A further slowing in growth
The longest period of bond market disruption since the GFC appears to be ending.
Australian capital markets are showing signs of reawakening with two notable transactions, after three months in deep slumber as COVID-19 shut down large sections of the economy and flattened financial markets.
In contrast with the U.S. bond market where investment grade issuance has had a historic run with both March and April 2020 seeing record volumes of corporate bond issuance, the Australian bond market has been virtually closed.
Large U.S. companies tend to meet nearly all their funding needs in the corporate bond market, which is much deeper and more liquid than in Australia, and many rushed to take advantage of longer term yields at historic lows and often priced close to cash.
“Australian corporates tend to have smaller balance sheets and they can go to their banks for bilateral facilities,” said Brad Peel, Director, Capital Markets Origination at NAB. Many firms drew down on existing lines of credit in March as lockdown measures were imposed and cashflow slowed.
“We saw corporate (bond) issuance starting to slow through February, and then the market really shut down by late February as volatility and uncertainty made price discovery difficult.”
Adding to the stress in credit markets was a flight to cash and a sharp fall in equities that forced some institutional investors to rebalance their asset allocations by selling bonds. There was added uncertainty in the domestic market from the risk of superannuation fund members withdrawing cash under emergency measures to draw down pension savings.
While financial institutions such as Bank of Queensland, Suncorp and UBS Australia continued to issue bonds and the Australian government’s sovereign bond sales met with record demand, corporate issuers were hesitant to test the market.
That changed when retailer Woolworths announced plans for its first A$ issue since April 2019. Woolworths issued A$400 million five-year bonds at 1.85% and A$600 million 10-year bonds at 2.8% coupon in a deal that was three times oversubscribed with about A$3 billion of bids from over 100 investors. NAB acted as joint lead manager, together with the three other major domestic banks.
“A non-discretionary retailer was going to receive the optimal reception from credit investors,” said Peel. “Woolworths took a pragmatic view that somebody had to go first and they were very well received.”
He said the response from investors was “overwhelming”, with a near even split between the five-year and 10-year tranches and a solid 40% interest from offshore investors. “Several investors expressed relief that the corporate pipeline has thawed, and they want to see more transaction flow.”
Last week in the securitisation market, La Trobe Financial issued A$1.25 billion in residential mortgage-backed securities, the largest transaction by a non-bank lender since the market disruption began. Investor meetings for both deals were conducted via virtual roadshows.
Australia’s relatively low rates of infection and rapid monetary and fiscal policy responses to the COVID-19 pandemic have reassured investors that the economic recovery, while slow, will begin to pick up as restrictions are eased across the country.
“I think we’re going to see issuance ramp up now that the window has opened and there is demonstrated demand. Investors are looking through the current phase of lockdown and ahead to when the economy does start to come back,” said Peel. He said defensive sectors such as utilities, telcos and consumer non-discretionary were well placed to take advantage of liquidity.
“There’s no shortage of investable funds at this time and much of the investor concern raised over prior weeks around fund stability and superannuation withdrawals, were not evident on this offering,” he added.
The Reserve Bank of Australia gave a clear declaration of support for the bond market when it added investment grade corporate bonds to the list of eligible collateral it would accept for short term loans as part of its policy response to the economic crisis. The move expanded bonds eligible as collateral from a previous minimum of AAA down to BBB-, though it stopped short of moves by other central banks to buy corporate debt outright.
The RBA said the decision was intended to support the smooth functioning of capital markets. Since the change was implemented, credit analysts say sentiment has improved and there has been a small benefit in tightening spreads.
NAB Head of Credit Research Michael Bush said the central bank’s move could also help investors such as superannuation funds faced with selling pressure to meet a wave of early redemptions from members seeking to access their super. “The move could potentially provide some liquidity boost to previously illiquid corporate bonds, particularly those that still retain a solid underlying credit profile,” Bush said.
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