Stay tuned

The 14th annual Debt Market Update (DMU), published by Commonwealth Bank of Australia (CommBank) in March, homes in on the potential for political turbulence to feed into capital markets as 2017 progresses. Borrowing conditions are positive at the start of the year, but CommBank is counselling its clients not to let their vigilance drop – and to have a plan in place.

Laurence Davison Managing Editor KANGANEWS

KangaNews spoke to key members of CommBank’s debt-markets team and had access to an advance copy of the DMU to gain an insight into the bank’s conclusions and recommendations. In addition, two CommBank clients shared their views on transactions conducted in 2016 to illustrate how a strategic approach to funding has paid off in diverse capital markets.

The 2017 DMU’s theme – “Stay Tuned” – highlights the core piece of advice CommBank is giving clients based on its analysis of market conditions now and through the year. Borrowers should keep in touch with their key funding sources, especially their relationship banks, to be aware of how the risk factors will affect the availability and price of liquidity. Coupled with a long-term, strategic funding plan this should give borrowers the best possible position to ride out periods of volatility.

Political risk

The biggest talking point from 2016 was the rise of political shocks in the west. The UK’s decision to leave the EU and the election of Donald Trump as US president both surprised pollsters, odds-makers and financial markets, and are the leading examples of a perceived rise in populist, antiglobalisation sentiment in the developed world.

Further tests for the political and economic status quo loom in the new year. France and Germany both have general elections this year in which populist right-wing parties are expected to perform strongly. The future of the EU may depend on the outcomes of these polls and on whether the next phase of Greece’s sovereign-debt convulsions once again threatens the solidity of the union.

Any of these events could have a serious negative impact on conditions in capital markets, as could the machinations of the Trump presidency. Within a fortnight of his inauguration, Trump had shown signs of following through on campaign rhetoric around protectionism. The impact of an “America first” trade policy, especially the potential for it to lead to a trade war with China, is high on the list of watch factors for market participants in the Asia-Pacific region. However, in mid-February 2017 it is impossible to say with any degree of conviction how these risk factors will play out.

“Clearly, 2017 is going to be a really interesting year,” says Simon Ling, CommBank’s Sydney-based managing director and global head of debt markets. “We are all looking out for signs of what impact the global political environment will have on markets in the longer term – including in Australia.”

However, the DMU highlights the fact that – so far – markets have responded positively to the economic promises made by the new US leadership and seem prepared to wait for events around Brexit and European politics to unfold. The report suggests the focus for global markets has shifted away from worries about the health of financial institutions towards government strategies relating to infrastructure investment and growth. How these strategies are executed will have a major impact on whether markets remain in a positive frame of mind throughout 2017.

“As the year develops, it isn’t unreasonable to expect increased volatility. But if this comes to pass it will in all likelihood be accompanied by further flow of capital into perceived safe havens.”

Conducive start

The start of the new year is offering at least a window of calm and positivity. Ling tells KangaNews: “Actually my sense is that in the medium term – meaning over the next few months – we are most likely to experience a continuation of the themes from 2016 when it comes to pricing and liquidity. The market tone seems to be broadly optimistic, at least in the sense that there doesn’t appear to be widespread expectation of impending disaster.”

Issuers with the flexibility to come to market early in the new year have been rewarded – as two deals on which CommBank was a joint lead manager attest. Bank of Queensland doubled the size of a new residential mortgage-backed securities (RMBS) transaction it priced on 9 February, to A$1 billion (US$767.5 million), with pricing well inside initial indications.

“The strength of demand for this transaction and the consequent volume and price outcome contrasts sharply with the slow start experienced in 2016,” says CommBank’s Sydney-based global head of debt markets securitisation, Rob Verlander.

In the corporate market, AusNet Services Holdings got issuance up and running with a bang when it priced A$425 million of new 10-year bonds on 7 February. The deal is Australia’s largest 10-year true-corporate deal since the financial crisis and, market participants say, hints at the potential for Australia to start offering a consistent 10-year issuance option for corporates. The proportion of Australian dollar corporate issuance with long duration continued to pick up in 2016 (see chart), and further development of the long end is an important goal for credit-market participants.

In fact, Rob Kenna, global head of debt capital markets origination at CommBank in Sydney, believes capital markets may to some extent have adapted not only to the increased prevalence of volatility events but also to the weakening of structural shock absorbers such as bank trading books that historically helped mitigate some of their consequences.

“One thing that has changed for the better in recent years is markets have become better at digesting news events quickly, which means the impact tends to be ironed out rapidly,” Kenna suggests. “Looking back to 2016, markets responded to the enormous surprise of Brexit exceptionally well. We saw, for instance, a UK bank issuing in the US the week after the referendum. A few years previously, we might have expected Brexit to sideline capital markets for an extended period.”

