|Summary: The issuance of ASX-listed interest rate securities dropped sharply in 2013, but the foundations were laid for a deeper and more diversified market in 2014.|
|Key take-out: There is likely to be an emergence of new corporate issuers, who are unable to access the wholesale market, using ASX interest rate securities, and also an expansion of the use of depository interests to list bonds from the wholesale market.|
|Key beneficiaries: General investors. Category: Fixed income.|
The market for ASX-listed interest rate securities took off in 2012, a year in which a record $13 billion of such instruments were listed. This year was subdued in comparison, with only $8.4 billion of notes being issued.
Nevertheless, the year was an important one because of the changes in market dynamics that will allow the emergence of a deeper and more diversified market in 2014. The ASX-listed interest rate securities market has developed as a high-yield, high-risk market to date, but this is set to change.
Hybrid note issuance by Australian companies outside of the financial institution sector all but disappeared in 2013. Such issuance, driven by credit rating agency criteria, accounted for $2.7 billion of transactions in 2012.
This year, as a result of a change in rating agency criteria, there were no such transactions. And there was only one corporate issuer – Healthscope undertook a second subordinated note issue, which raised $305 million.
Healthscope has issued just over $500 million of subordinated debt, which sits between its private equity owners and senior bank lenders. This debt, like that of MYOB, offers holders a potential equity kicker, with the notes convertible into discounted equity when the companies are re-floated on the ASX.
The remainder of the issuance seen in 2013 has come from financial institutions seeking to boost regulatory capital by raising subordinated debt or hybrid capital. And by the end of August, it seemed that the financial institutions had raised all that they needed.
It was only last month that activity re-emerged in the market, with AMP and NAB launching subordinated and hybrid note issues, respectively. AMP’s subordinated notes 2 issue was set at $300 million and NAB’s CPS II at $1.5 billion. Each will commence deferred settlement trading this week.
With these two note issues seeing out the year, it is likely that further such issuance will get underway quickly in 2014. There is $5 billion of listed notes that will reach their call dates or maturity next year, and there is additional capital that the banks need to raise.
Seeking out alternatives
However, apart from replacing maturing debt, additional capital raising by financial institutions and the major banks in particular may prove challenging. Retail investors will increasingly ask themselves, how much bank subordinated debt and hybrid capital do they really want to hold in their investment portfolios?
In any bond portfolio, diversification is far more important than in a share portfolio. While a share portfolio can be reasonably diversified with a holding of shares in 10 different companies, a bond portfolio needs the bonds of 100 different companies to achieve the same level of diversification (though I appreciate this is not a feasible option for Australian bond investors).
Retail investors will also be questioning whether the returns on offer provide adequate compensation for the risks involved. NAB’s current CPS II hybrid note will pay a gross yield of around 5.75% per annum (at current bank bill rates), but the cash coupon received will amount to just 4% per annum plus franking credits.
Moreover, do retail investors realise that they are being targeted for these offers? Institutional investors would demand a margin over the bank bill rate that would be closer to twice the size of the one on offer.
Market growth and development in 2014 is likely to come from the emergence of new bonds and issuers.
Government bonds on the ASX
An important development that went almost completely unnoticed during the year was the listing of Commonwealth government bonds, in the form of depository interests, on the ASX. While the initiative took the size of the listed bond market to $250 billion, from $35 billion, it proved to be a complete non-event.
Commonwealth government bonds yielding 3% per annum, or thereabouts, simply don’t cut it when retail investors can take the same credit risk but get higher yields on government guaranteed term deposits. However, the process of listing CGS on the ASX is a good one because the same process will be used to list corporate bonds from the wholesale market.
Wholesale corporate bonds
The bonds issued by Australian companies in the wholesale market are now offering relatively attractive yields. This year cash yields have averaged 5.5%, and in some cases exceeded 6% per annum, with the maximum being 6.5%.
These are the sort of wholesale corporate bonds that could find ready interest among retail investors, if listed on the ASX. And if this initiative proves to be successful, more companies will line up to issue their bonds directly into the listed market.
The obvious candidates for such issuance are those companies that can take advantage of the short form prospectus provisions – those listed on the ASX – but are unable to access the wholesale market because their credit quality falls outside of the investment grade rating categories.
Use of a rating estimate model, designed to replicate the credit ratings of Fitch Ratings, Moody’s Investors Service and Standard & Poor’s, shows that there are 19 unrated companies in the S&P/ASX 100 index that are likely to fall into the ‘BB’ rating category, just outside of investment grade. Of these, seven may be rated ‘BB ’, nine ‘BB’ and three ‘BB-‘.
These companies are large enough to have term debt funding requirements that could be met by the ASX-listed interest rate securities market. They will also offer more attractive yields than those available on listed wholesale bonds, with reasonable credit quality.
The emergence of such bond issuers, and the expansion of the use of depository interests to list bonds from the wholesale market, will result in a deeper and more diversified market in 2014.
Philip Bayley is a former director of Standard & Poor's and now works as an independent consultant to debt capital market participants. He also writes on matters concerning debt capital markets and banking for various publications and is associated with Australia Ratings.