01 Jan 2006, Alan McNee, Credit
The Australian corporate bond market is relatively young, and many Australian companies still turn to banks or to offshore sources of funding such as the US private placement market. John Bulford, executive general manager, debt capital markets at Commonwealth Bank of Australia (CBA), says the decision to hit the domestic capital market is still not an easy one for the majority of Australian corporates. "There has been a growth in investor interest, and low spreads have meant that investors are willing to look at lower-rated paper in a bid for diversification and spread," he says. "Corporate yields are not lavish, but they are certainly better than government bonds."
However, despite strong demand and increasing issuance of longer-term paper, Bulford says the domestic capital markets still struggle to compete with the syndicated bank loan market. A scramble for market share by Australian banks over the past few years has kept the bank market extremely competitive. Furthermore, corporate Australia was still in a deleveraging cycle until last year, adding to the scarcity of single-A and triple-B names wanting to issue. "Those corporates that did need to take on debt could easily go to the bank market or the US, where it was much easier to get large amounts of capital," says Michael Bush, head of credit research at National Australia Bank (NAB). "Until recently, it was unusual for an Australian dollar issuer to be able to do more than A$1 billion (US$732 million) in the domestic market, and to get long maturities. This latter point is still true for maturities beyond 10 years in large amounts, with a few exceptions such as (mining firm) BHP and (telecoms company) Telstra."
Simon Maidment, head of fixed income, rates and currencies at UBS Australia, says the Australian corporate bond market really took off in the late 1990s, in part as a result of the Australian government's improving fiscal condition. "Government debt has fallen dramatically since then, and state debt has been fairly stable. So sovereign issuance has dried up, while at the same time the compulsory 9% of salary that has to go into superannuation schemes continues to work its way back into the capital markets." This means there is fairly constant demand for bonds, and the non-government market has grown to meet this demand. "It was mostly domestic at first," says Michael Hendrie, head of fixed-income distribution at UBS Australia, "but from the late 90s the Kangaroos (foreign issuers who choose to issue in Australian dollars) have now increased to the point where they account for 40% of domestic issuance this year."
The rebalancing of the UBS Composite Bond Index earlier this year to include triple-B minus names, from a minimum single-A minus rating previously, has been widely hailed as giving fresh impetus to the development of the corporate bond market by allowing investors to move down the credit curve. According to Maidment, though, the change to the index was a response to gradual market developments such as wider mandates and a growing hunger for yield. "The change hasn't led to a massive surge in issuance, but it has certainly been helpful in giving some investors more confidence about lower-rated bonds," he says. "The fact is, though, that Australia doesn't have a great number of triple-B corporates, and those that we do have often have volume or tenor objectives that are difficult to meet in the domestic market." He cites the example of retailer Woolworths, which recently carried out a US$725 million, six- and 10-year transaction in the US. "That's roughly A$1 billion, and it's unlikely they could have done that size and tenor so easily in Australian dollars." Overseas issuance, particularly in the US private placement market, continues to be more attractive than issuing locally for many Australian corporates.
However, domestic maturities have moved out in the past 18 months or so from a previous limit of five years to around 10 years. "There is appetite for triple-B 10-year, but the question still remains whether the pricing is attractive compared with the US market," says Maidment.
An issue in 2004 by Australian gambling and entertainment group Tabcorp is widely regarded as key to the development of a more active market in lower-rated corporate bonds. "The Tabcorp transaction was a defining moment for lower-rated investment-grade credits in the Australian corporate bond market," says Enrico Massi, global head of credit markets at Westpac Institutional Bank. Westpac was sole lead manager for the Tabcorp transaction, which comprised a A$385 million (US$280m) fixed seven-year medium-term note and a A$65 million (US$47m) floating seven-year medium-term note. At the time, it was the largest ever triple-B issue, and it remains the largest seven-year triple-B issue to date. Over 26 investors bought both the fixed-rate and floating-rate notes, all of them domestic Australian investors.
"Tabcorp started the true corporate bond market rolling, in the sense that it signalled the Australian corporate bond market was open to triple-B rated corporates looking for longer tenor in reasonably significant volumes," agrees NAB's Bush. However he adds that the Tabcorp deal has not yet transformed the market. "While Tabcorp represented something of a turning point, the amount of issuance by single-A and triple-B rated corporates is still swamped by issuance of triple-A and double-A," he says. "And financial institutions are still growing as a proportion of total issuance. This year they account for about 84% of total issuance."
