Australian government-sector issuers ride the waves of COVID-19
In June, Westpac Institutional Bank and KangaNews brought together the biggest issuers in the Australian government sector to discuss a rollercoaster ride in markets since the end of March. The issuers describe a relatively straight-line improvement since the thrills and spills of the March-April period, with returning investors supporting increasing issuance volume and liquidity at extended tenor.
Davison How would issuers summarise market access and conditions over the course of the COVID-19 crisis?
NICHOLL In March, during the heat of the dislocation, the only thing we could access was the Treasury notes market. We got a few small bond tenders away but these did not reflect any meaningful access to the market. I think it was the first time the AOFM [Australian Office of Financial Management] had ever faced anything like this – it was totally unprecedented.
It is interesting to think about how quickly the market was cleared once the RBA [Reserve Bank of Australia] commenced its operations. It announced that it would start clearing the market before it actually announced the policy of yield-curve control.
Once the RBA started it took several weeks for the market to begin to return to any sort of normality. As one would expect in circumstances like this, we had disengagement from offshore investors. These are often the last to return to the market.
We also saw a strong aversion to duration risk at this time. Once we regained access to the market it was only in the short end and it was some while before we could work our way out to the 10-12 year part of the curve. I would argue that the very long end of the curve is now trading again and has been for 3-4 weeks, but not yet with sufficient liquidity for us to be active.
There is still some recovery to go. Our lack of access in the long end could be due in part to the fact that the market is expecting us to bring a new 30-year benchmark at some point. This seems to be hanging over the market, unfortunately.
Davison Has the recovery progressed in a reasonably straight line or have there been bumps along the way?
NICHOLL It has been a fairly straight-line experience. We have done two syndications, for 2024 and 2030 maturities, and both required a new-issue premium beyond what we would have been willing to pay prior to COVID-19. These both came when there was still some turbulence in the market.
As we went through April and May, we began to get more meaningful offshore-investor engagement. This was a gradual process, but I would say it has been all in one direction – improvement – from the commencement of the RBA’s bond purchases to now.
Davison How do the state borrowers assess market conditions over the last couple of months?
FAJARDO Our experience was similar. Diversity of funding access was heavily affected after the emergence of COVID-19. The demand for our bonds was reduced to a relatively small number of investors – including bank balance sheets focused on short-dated issuance.
The domestic real-money accounts that were major supporters prior to COVID-19 became focused on liquidity, as we all were. They were forecasting redemption profiles and superannuation withdrawals while offshore investors localised their investments, similar to what happened during the financial crisis.
While the investor base in March and April was shallow there was an enormous amount of issuance during this time – close to A$30 billion (US$20.8 billion) across the semi-government sector. This was done at wider spreads to ACGB [Australian Commonwealth government bond] and with greater new-issue concessions than we had seen previously.
Since late April, we have seen broad-based investor demand come back across the semi-government sector. This has increased our ability to access the market and vastly improved issuance conditions, including for semi-governments in the 20-year part of the curve.
QTC [Queensland Treasury Corporation] was in a fortunate position entering the crisis as we had completed our indicative borrowing programme and raised approximately A$2 billion in additional funding. As a result, we did not have any large liquidity requirements going into the crisis.
KENNEDY SAFA [South Australian Government Financing Authority] completed its 2019/20 financial year funding programme in February so we did not need to be an aggressive issuer. We only have a small programme at the best of times, anyway, so we have some flexibility around market access.
Conditions were very constrained but this has eased substantially with the support provided by the RBA. As conditions have improved we have seen the states with the largest funding requirements able to meet their needs including via points further out on the curve, in larger volumes. This is a welcome development.
In early April, when we accessed markets via a public transaction, we were focused on building a trade with the investors that came to us with requirements. Our recent public transaction was centred around further development of risk-free-rate issuance into longer tenor, again based off specific investor demand.
With the RBA’s support remaining in place and rates – especially short-end rates – remaining low, a lot of confidence has built around the rates market for issuers and investors alike.
