The single biggest theme for the local markets has been a growth in the debt requirements of companies like Westfield, Woolworths and Coca-Cola Amatil. While these corporates used to do a deal once every few years, they have now become frequent debt issuers. They are actively surveying the markets all the time. This means that the fixed-income business is far more dynamic as borrowers look for the best issuing opportunities whether it be doing a deal locally, or going offshore to the US, European and Asian markets.
Australian issuers have needed to go offshore because it has been difficult to do big deals in the local market. Is that still the case?
It is for some credits, but Australia is absorbing bigger deals all the time. Wells Fargo did a $2 billion placement last year which was a deal of unprecedented size. The reason that capacity is increasing is because funds are growing. The superannuation pool is really filtering into various fixed-income portfolios. With greater capacity, the domestic markets are giving the offshore markets a run for their money because the domestic markets offer more competitive pricing.
So how much can an A-rated corporate issue in one hit these days?
Anywhere between A$300 million and A$750 million depending on the name. But issuers have to be careful of the tendency for indigestion to occur in this market. When an instrument is hot and pricing is favourable, issuers have a propensity to pile in with a succession of quick-fire deals, and by the time the last one gets out the door, investors have had enough and interest dies off. The same indigestion occurs with Aussie issuers offshore. In the middle of this year we saw a number of banks take advantage of competitive international sub-debt pricing for 10-year non-call five transactions. Rabobank, ANZ and Macquarie all did quick deals and numerous others were looking at the market. But once the first few had issued, investors got indigestion and prices evened out. So bottlenecks do occur in this market.
Why does this happen?
ItÆs partially psychological on the investorsÆ part, but it also relates to portfolio size. Portfolios are growing here but they are relatively small and itÆs quite easy for fund managers to reach limits on certain debt instruments. The bottlenecks occur as investors realise they are reaching these limits and need to take time to rebalance their portfolios. Because there are relatively few issuers in the market, and most of these are financial institutions, investors quickly get their fill on a certain credit. ItÆs always going to be easier to sell new names like Vodafone and Wells Fargo.
With fund managers crying out for diversity, why arenÆt more issuers, especially offshore issuers, attracted to Australian dollar deals?
Probably because of the limited number of Australian dollar buyers in the market. There are between 25 and 30 funds that drive the Aussie market compared to about 1,000 investors in Europe that are prepared to buy euro paper. That means investors here have much greater price leverage than they do in other markets.
Are there more dedicated fixed-income funds being raised?
There arenÆt many new entrants. I'm not sure if the big funds like AMP and Colonial are necessarily changing their asset allocation mix, but they are growing in size which means more money is dedicated to fixed income each year. There has been some new boutique funds form to focus on things like high-yield. But these are still not abundant.
So that must increase the importance of Asian investors in Aussie dollar debt?
Definitely. Having investors like SAFE, GIC, DBS and the Hong Kong branches of European banks involved in local deals has been a great boost to the market. Being able to sell 20%-30% of an issue into Asia has created necessary price tension. Issuers love to have diversified investor books and Asian investors help to achieve this. This is only likely to improve as Chinese banks increase their international holdings. Citigroup has been able to tap the Asian market for clients because of our reach in the region.
LetÆs talk about the number of large leveraged buy-outs (LBO) that have been announced in Australia recently. What sort of impact has this had on the debt markets?
The LBO trend has only come to the fore in the last six months as the Asian arms of US and European firms have cast their net over Australia. We expect to see a lot more of this activity in 2007. The impact on the debt markets is significant when you consider that it is the ability to get leverage for these deals that is driving the market.
So how will these local transactions be financed?
Initially they are financed with leveraged loans and bridges provided by institutions like ours. In the US and Europe these loans are eventually replaced with high-yield corporate bonds. But this isnÆt likely to happen in Australia because there are only about five funds that focus on high-yield notes. So the biggest deal you could secure would be around the A$150 million mark. Sponsors might consider going to the US high-yield market but they might encounter difficulties when it comes to swapping the proceeds back into Australian dollars.
Instead, I think these deals will be funded in two ways û firstly by the bank loan market which is very liquid in Australia, and secondly by retail notes. There have been a few retail note deals this year including MyerÆs A$225 million transaction, and a A$160 million deal for BIS Cleanaway. Time will tell what the capacity of that market is.
What are the features of these retail notes?
They are essentially hybrid transactions. They are perpetual, callable securities with cumulative, deferrable coupon payments. The notes have a five-year call period and potential conversion into the IPO at, say, a 2.5% discount. The yield on these is tantalising and the eyes of retail investors light up when they look at these instruments.
Turning to 2007, what are likely to be the most popular debt instruments for Aussie issuers next year?
I am predicting it will be a big year for bank funding. Banks had a quieter year in 2006 and they tended to fund shorter given the effect of the cooling mortgage market on their balance sheet growth. But next year they will be pushing to grow their balance sheets again, increase the maturity of transactions and re-issue expiring debt. Consolidation in the financial space will continue and this will create some new institutions that have the size and appetite to issue in the international markets. On the corporate side, we should see more issuance by cornerstone borrowers like Westfield and I also expect the property trust sector to be very active. Geographically, the high-yield market in the US is likely to attract some issuers whether they be private equity players trying to fund local acquisitions or resource companies looking for capital.
What about the European markets?
Hopefully weÆll see some more issuance in Europe this year. The US has been more popular in the last 12 months because of the favourable interest rates. Europe also introduced new prospectus directives this year which turned people off because of complicated disclosure rules for offshore issuers. Now companies and banks have digested these new rules and the European markets will probably open up again.
The other market I see attracting interest is the yen bond market. After two stagnant years, yen yields are rising and the cross currency basis swap between yen and Aussie dollars is starting to look attractive.
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