The Tabcorp deal also needs to be seen in the context of a number of earlier deals which paved the way for greater issuance by lower-rated corporates. Energy firm Snowy Hydro issued a A$170 million, 10-year transaction in February 2003. Then in July of that year, construction firm Holcim launched a A$260 million, three-year transaction, which at the time was the lowest-rated Kangaroo corporate issue. GasNet, an Australian gas transmission business, issued a five-year A$150 million bond in July 2003, extending the period for triple-B issues. In March 2004, building materials manufacturer CSR issued a A$200 million, five-year transaction.
While the market has been relatively muted this year, there are indications that the Tabcorp deal and the other issues that led up to it may have opened the door to further domestic issuance. In September this year, Santos, an Australian oil and gas exploration firm which has tended to use the US private placement market, issued a dual tranche bond consisting of A$350 million in six-year notes and A$100 million in 10-year notes.
While the Australian securitisation market is one of the more developed markets globally, it has historically been concentrated on residential mortgages. This year has continued that trend, with close to 95% of public issuance coming from residential mortgage-backed securities (RMBS). After residential mortgages, commercial mortgage-backed securities (CMBS) form the next biggest asset class, with other assets - primarily auto and equipment lease transactions - forming a fairly small proportion of total issuance.
Philippe Blin, head of securitisation at National Australia Bank, says there are two aspects to the Australian securitisation market: the public market, which is transparent, and the much less visible private market. "There is a very active conduit and balance sheet funded market, but most of those deals are not public," he says. The public market was growing quickly until last year, with total issuance of A$50-55 billion (US$36-40bn) in 2004, but growth has now tailed off. The private market is estimated to be around A$30 billion (US$21bn).
The tailing off of growth in securitisation is attributable in large part to stagnation in the domestic housing market. RMBS comprises 95% of the public market, although only a small part of the private market. "The Australian property market, with the exception of Western Australia, is not in good health," says Philippe Blin. "Debt-to-income ratios, house-price-to-income ratios and house-price-to-GDP ratios are all at historically high levels, so we are unlikely to see any durable increase in house prices any time in the next few years, and during that time household debt will only grow marginally. So the growth in securitised debt should be modest."
Most of the RMBS market consists of prime mortgages, although the non-prime market has been growing in the past few years. "This is likely to continue in the years ahead as innovation drives the reach of this segment," predicts Tim Nallaiah, division director for structured and securitised debt at Macquarie Bank. Credit spreads for prime RMBS are at record tight levels, and although issuance in the prime sector has been healthy this year, it is slightly lower than in 2004. The slower growth can be attributed to the cooling of the Australian property market, as well as the fact that one of the major non-bank originators, AMS, has been removed from the securitisation market as a result of GE Consumer Finance buying its parent company, AFIG.
CMBS is the next largest asset class after RMBS, but the market is split. "On the one hand," says Blin, "there are the so-called trophy buildings: large, one-off buildings where expected cashflows and part of the property value are securitised. Few of these have been done since it's difficult to match the requirements of the issuer with the expectations of the investors. Investors want transparent deals that are easy to understand, while issuers want flexibility and therefore structure complexity." The other segment of the market - smaller commercial loans on properties such as shops and warehouses - is developing more steadily. "Smaller-scale CMBS is often a by-product of RMBS, with RMBS issuers moving into CMBS as a natural way of complementing their product range," says Blin. "So we see a growing volume of small-scale commercial property loans being securitised." Although volumes on CMBS in 2005 to date are higher than last year, this is mainly due to a single transaction: the A$1 billion (US$732m) issue by Multiplex Group, Australia's largest-ever CMBS transaction, which was lead-managed in March by ANZ Investment Bank and Royal Bank of Scotland.
There continues to be very strong global and Australian investor demand for Australian RMBS. "The Australian credit story is a good one," says Blin. "There's a strong house-owning ethos, where homeowners will try very hard not to default on their mortgage, and the legal system is transparent and lender-friendly." Australian mortgage product finds a lot of interest from Asia, and more recently from European investors. In particular, structured investment vehicles (SIVs) have become active buyers in the past couple of years. "The key thing is that in Australia, delinquencies have been at consistently low levels even in the sub-prime end of the market," says Blin, who notes that S&P's Spin index of arrears on securitised home loans has shown only marginal increases despite a gloomy property market. The vast majority of residential loans securitised are fully credit-insured.
Macquarie's Nallaiah says 2005 has been noteworthy for the amount of issuance in Australian dollars, as opposed to other currencies, and for the size of transactions. "The Puma (an RMBS programme started by Macquarie in 1993) A$1.6 billion transaction was the largest Australian dollar transaction to date," he says, "and (Australian mortgage provider) Interstar's A$1.8 billion transaction contained a A$1 billion single tranche, the largest unwrapped tranche in a low-doc transaction." Low-doc mortgages are those where the borrower simply has to certify their income and confirm that they are able to service the debt, without necessarily providing proof of income. This typically applies to self-employed borrowers. They tend to fall into the prime rather than sub-prime class, partly because they are insured. Four 100% low-doc transactions have been done this year, and all were well-subscribed. "It seems likely there will be more low-doc issuance this year," says Nallaiah.