After a patch of short-dated issuance driven by market dynamics, issuers are keen to take advantage of returning demand at the long end.
NICHOLL There is a combination of factors here. The RBA’s participation in the market featured heavily in the investor updates we did during April and May. We took the opportunity to reinforce what we thought the view was from the RBA’s actions at the time: that it did not see structural support across the curve as key to achieving its monetary-policy objectives.
In addition, the bulk of market-clearing activity required was bonds from the belly of the curve that had quickly accumulated on trading accounts.
These were bonds sitting on investors’ books that are in a part of the curve where we are not normally very active as an issuer. They are bond lines that don’t tend to attract a lot of interest until they roll towards the three-year futures contract.
LOFTING We were similar to some others in that we had completed our funding requirement for the 2020 financial year before COVID-19 hit. We then began getting early information from our Treasury on the possible expenditure requirements as the government had to scale up the health system potentially to deal with thousands of COVID-19 cases.
We realised pretty quickly that we needed to stay ahead of the game with our funding. We were quite aggressive with our issuance early on, but only via private placements. We never felt comfortable enough that a public transaction would be well supported so we went with what we deemed to be the less risky option.
As Jose Fajardo says, early on the pool of investors was very shallow. But there were still some deep pockets we could tap.
Our first deal was a floating-rate note (FRN). After this, we progressively moved to longer-dated, fixed-rate issuance. We ended up issuing more in a two-month period than we have ever issued in a year, so it was very significant scale for us. We were getting volume and a maturity profile we were comfortable with so we did not feel it was necessary to issue in the public market.
TRIGONA The crucial turning point was when the RBA stepped in. Its support in buying government and semi-government bonds brought back investor confidence and allowed us all to access markets, which was critical given the volume we all needed to issue at the time.
The reason we felt comfortable entering the public market when we issued our 2023 FRN and 2024 benchmark increase was because of the support the RBA had provided in freeing up markets and the proactive engagement of some larger ADIs [authorised deposit-taking institutions]. Clear communication with our panel banks was especially important during this period.
GULICH The market was incredibly dysfunctional for a few weeks. We could access short-dated liquidity but relying on this is not ideal in the longer term. We saw the RBA come in with size which stabilised market sentiment. Towards the end of May, the market had returned to the point where we were comfortable to raise longer-dated funds.
It has been a rollercoaster. But it is good to be where we are now after what was a painful, if relatively short, period of time.
Davison What is the state of demand for Australian high-grade bonds in late June?
GRICE It has felt like a long 3-4 months. Going back to March, the emerging crisis was compounded by the fact that there was yet to be any guidance on monetary and fiscal policy, and that we were heading into the futures roll.
We were beginning to see what we have experienced in other crises: offshore investors returning to their core markets. There was significant liquidation and deleveraging from offshore real money and hedge funds. This was exacerbated locally by the fact that domestic fund managers were concerned about asset reallocations that were pending on the collapse of the equity market.
Later, the retreat of investor liquidity was compounded by the government decision to allow early access to superannuation, which also meant local funds needed liquidity. This continued until the RBA gave some guidance around its plans to buy bonds in the secondary market as the marginal investor and to cut the cash rate to 25 basis points.
The relative value of Australian dollars for global investors has changed. First, the currency collapsed – which was exacerbated by domestic superannuation funds re-hedging offshore asset exposures.
Then 10-year yield differential to the US went to 35 basis points over from 75 basis points under very quickly. This led to re-engagement from offshore investors in April and May. We were seeing this in nominal and inflation-linked bonds as Australia’s nominal and real yields looked attractive again globally, as did the currency. The RBA had also stepped in to buy enough of the slack on trading books that we could better facilitate customer risk locally and offshore.
By late March and early April, all the issuers had access to markets and there was capital to be deployed. ADIs were some of the first movers stepping in to buy semi-government bonds. Looking at our high-level flows, there was good buying in January and February, an aggressive switch to net selling in March, and then we have seen buying slowly return in the last couple of months.
