets at Rabobank, said bluntly: “We are only active in a market and in a currency if it provides a decent level of arbitrage – the swap is important to us.”

Despite the basis swap being very volatile of late due to supply and the removal of the cap by the Swiss National Bank, the Australian dollar basis swap for issuers in the medium term is unlikely to change to a level that will prevent them from looking at the Kangaroo market.

“The basis swap between Australian dollars and both US dollars and euros is still attractive. It is around 30bp across the curve for the US dollar and there is a 50bp–60bp pick-up for the euro, with euro funders finding the market even more attractive following the moves from the SNB,” said Oliver Holt, vice-president, Australian dollar syndicate, at Nomura International.

The other major event that could derail issuance and cause more cautious investors to run back to the arms of familiar names would be a change in interest rates. At the moment, however, little appears to be affecting them. “There is no headwind to rates,” said one Sydney banker.

Certainly, Australia’s central bank has hinted that interest rates will remain at or near their current record-low levels for the foreseeable future. The benchmark cash rate has been at 2.5% for well over a year and the central bank’s official stance remains clear in its much-repeated key phrases: “The exchange rate … remains high by historical standards” and “the most prudent course is likely to be a period of stability in interest rates”.

Few are arguing. In a recent note, Commonwealth Bank of Australia’s chief economist Michael Blythe went as far as to write that he expected no movement this year and only the sign of a shift next year. “It is now quite likely that the Reserve Bank of Australia continues to sit on the sidelines through 2015,” he said. “Nevertheless, we expect that the debate will shift towards interest rate normalisation by year-end and we now see an initial rate rise in the first quarter of 2016.”

All of this remains positive for the continued issuance of Kangaroo bonds and while their liquidity, frequency and general familiarity means that the more common borrowers will dominate the market, other SSA names are likely to make an appearance.

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