The heart of the deal

And yet true corporate issuance continues to lag. The A$4.7 billion (US$3 billion) of corporate supply in H1 2023 represents a step up from 2022 – during which A$5.6 billion priced across the whole year – but is still well short of the historical run rate. While the story of 2022 was one of ultra-cheap bank debt financing for corporate borrowers, this year has seen issuers return to the capital markets – but primarily outside Australia.

Even putting aside the cohort of borrowers with funding needs of a scale that require the deep pools of liquidity only  present in US dollars and euros, it seems many Australian corporate issuers remain unconvinced about the reliability of their domestic market. This view is not universal and the skepticism that exists comes from a variety of factors. For instance, the Australian dollar credit investor base is typically less naturally aligned with the extended tenor many issuers favour.

However, many – perhaps most – market sources argue that execution in Australia is imperfect and that this is a notable  handicap to the corporate issuance market. Investors say deal information is inconsistent and issuance opportunistic. Arrangers say investor unwillingness to commit or even provide strong guidance often leaves books struggling to gain momentum. And issuers are often left in the dark about why their transactions failed to excite – even when they themselves could have facilitated a superior outcome.

KangaNews spoke to a range of market participants, on and off the record, about their perceptions of the deal process. Views are not universal: some deal parties even declined to contribute on the basis that they do not believe there are significant problems with execution. But the overall picture that emerges is one in which market segments do not fully understand each other’s drivers, limitations and concerns.

There are grounds for optimism. In the past half-decade, regulators and market bodies have devoted some attention to the deal process and it is clear that disclosure has already improved – with hopes for further transparency in future (see box). Meanwhile, the very fact that corporate deals in 2023 have delivered differential outcomes – including some notable highlights – implies that it is possible to run a successful process in Australia (see box).

Market participants universally agree about what the end goal of a transaction should be: the issuer raising volume and tenor of funds it is happy with, at a price that is acceptable to all parties – one that is at least competitive with alternative funding or investment options. The execution process itself is about reaching common ground on price and tenor while confirming sufficient demand to deliver volume.

This process starts with a market-sounding process via a nondeal roadshow or a handful of one-on-one issuer-investor discussions. Buy-side sources tend to argue that, although not used for every transaction or by every issuer, this aspect still has a role in uncovering information that is useful to both sides of the deal without requiring formal wall-crossing.

Sean Rogan, senior credit analyst at Western Asset Management in Melbourne, says: “The worst-case scenario for the issuer, and ultimately the market, is a failed deal. Soft sounding is a useful tool to navigate this, because it can provide a rough indication of pricing that the execution process examines further.”

Some investors believe additional direct contact with issuers could be beneficial. Rogan comments: “A very small number of corporates in Australia will contact us outside of a deal, and not via any lead managers, for general feedback. These more direct conversations support a healthy, functioning market and they work well for both sides.”

The first formal step in the execution process is an issuer awarding a mandate, which is followed by a series of preparatory calls between issuer and its newly appointed lead managers. Typically, these take place three business days prior to the pricing window – though the process can be extended, especially for new or international issuers – and cover pricing and tenor expectations, deal parameters, execution expectations and market conditions.

Once the sell-side outline strategy is agreed, there is typically a mandate announcement – which may outline timing and the style of pre-deal marketing the issuer plans, for example a full roadshow or a series of one-on-one calls. This marketing process should provide issuer and leads with information sufficient to give a good read on market, issuer and deal sentiment from a wide range of buy-side participants.

Some investors say they are committed to contributing as much as they can to this process. Kapstream Capital is often named by intermediaries as a reliable provider of feedback, and Pauline Chrystal, Sydney-based portfolio and ESG manager, says Kapstream’s preferred approach is to take up the opportunity of engaging at this early stage.

“We may attend a one-on-one or group meeting, after which we undertake our credit work and communicate our intent to the lead managers,” she says. “We express our views on fair value based on the comps we have identified, and we are very open about our pricing and volume expectations.”

However, overall the feedback process is not reliably generating the breadth or depth of information deal groups believe it should. Lead managers tell KangaNews that some investors – including large, mainstream funds – rarely if ever provide detailed feedback, leaving arrangers more or less in the dark as to what their level of interest or likely participation might be.

The feedback process should be a quid pro quo, under which investors can help secure allocations by providing assistance to early accurate pricing and thus deal momentum. But some leads express frustration at occasional comments from some investors that they do not believe there is a benefit from providing feedback. These leads say issuers typically make clear that they will reward early support and market leadership on volume or pricing by considering these factors in the allocation process.