BARRELLE It is worth emphasising the package of measures in the RBA’s QE programme. It really was a package, and was well advised. The cash-rate target, yield-curve control and bond buying have all worked in the same direction. This gave issuers, investors and market makers confidence to come back.
From the trading desk, having repo volume and price guaranteed was important to provide surety of funding. This allowed us and other market makers to take on excess selling.
Davison The RBA has been able to taper its bond purchases quite quickly. Are market participants confident central-bank intervention will not need to become a permanent fixture in the market?
MCCOLOUGH The RBA has two reasons for implementing its asset-purchase programme: to target three-year ACGB yield of around 0.25 per cent and to restore market function. It gets two ticks for these.
Will Grice mentioned shifting relative value globally in favour of Australian dollars. I think this has meant more marginal investors coming in – so we should not need the RBA to continue to access its own balance sheet.
A big part of the success so far is that there was not a volume target for bond purchases but a level target. The market is very comfortable that the RBA will do what it needs to achieve its goals. This is not jawboning but the messaging is strong and it means going forward the RBA should need to do less rather than more.
Davison Several issuers have already mentioned the importance of the RBA’s intervention. How did the reserve bank’s role assist the return to benchmark issuance?
KENNEDY When we went to the market in April it was a day-by-day proposition as to whether we could issue and get the traction required to print a transaction that would not be detrimental to the sector at that point.
We had to pick the right time to show there was enough confidence to facilitate access to public markets – and this was based on external factors in markets and, more importantly, the direct policy action from the RBA. We felt the time was right by the end of March and we issued in early April.
GULICH It was always our intention to bring a new 2031 benchmark bond to the market – this was originally planned for March as part of our refinancing plans for our July 2020 maturity. Very early in March, though, we realised this would not be a good outcome for anyone.
We kept a very close eye on the market and we saw the impact of the RBA activities in soaking up excess supply. There was widespread sentiment that the RBA had supported the market early in size and with the stated intention to keep being active as required. These were all really important messages. When the RBA began to taper it was on the back of market confidence that it would step back in again if needed.
By May, bid-offer spreads returned to reasonable levels and we were seeing increased secondary activity. The RBA had been out of the market for about three weeks at this point, which gave us a further indication conditions had settled.
We scheduled our deal for the third week in May. There was a bit of disruption just before this with spreads moving a bit wider. This highlighted some ongoing fragility from sell-side pressure, but also represented value to investors.
We decided to pursue the deal because it was more about access, though outright pricing was comparable to pre-COVID-19 levels and remained at a historic low. The feedback we had from our panel banks was that investors were interested in semi-governments and in our name. With the tenor being beyond 10 years, we expected some offshore participation as well.
LOFTING The semi-governments have been meeting with the RBA every week to provide feedback on market conditions. The reserve bank has been very open and listened to us on what parts of the market needed support. This gave me a lot of comfort that it was willing to do whatever was necessary to ensure the semi market remained operational.
This was true all the way through the crisis. The RBA’s focus has been on ensuring markets are operating effectively. I feel confident that if there are further problems, which I hope there will not be, RBA support will be there.
Davison How has the supply story played out over the last few months?
FAJARDO We need to take the demand in the context of a reduction in supply from semi-governments in May and June. We will probably get a clearer picture of demand once we are all active issuers, in the new financial year. So far, signs are positive that capacity can be absorbed in Australian dollars – but we need to start going back to being more regular issuers.
We also have feedback from our marketing offshore that investors would like to see issuance from QTC in US dollars or euros to diversify their credit risk. If capacity in the domestic market ever becomes an issue, we are capable of pulling that trigger as we have current USMTN and EMTN programmes.
Larger funding tasks in the wake of the COVID-19 crisis make foreign-currency issuance a more plausible prospect for semi-government issuers. But it is still not likely to emerge in benchmark format.