How Australia will fare following geopolitical events remains unknown, though. The country’s strong banking system, defensive corporate landscape and traditionally stable politics could make it a favoured investment destination, but its economic ties to China could make it vulnerable to the consequences of trade wars.

The most important message of the DMU is for borrowers to keep abreast of events on the horizon, to be aware of market conditions and to maintain contact with relationship banks. “We think it’s important for our clients to have a strategic approach to their funding tasks rather than being purely opportunistic,” Ling adds. “There was ample liquidity available in 2016 whereas it’s very hard to pick where we are going to be in 6-9 months’ time. This makes it vital to have a strategic, long-term funding plan.”

Ling says: “As the year develops I think it isn’t unreasonable to expect increased volatility, including some or even all markets closing down periodically. But if this comes to pass it will likely be accompanied by further flow of capital into perceived safe havens. I think Australia could be a recipient of some of these flows given the relative stability of our market and our region.”

Core funding

In this context, there is a good chance the loan market will be as important as ever to corporate borrowers. For Australian corporates, loans have historically been the go-to option. CommBank does not expect this to change, and in the context of a potentially choppy environment later in 2017 the bank suggests its clients stay close to their lenders.

“The loan market has always been resilient and played a backstop role in situations where there is a lot of volatility or uncertainty, so our emphasis is on the importance of maintaining relationships with lenders that will be there when they are most needed,” says Loretta Venten, executive director and global head of loan markets and syndications at CommBank in Melbourne.

A number of factors, some contradictory, drove loan-market activity in 2016. CommBank’s DMU says conditions were generally favourable, with liquidity plentiful even though spreads widened in the first half before stabilising later in the year.

“Markets have become better at digesting news events quickly. Looking back to 2016, markets responded to the enormous surprise of Brexit exceptionally well.”

ROB KENNA COMMONWEALTH BANK OF AUSTRALIA

Case study – Thinktank targets incremental investor engagement

Thinktank Commercial Property Finance (Thinktank) has taken precisely the strategic, long-term approach to funding its growth recommended by Commonwealth Bank of Australia (CommBank). It priced its second securitisation in 2016, more than doubling the size of the first.

Thinktank Commercial Property Finance (Thinktank) has taken precisely the strategic, long-term approach to funding its growth recommended by Commonwealth Bank of Australia (CommBank). It priced its second securitisation in 2016, more than doubling the size of the first.

Thinktank’s debut commercial mortgage-backed securities (CMBS) deal, Think Tank Series 2014-1 Trust, came to market in June 2014 for A$113.6 million (US$87.2 million). Think Tank Series 2016-1 Trust followed in October 2016, printing A$280 million. CommBank was instrumental in both deals, arranging the second.

The issuer was not idle between times. Jonathan Street, Thinktank’s Sydney-based chief executive, tells KangaNews: “Investor relations has been an important factor for some time, and in fact we started working with CommBank on a follow-up quite soon after our debut. We have been on quite an aggressive growth path and we were aware that this meant we would need to term out warehouse facilities and recycle capital relatively soon.”

JONATHAN STREET

We want to build a track record of deal performance before trying to increase transaction size significantly from what we achieved last year. We are aware that we still have more to prove to the investor market.

JONATHAN STREET THINKTANK COMMERCIAL PROPERTY FINANCE

However, a relatively small refinancing pipeline and political-risk-driven corporate growth conservatism suppressed volume (see chart).

While the loan market will continue to be a core funding option, CommBank is also advising clients to maintain or enhance their engagement with capital markets. Another theme of the DMU is the impact of regulatory and capital costs on banks’ abilities to lend at cost-effective levels from their own balance sheets.

“We are here to support our major clients from our balance sheet but, from a return perspective, this alone is unlikely to support our business in the new regulatory environment,” Ling explains. “This has already happened to banks internationally, but in Australia we are now looking to deepen our relationships with our clients by providing them with additional support across a wider product range.”

For Kenna, the dynamic is not about banks trying to reduce their exposures to clients. Rather, the goal is managing funding relationships holistically to ensure all sources of liquidity, including the bank’s balance sheet, are available especially in times of stress. “Nothing has changed when it comes to our willingness to provide support to clients,” Kenna insists. “There is intensified discipline and increased focus on deepening client relationships to ensure we continue to be able to provide liquidity when and where it is needed.”