Perhaps the issue is that feedback in the deal process is only one factor issuers want to reward. Chrystal suggests preferential allocations are far from guaranteed, noting the contrasting outcome of at least one deal where cornerstone allocations were given to investors on the basis of past support for the issuer. While she does not disagree with this principle – and says Kapstream’s approach to feedback is consistent regardless – she says it is not always clear what issuers are likely to prioritise.

It is also not unusual for investors and intermediaries to be at odds on the pricing comps that will be taken into account by the deal group when determining initial price thoughts (IPTs).

Nikolaus Romuld, Sydney-based head of bond syndicate at Commonwealth Bank of Australia (CBA), tells KangaNews which comps investors regard as relevant are a fundamental component of the early price discovery process. However, Chrystal says even though Kapstream discloses how it has calculated theoretical fair value, in her experience the information provided is not always taken into account.

In theory, none of this initial work commits an issuer to a bookbuild – though not progressing after a public mandate and deal-specific investor engagement is relatively unusual in Australia. The must-have for deal groups from the feedback process is confidence of investor support sufficient to – assuming conducive wider market conditions – proceed to launch.

At around 8.30am on the potential pricing day, issuer and syndicate conduct a go or no-go call. On the demand side, the group is seeking indications of interest (IOIs) somewhere in the region of at least 1.25 times the issuer’s volume aspirations. Taking into consideration prevailing market conditions, launch can proceed. Alastair Watson, head of treasury at AusNet in Melbourne, says the green light call comes from joint expertise. “It would be foolish to go against the lead managers’ advice but I can’t immediately think of a time when the group was unable to reach agreement. We get a reasonable sense of the viability of a transaction during the roadshow.”

The next stage is to release a public IOI announcement to the media and investors. IOIs are generally released with a spread area over swap benchmarks, and market convention has become to tighten pricing somewhat from this level. This is where views start to get particularly pointed.

Price and volume are the ultimate scorecards for deal success and are therefore the critical components of execution to get right. Arrangers agree that a good starting point can make the difference between a deal that builds momentum and leaves all parties with a positive experience, and one that struggles to hit targets. But hitting the right first note is not straightforward or trouble-free.

Assuming a well-supported marketing and feedback process has taken place, the spread used to test market appetite at the IOI stage typically factors in what the lead manager group believes to be an appropriate new-issue concession.

Intermediaries say it is generally challenging to define this concession in Australia because many corporate issuers do not have existing curves with multiple pricing points, while secondary marks are often not based on significant trading volume and are thus only somewhat reliable as a guide.

Brad Scott, managing director and head of DCM at Bank of China in Sydney, suggests that the market in the first half of 2023 generally factored in around a 10 basis point new-issue concession – a relatively benign level for corporate issuers. But he adds: “With fewer bonds on curves, particularly at the longer end – due to slower pace of issuance of late – the theoretical fair-value calculation is more subjective. Dealers don’t try to overengineer the price-discovery process, as determining fair value is more art than science and this is where granular investor feedback is welcomed – but rarely seen.”

In a market where many corporate names are not frequent bond issuers, leads are often dealing with treasury teams that have changed since an issuer’s last transaction or have never addressed the debt capital market at all. In this context, bankers tell KangaNews some corporates push back on the idea of offering a new-issue concession at all, despite leads’ explanations that the nominal price of a small parcel of bonds in the secondary market cannot be taken as the clearing level of a substantial new issue.

Investors, by contrast, generally insist on – or at least expect – a concession in Australian dollar deals. Several point to Stockland’s A$250 million seven-year deal priced in April as one that focused on price with little issuer appetite to give up a new-issue premium. These investors argue that the result was limited demand: the book closed “in excess of A$300 million”, as reported by KangaNews, which was less than the borrower had anticipated.

Australian investors generally suggest the pay-off for deals that open with a concession on offer is the potential to tighten during the marketing process. David Hanna, Sydney-based division director and senior portfolio manager at Macquarie Asset Management, says: “A bookbuild should take its course. Orders should naturally influence pricing while at the same time participants must be afforded equal opportunities to show their cards. In this way, appetite and pricing are fairly determined.”

Local investors are exasperated at the apparent unwillingness of some Australian corporates to recognise what they say is a constructive approach to an auction. Phil Strano, senior portfolio manager at Yarra Capital Management in Melbourne, compares Australia to the European and US markets. “Typically, no deal is launched in Europe or the US without an initial concession in some form – it is not at all unusual to see 20-30 basis points in the US,” he says. “In Australia, some issuers just aren’t prepared to build a book at more attractive levels for investors and tighten pricing if it is warranted due to excess demand.”