Although the securitisation of assets other than commercial or residential mortgages is still confined to a relatively small pool, the implementation of Basel II could change things. Some securitisations have already been done on net interest margin (securitisation of the excess spread in mortgage transactions), as well as on auto loans and personal loans. "The advent of a Basel II regime may result in banks securitising assets which attract significant risk capital," says Harish Kartha, associate director, securitisation at ANZ Investment Bank. "This may result in an increase in the securitisation of corporate loans and may also result in newer asset classes being securitised."
CDOs: Market aims to arrest Issuance slowdown
Accurate figures for the Australian collateralised debt obligation (CDO) market are difficult to come by, but most estimates have the public, rated market peaking in 2003 at around A$2 billion (US$1.46bn), then falling away to A$1.2 billion (US$879m) the following year. Issuance of public deals this year is not expected to exceed A$1 billion.
Gary Vasallo, head of interest rate and credit derivatives at Macquarie Bank, attributes this fall to a number of factors, among them the general tightening in credit spreads, which has led to lower returns and higher risks for these securities, and the impact on market sentiment of the Parmalat, General Motors, Ford and Delphi problems. Vassallo believes the fall is only temporary, and that as some of the volume which has been done in the past (much of which was five years or less in maturity) begins to mature, investors are likely to return to the market. "A general chase for yield and the increasing liquidity and transparency of secondary market trading should also help to reinvigorate CDO issuance and demand," he says, although he warns that this turnaround may not begin until 2007 or even later.
Enrico Massi, global head of credit markets at Westpac Institutional Bank, says there have already been about 15 public CDO deals this year to date, totalling around A$800 million in volume. "By the end of the calendar year, we expect to have as many as 18 issues for the year, and volume of between A$900 million and A$1 billion," he says.
The CDO investor universe is split into institutional investors, the middle market (councils, schools, churches and some high-net-worth individuals) and retail buyers. Massi says to date the middle-market area has received the most attention from issuers. "Australian institutional investors are showing interest in the CDO product and have begun to enter this market through small secondary trades," says Massi. "The retail market has provided a significant amount of demand for this product, although this has slowed recently - most likely because with spreads generally tight, it's hard to achieve the headline levels that originally made this product attractive to retail investors."
This concentration on the middle and retail markets as buyers of synthetic CDOs is almost unique to the Australian market. John Bulford, executive general manager, debt capital markets, at Commonwealth Bank of Australia, says: "CDOs work well with the retail investor base in Australia because they appeal to what is known locally as the 'self-managed super' - the person who does their own asset management for their mandatory pension plan. These types of investors have traditionally been buyers of subordinated bank paper, and CDOs appeal to them because they give the opportunity to get diverse bond exposure without having to go out and buy lots of bonds."
Middle-market and retail investors tend to be attracted to different parts of the risk spectrum in their choice of CDO. The middle market primarily purchases triple-A or double-A tranches, while retail interest focuses on the single-A to triple-B area, as well as 'combo notes' which have a highly rated principal component and an unrated coupon. "While I expect these sectors to grow, I also expect the participation of the wholesale investor base to increase significantly," says Macquarie's Vassallo.
Michael Hendrie, head of fixed-income distribution at UBS Australia, points out that while middle-market accounts are the main buyers of synthetic CDOs, cashflow deals tend to be purchased by sophisticated credit managers buying for total return funds. "Less than a dozen local core clients invest in the equity and mezzanine tranches of cash CDOs," he says, although the client group is growing and most institutional investors are beginning to investigate both cash and synthetic CDOs.
Greg Wakelin, executive director, structured products at ANZ Investment Bank, says the dramatic fall in implied correlation in May this year, and the corresponding drop in mezzanine spreads, coupled with a cautious to bearish outlook for credit has caused issuance to slow. "Deals are still predominantly double-A or triple-A," he says, "but increased proportions of high-yield names are being added to synthetic CDO structures to improve yields."
ANZ recently brought to market a deal arranged by Calyon, which aims to respond to the difficult correlation market by offering a CPPI (constant proportion portfolio insurance) product linked into the IG CDX and iTraxx indices. "This product reduces much of the event risk concern around investing in credit, and makes it more saleable to a broader market," says Wakelin, who argues that despite the recent decline in issuance, structured credit will become an increasingly accepted investment product that will be sold to a broader investor base.