FAJARDO Our position hasn’t really changed – it comes down to whether there is a capacity issue for Queensland Treasury Corporation’s issuance in Australian dollars. I don’t see one right now.
We also look at relative value compared with our domestic curve. The 3-10 year part of the curve in US dollars is still well away from domestic pricing and we would have to see this move substantially to look at benchmark offshore issuance.
However, I think it is fair to say the pricing hurdle to undertake offshore benchmark issuance has gone down a little since the COVID-19 crisis. When you see a period where only short-dated funding is available in Australian dollars while the US market is still open, be it at a price, you may be more comfortable to pay a slightly higher price than before to have a foothold in those markets.
MCCOLOUGH We have already talked about the surge in supply early on and, as Jose Fajardo says, this has slowed down recently. Price action has followed – we saw a big widening in semi spreads to ACGBs but they have now come all the way back in again.
The next big move or potential driver of price action will be when we get clarity on what supply will be for the upcoming financial year. That won’t be until October or November for most issuers, or September for QTC because of the timing of the state election.
Whether it’s the Commonwealth or the semi sector as a whole, I believe the announcement from Victoria of a A$24 billion programme recalibrated expectations – in a positive way. There were estimates being thrown around like A$150 billion of extra supply from semis through the latter half of the 2019/20 financial year and into 2020/21 financial year. This got wound back to more like A$100 billion across the sector, and now it’s about A$60 billion more for the upcoming fiscal year.
I think the market will be comfortable with this. There may be individual surprises state by state. But the market should be comfortable with something like an extra A$60 billion of semi-government supply and Commonwealth outstandings of A$800-850 billion by June 2021.
Davison The fact that issuance volume is set to increase quite dramatically is well known. But, with budget rounds largely postponed, the market does not yet know exactly what volume is coming. What has issuers’ dialogue with investors and dealers been like?
GULICH We put out an estimated 2021 borrowing programme in late May. This followed an update our treasurer gave parliament reflecting some estimates of the COVID-19 impact on revenue and key economic conditions in the state.
We are all aware this estimate will change somewhat, though – not least because the length of the lockdown and the return to economic activity is quite different even now compared with what we were anticipating six weeks ago. There is a lot of water to run under this bridge.
At the end of May, we had an estimated new-money programme of A$1-3 billion. That’s a step-up – we were anticipating a zero new-funding requirement for the state in our previous update. We also have the maturity of the July 2020 bond and an FRN early next year.
Between our prefunding and where we are at with the run rate this year, our programme next year is likely to be A$2.6-4.5 billion. This is probably on the lower side of what the market might have been anticipating and it covers quite a range. We also expect to be making inroads into the July 2021 maturity during the course of next year – so our actual activity may be a bit higher than that range.
LOFTING Initially, we were unsure of the scale of the COVID-19 impact on expenditure and revenue as the budget process has been delayed until October.
Treasury came up with a range of A$20-24 billion for the 2020/21 financial year, which is about an additional A$14 billion on the original TCV borrowing forecast for 2020/21 of about A$10.5 billion.
At this stage, we expect the borrowing requirement to be at the lower end of the range as the impact on the health sector has not been as significant as expected and we have not seen the full revenue impacts yet. Things like GST [goods and services tax] revenue are only starting to flow through and will continue to do so over the next few months. At 30 June, we had completed around A$7 billion of the 2020/21 funding requirement.
TRIGONA We are also not in a position to say what the funding task is for next year – we will get more clarity in October. Having said this, the state government has already forecast a A$9 billion hit to the budget. This is why we embarked on a funding task in March and April. We are in a similar position to other semis in that we acquired a lot of funds at that time that haven’t yet been used.
Governments haven’t had to forecast for a pandemic before, so they looked at worst-case scenario options. Initially, too, the health impacts were expected to be far greater than originally forecast.
The better-than-expected outcomes should result in less deterioration in revenue. But we are yet to see the impact on payroll-tax revenue and stamp duty, or even GST.