Hanna adds: “Everyone knows the new-issue concession will likely erode during the bookbuild process, and with very robust demand it may even diminish entirely. But its inclusion allows the broadest range of investors to consider the transaction and for demand to build. Some will inevitably fall away if the price tightens, but making sure it is an organic process provides confidence that the final price is fair.”

This should not mean deals opening with an excessively wide indicative margin range. The Ramsay Healthcare five-year domestic deal that was mandated in May but did not proceed to launch is cited as an example by some. One investor says the deal was sounded in the range of 225-350 basis points over swap, adding that “this is too big a range to provide us with any confidence at all around where pricing might have landed”.

Successful issuers are prepared to give firm guidance while accepting that a range of outcomes is possible. “There are times, in challenged markets, when the IPTs become the final pricing – perhaps because of an overnight event,” Watson says. “In these situations, we will take feedback and – where it fits within the parameters we have previously set – we will do the deal. We never go out with a price at which we are not prepared to print.”

Some leads agree the approach followed in the US and Europe, where the range offered builds in plenty of room for the final spread to move, makes sense. “Better guidance would help us land on appropriate spreads,” says Desmond Fennell, managing director and head of capital markets and syndicate at CBA in Sydney. “We need flexibility in the bookbuild process to include all the moving parts. We also need all parties to walk away believing pricing was fair. I say ‘fair’ rather than ‘happy’, because if one side walks away too happy it suggests the other did not.”

While Scott agrees it is important to land on a price that strikes the right balance of value for the issuer while encouraging investors to engage, he also says it is not as straightforward a fix as simply marketing new-issue guidance 20 basis points wide of the ‘real’ pricing level.

He explains: “In the US or Europe, IPT typically adjusts by at least 25 basis points from launch, but then again bond investors expect it to. The Australian dollar market isn’t Europe, however, and adopting such a scattergun approach to de-risk execution would only muddy the waters, while raising the ire of investors.”

The other reality deal groups have to manage is volume. While issuers may be able to print some sort of deal at a very aggressive price point, they are much less likely to get the volume they were seeking, while at the same time all-but ensuring poor secondary performance for those that did buy. With scale of demand a touchy subject in the Australian market, some investors say it can be even more difficult to get indications of volume early in the bookbuild process.

While some issuers are open to volume discussions during the IOI process, intermediaries argue that it is not unreasonable to expect investors to draw their own conclusions to some extent. “Issuers’ previous deal sizes and upcoming redemptions can be indicative.” Romuld says. “We pass on investor questions to the issuer during the deal process, but issuers generally point to historic transaction sizes.”

The outcome investors are seeking is deals that price within an accurately communicated target range and print volume that is in line with what they have been led to believe the issuer’s aspirations are. “If a transaction is much larger than expectations it may imply the issuer has taken everything off the table, leaving no price tension and potentially no demand in secondary,” Chrystal comments.

Securing target volume while managing price expectations tends to be a function of the bookbuild process developing robust momentum. Scott says the “ideal scenario” for an issuer is to be able to provide an update to the market shortly after launch that the book is strongly subscribed, reflecting interest from the previous day’s IOI process.

Offshore accounts often play an important role at the start of bookbuilds. Market sources say Asian investors often bid more speedily than domestic accounts and are therefore often instrumental in building early momentum. More than one intermediary has suggested that many domestic accounts wait to take their lead from the international bid, even for local credits with which they should be the most familiar.

Even some buy-side sources agree that not all local accounts engage in the spirit of the process. Chrystal expresses frustration at investors that make known they will participate at the reoffer level – whatever it turns out to be. “This doesn’t contribute at all to the process of fair-value discovery,” she adds.

Meanwhile, late participation contributes to delays in proceeding with the allocations process – leading transactions to price very late in the business day. This is a particular bugbear for some investors but lead managers say they have very little control over it.

While early support building momentum is clearly essential, the quality of accounts is just as important to the robustness of the outcome. Investors also pay close attention to the makeup of deal books.

For instance, Hanna recognises that bank balance sheets’ largely buy-and-hold behaviour can lead to negative outcomes post-pricing. “They may bid in volume in primary but are not likely to be as active in secondary, and hence price tension at the issue price disappears,” he says.

The volume of lead manager involvement in transactions is also the subject of increasing scrutiny in the market. Intermediary participation has long been a reality in the Australian securitisation sector – market users say it was often critical to deal success in the challenging conditions of 2022. Signs are that this bid has begun to leak into the corporate sector, too.

Trading desks are effectively competing with real-money and balance sheet investor bids. But issuers often have a motivation to agree to allocations to trading desks, on the basis that they believe these increase secondary market liquidity in their bonds.

