ASX-listed companies that have traditionally looked to equity markets or bank debt to fund their growth plans are noticing an increasingly attractive alternative source of funding: the burgeoning non-rated corporate bond market.

Supported by strong appetite from investors, the volume of non-rated corporate bond issuance in 2017 was over A$1.0 billion and year to date in 2018 nearly A$0.6 billion, according to NAB data. In 2017, non-rated issuers represented one in every four corporate bond transactions in the A$ market and so far in 2018 non-rated issuers represent  nearly one in every two corporate bond transactions — yet this growth has come with little fanfare.

“For borrowers that have a growth agenda, non-rated debt can provide the flexibility and capital to support those growth plans, without having to raise equity and dilute your shareholders,” says Andrew Gordon, director, debt markets at NAB.

These higher yielding bonds are similar to those issued by investment grade rated corporates but are not rated or are sub-investment grade and therefore offer a higher rate of return to investors. Investors are willing to provide additional flexibility such as limited covenants and accepting some level of subordination to generate this higher return.

Funding for capex

In recent deals, capital raised has generally gone towards capital expenditure or to refinance existing debt. Names that have tapped the market through NAB include Seek, NEXTDC, Afterpay Touch, Qube, QMS Media, Peet and Centuria.

In July, Australia’s leading data centre provider, NEXTDC Limited (ASX:NXT), issued A$300 million of senior unsecured notes maturing in June 2022. The latest NXT transaction was split between a $200m floating rate tranche (which priced at 3M BBSW + 375bps) and a $100m fixed rate tranche (which priced at 6.00%). NAB acted as sole arranger and sole lead manager on NXT’s fourth transaction in the A$ non-rated market, taking NXT’s total issuance to $A600 million.

As in all A$ high yield issuance, one of the key ingredients to success is the co-mingled investor base. The order book for NXT Notes IV was made up of around half institutional investors and half non-Institutional wholesale and sophisticated investors.

NAB has moved quickly to support the growth of the market, becoming the market leader in the A$ non-rated bond market and acting as lead arranger on over A$1.1 billion of non-rated corporate issuance out of a collective A$1.65 billion in offer proceeds over the last 18 months.

“We’re basically seeing more demand than supply. All the order books have been oversubscribed, the issues have priced tightly and they’re trading well in the secondary market,” Gordon says.

Appetite for fixed income

Non-rated debt appeals in particular to investors who wish to receive a similar income stream that dividends typically provide to share investors, while avoiding the volatility of the stock market that can lead to share price declines even among blue-chip stocks.

Driving the non-rated debt market is growing appetite for fixed income overall as investors seek to diversify their portfolios, coupled with the hunt for yield that has been the driving theme in investment markets over the past decade.

“There’s a new generation of highly specialised fund managers who run mandates for both rated and non-rated paper, and they are happy to do the credit analysis on these transactions.”

As the market evolves, credit teams at larger asset managers are also working with specialised fund managers to assess issuer quality, sometimes tapping in to their internal equity coverage to evaluate management and the business strategy.

In the non-institutional space, high-net worth individuals and self-managed super funds are looking for a larger weighting to fixed income as the Baby Boomer demographic heads into retirement phase. Often these investors are willing to commit to more investment risk for a small part of their portfolio in return for the higher yield on offer compared to term deposits or other cash-like investments.

“There’s a lot of capital out there, and we’re working closely with investors to tap into those capital flows and at the same time help our issuers to grow their business,” Gordon says.