The pertinent fact is that we are in a very liquid position going into the new financial year. We won’t have the pressure on us that we thought in March might be there.
FAJARDO Like the other states, Queensland deferred its budget. We will be publishing a COVID-19 fiscal and economic review in September 2020. We have continued to keep investors informed of all the latest publicly available information, and we have found them to be very understanding of the situation. It’s a significant global event and governments around the world are still assessing and managing the impacts.
The sector has already undertaken a large amount of issuance, which may mean investors are broadly more comfortable with the issuers’ funding positions ahead of state budgets.
QTC is in a very strong position having raised an additional A$9.2 billion in net issuance above our indicative borrowing programme.
KENNEDY South Australia’s revised funding task at the mid-year budget review in December 2019 was that we needed to raise A$3 billion of term funding. Through to 30 June, we have raised just more than A$5.25 billion.
There has been no formal update from the government on the current budget position. My understanding from Treasury is that we will not be provided with an interim financial position report so we will be unable to provide investors with any update until we get our budget in late October. This includes future-year funding forecasts.
While this makes things a bit frustrating in the sense of how best to communicate our funding requirements to investors, they are also understanding of the situation given its unprecedented nature.
We had forecast our 2021 borrowing programme to be A$3.6 billion at the 2019/20 mid-year budget review. Obviously it will be bigger than this, but it’s impossible to put a quantum on it. I’m not sure we have seen the immediate impact on revenue we might have expected back in March – which is probably why we are all in a better-than-expected funding position at this point in time.
I think all the states acted prudently in ensuring they had sufficient liquidity against a worst-case scenario. When we look back on this situation in a couple of years, I hope we will be able to say we did a really good job of ensuring, in difficult conditions, that we were able to maintain the funding and liquidity position for the states.
LOFTING I’d add that I don’t think we’ve ever been in a situation where our ability to finance governments could materially affect the ability of governments to invest in the health infrastructure they needed to keep people alive. There was no choice: we needed to ensure there was enough liquidity around to fund, for instance, a state order for ventilators as quickly as possible.
KENNEDY That’s 100 per cent correct. If excessive pressures on our health system had emerged there is no question all our health departments would have required immediate access to funding so they could upgrade their day-to-day operations to deal with a pandemic. I think we all accredited ourselves well in being able to provide this should the emergency event have arisen.
FAJARDO We also really had to think about the initial chase for liquidity while trying to minimise the impact on our funding costs. We looked, for example, at liquidity initially through T-note issuance and then waited for the market to improve to undertake term funding.
TRIGONA This is a good point. The need for most of the semis to get access to liquidity, especially in March and April, meant the majority of issuance was less than six years in tenor. Subsequently, we are seeing a lot more issuance in the very long end and even ultra long. For example, we have issued close to A$2 billion in tenor longer than 17 years in the last month or so. I know the other semis have also issued in the long end.
The first part of the crisis was about trying to access funds at the most cost-effective rate we could achieve while meeting investor demand, which meant shorter-term funding. We’ve been able to extend our debt profiles as the market has improved in the last six weeks.
Davison What has been the AOFM’s experience of communicating the supply picture in this environment of uncertainty?
NICHOLL We found that investors were very forgiving of the absence of a gross programme number for the year. We have been in daily contact with Treasury for months and there have been many revisions to the outlook for financing tasks during this time. Each iteration has less volatility and variation than the one before. I think we’re getting very close to having a good understanding of the underlying budget impact.
One thing we said to investors was that the government’s fiscal response had been costed and there was a relatively high degree of confidence about those figures, putting to one side the adjustment that was made to the JobKeeper programme. What we didn’t know – and what nobody knew at the time – was what was happening to the underlying budget position. That’s what made things very difficult – and still does, given the uncertainty of the recovery outlook.
We have provided the market with periodic guidance on issuance rates rather than giving specific programme numbers. Every investor I have spoken to has appreciated this and said it’s more than sufficient for their needs for the time being.