The Australian Securities and Investments Commission (ASIC)’s Allocations in Debt Capital Market Transactions report, published in 2020, points out that, while these bids can help meet issuer objectives, they can also give rise to conflicts of interest. It stipulates that lead manager interest allocations should be appropriately scaled or avoided where possible.

Meanwhile, Australian Financial Market Association (AFMA) guidelines on disclosure of lead manager orders acknowledge that “investors often express an interest in knowing the proportion of debt securities bid for by trading desks associated with lead managers, as this can form part of the decision-making process around their potential participation in a transaction”.

The guidelines say book updates in the Australian dollar market should either specify the amount bid for by trading desks in aggregate across the syndicate or exclude such amounts from coverage levels.

Real-money investors say they are told that banks’ self-interest in deals is at arms’ length. However, they also point to occasions on which this bid has not had an expected influence on price.

Anthony Kirkham, Melbourne-based head of investment management and Australian operations at Western Asset Management, comments: “We have seen trades in which the book grows but the indicative margin remains unchanged until the final update, when it moves inside the original range. It subsequently emerges that the firm orderbook contained a disproportionate volume of lead manager interest.”

Kirkham concludes that leads “are providing information but at times it feels one-sided and conflicting with where demand is really at”.

Investors agree that trading books play an important role in ensuring secondary market support. This leads them to look closely at banks’ history of playing an active role in trading deals they have led.

Chrystal explains: “Where a lead manager does not have a track record of supporting transactions in secondary, we look for minimum cover on the book, excluding lead manager interest, or we reduce our order. If transaction volume isn’t well covered, all it takes is one investor to flip and – if there is not lead manager support – the bonds will immediately and inevitably widen in secondary.”

Given all these inputs, it should come as no surprise that allocations themselves are another contentious component of the deal process. Investors insist their complaints are not a case of sour grapes; in fact, they insist their views hold even when they are the beneficiaries of favourable allocations. It is lack of transparency and clear justification in the process that leads the buy side to question the approach to and motivation behind the allocation process.

“The allocation process is usually very unclear,” Kirkham tells KangaNews. “It should be relatively straightforward to understand why our allocation is scaled. As it happens, we usually end up on the more favourable side – but what concerns me is the perceived level of unfairness that happens in the absence of appropriate feedback.”

ASIC has provided guidance on allocations and the regulator expects licensees to have appropriate policies and procedures in place. Noting that issuer objectives and decisions of issuers are primary concerns, AFMA also outlines factors to consider during the allocation process.

Issuers can leave decisions on allocations to their lead managers, take sole responsibility for them or agree them in collaboration with the lead group. Market users say the latter approach is the most commonly used in Australia. Issuers and leads say their main goal is to be fair. For instance, Watson says AusNet ensures investors that submit bids early, that have shown leadership by engaging in the marketing process or have been active supporters of the issuer’s previous deals are considered in the allocation process.

Investors tend to acknowledge the subjective nature of the process but still say it could be more transparent. The main complaint is that there is generally limited or no feedback on allocations, leaving them in the dark as to where they stand on a “straight line” basis: where the proportion of their bid they were awarded landed relative to deal size and oversubscription.

The main problem, investors say, is that they do not believe issuers and leads are following through with their promises when it comes to allocation time. “We agree that there is a strong argument for investors that have shown leadership to be appropriately rewarded but we don’t see this process being generally followed or any official messaging around it,” Kirkham insists. “Even when we have shown leadership, we haven’t always ended up in a better position.”

While it is not hard to find market participants who believe the Australian corporate deal process is working more or less fine, most agree that there is a lot to fix before the Australian market is a consistently conducive environment for corporate issuance. The primary demand is for greater transparency.

Even the most disgruntled investors do not disagree with lead managers when they point out that more information is disclosed during the deal process now than ever before. It is the detail and effective intermediation that they allege is lacking.

Kirkham says: “We look forward to receiving regular intrabook updates. However, the information often doesn’t provide the clarity we are looking for. For example, a bookbuild can be in progress and suddenly the volume jumps – but this isn’t reflected in a pricing revision until the last moment. Yes, regular information comes out – but it is still not complete.”

Growing issuer familiarity and comfort in the debt capital market should help. Fennell says: “We tend to get a better outcome when a treasurer has the freedom to make decisions based within broad parameters the board has set, and where the chief financial officer or treasurer is available to us throughout the deal process.”

However, Kirkham also questions whether investor feedback always reaches issuers. “There are two parties needed for every transaction and the leads need the investors just as much as they need the deal flow,’ he says. “However, at times it feels like the banks know that with limited supply investors will have no choice but to get involved.”