Another thing we’ve done is make a deliberate attempt, in all our investor updates through April and May, to describe what investors could expect as a pattern of issuance behaviour from us – broadly speaking. This complemented the issuance-rate guidance.
Also, as soon as we could we got out and made clear where we would be introducing new maturities via syndication. Then, in late May, we said we wouldn’t be doing anything more until providing updated guidance to the market in early-to-mid July.
We are now thinking about the next round of guidance we’re going to give, and we’re also in the position that the treasurer is going to make a statement on 23 July. We have taken every reasonable opportunity to use whatever information we have and to provide the market with the kind of guidance we could give on a ‘no-regrets’ basis. By this I mean not giving as much detail as we usually would but as much as we can, and then making clear when we think we will be in a position to update investors again.
All this has required us to step aside from the normal process we follow because of the absence of official budget updates. It has been a question of balancing what we need to say to give the market some guidance with what we can’t say until an official update is forthcoming. I think we’ve managed to find our feet pretty well through this, which the market has appreciated.
Davison Is there any risk to the approach Justin Lofting mentions, in other words of starting with the biggest possible number for future funding requirement and potentially revising it down if outcomes come out better than expected?
NICHOLL We have taken the approach, to date, of giving guidance we can hold to for the periods we give it – like the weekly issuance rates we publish. Where we are using syndication this gives us flexibility around volume, so markets aren’t focused on trying to reverse engineer a particular deficit or budget outcome for the year from our guidance.
If we go out and say to the market we’re going to do something for a particular period, we will have thought about all the possibilities around the volume being higher or lower and what we might do in those circumstances. But being able to hold to our guidance has seemed important to us.
It’s easy for anyone who is not in our shoes to think they can take numbers from Treasury and convert them into issuance programmes. But the basis on which our programmes are formulated makes us the last step in a process the foundation of which is what’s going on in underlying budget positions. This has been very difficult to read for outsiders, and I would argue it remains so.
I think we’re a long way from having what we would normally think of as clarity on the way forward. My understanding is that on 23 July the treasurer will focus on 2019/20 and 2020/21 with detailed mention of out years to wait until October when the actual budget is handed down. This should be more than sufficient for the ACGB market until the budget, though.
As long as we are transparent with the market – and, if things change, we adjust our advice to the market pretty quickly in recognition of the change as opposed to just ignoring it – the information we are able to provide should be welcomed by investors.
GULICH I agree with all this – it’s about transparency. Everyone is in a very similar situation at the moment and certainly the accuracy of funding projections we would normally rely on isn’t there. It’s about being honest about this but also about not getting ahead of what your premier or treasurer is in a position to say.
It has helped that the approach across all the jurisdictions – including the Commonwealth – has been consistent. We all have a good feel for what we can say and how we can best say it to position ourselves amid this degree of uncertainty. For the most part, what I’m hearing from investors and panel banks is that there have been no real surprises or outliers so far.
What we are saying is resonating relative to the economic and health situation. This has been a real positive and it gives support to our market more broadly.
The role of GSS bonds
Australia’s government-sector issuers do not expect radically to increase their issuance of green, social and sustainability (GSS) bonds. At the margin, though, there may be room for a greater social component of existing and new programmes.
FAJARDO We have approximately A$6 billion (US$4.2 billion) in our green-bond project pool and we have close to A$2.5 billion of green bonds on issue. So we certainly have capacity for further issuance.
We are seeing a lot of interest and enquiry from domestic and offshore investors for our green bonds so it’s more likely to become a supply issue than one of demand. We continuously review and evaluate projects for inclusion but it’s uncertain whether the expansion of the pool will meet future demand.
We have been working hard on how we as an issuer can increase the liquidity of the product. What we’ve done, as a programmatic issuer, is enable investors to access existing bonds through reverse enquiry. We have also provided stock-lending facilities to our dealers and have done four taps of our 2029 green bond.