Venten agrees the regulatory environment may not hinder the availability of liquidity in the loan market, though it could alter pricing dynamics. Increased capital costs and the need to ensure appropriate risk returns from balance-sheet lending have only heightened banks’ desires to explore options to manage their lending portfolios.

Venten adds: “We expect banks globally will further engage with evaluating lending risk returns and exposure-management tools to manage their capital positions. Examples of this include secondary trading of loan exposures or the use of credit insurance, especially in loans that are not providing sufficient balance-sheet returns relative to their capital position and overall relationship income.”

“One of the key questions is what global geopolitical uncertainty will mean for companies looking at international M&A opportunities. There is the potential to adopt a ‘wait-and-see’ approach as to how event risk plays out before committing.”

Domestic capital markets

The securitisation market is an example of a funding option that CommBank anticipates will be used not only by frequent issuers. “We expect securitisations increasingly to be issued by newer participants, including some using it as a primary source of funding for M&A transactions. Securitisation has demonstrated its capacity to solve for the funding of large, complex asset portfolios,” says Verlander.

While there has been an overall drop in volume, from $A28.5 billion in 2015 to A$23.9 billion in 2016, this can largely be accounted for by a smaller prime RMBS sector, especially issuance from the largest banks. These issuers tend to have multiple funding options available and in 2016 the senior-unsecured route in particular tended to be more cost effective. By contrast, CommBank’s DMU highlights growth in nonconforming RMBS in 2016 and growing issuer diversity in the securitisation market as a whole as signs of the relevance and robustness of structured finance to a greater range of Australian issuers.

The fact that these transactions tend to be smaller than major bank RMBS means they are yet to account for the tailing off of major-bank RMBS volume. But to borrowers like Thinktank Commercial Property Finance access to public securitisation markets represents just the kind of strategic funding approach CommBank is recommending (see box).

Australian domestic corporate bond issuance also had a slower year in 2016. The local credit market has become increasingly dominated by bank deals, which accounted for more than half of all volume in 2015 and nearly two-thirds of the total in 2016 (see chart).

Like the loan market, domestic corporate supply in 2016 was suppressed by conservatism due to the geopolitical environment and limited refinancing requirements, the DMU suggests. The role of the loan market as a backstop also played a part, as bank pricing was less susceptible to volatility than the domestic bond option. This is not necessarily a bad thing, Kenna claims. “The fact that Australia has a very robust banking system at times acted against the development of the local corporate bond market in one sense. But it has contributed to the resilience of our market as banks are able to raise liquidity relatively easily and transfer it on to corporate borrowers.”

Australian corporates tend to have both relatively smaller funding requirements and not be overexposed to the bank sector, Kenna continues. But he is also quick to reject any claim that the domestic bond option is less valid for local corporates. “We see domestic and global corporates getting really good outcomes in the Australian market. The market is often criticised for the variability of outcomes, but I think this is just a function of it being less mature. There are funds looking to be put to work and there will continue to be opportunities for issuers.”

Case study – Monash finds funding to match corporate strategy

Sustainability is a key focus for Monash University (Monash), in both its academic and growth strategies. The ability to print its second-ever US private placement (USPP) deal as a climate bond – a world first for a university – was therefore a major success story for Monash.

Monash returned to the USPP market in December 2016, having debuted with a US$150 million, 25-year transaction just over two years previously. Its latest deal was for A$218 million (US$167.3 million) equivalent spread across four tranches, three maturity points and two currencies (see table).

Monash University December 2016 USPP deal structure
Tenor (years)CurrencyVolume ($m)Coupon (landed cost; per cent)
15 AUD 30 4.74
15 USD 37 3.64
17.5 USD 50 3.80
20 AUD 70 4.90

SOURCE: COMMONWEALTH BANK OF AUSTRALIA FEBRUARY 2017

DAVID PITT

We thought it was worth accelerating the deal process to completion in 2016 given the complexities of the political situation in the US. It’s amazing how quickly you can get to market when you believe it to be necessary.

DAVID PITT MONASH UNIVERSITY
Offshore options

The DMU also suggests the softer corporate issuance year should not be viewed in isolation. International funding markets also saw either or both of down years overall or reduced issuance from Australian borrowers. For instance, in the offshore market that is most relevant to the largest group of Australian corporates – US private placements (USPPs) – issuance was down 10 per cent in 2016 after several years of uninterrupted growth (see chart).

Australasian-origin issuance in USPP format was also down – at US$5.9 billion, the figure for 2016 was similar to the domestic market total. But the DMU suggests that Australasian credits “remained highly sought after” by USPP investors in 2016, which supported growth in average Australasian deal size to US$350 million from US$289 million in 2015.

USPP clearly continues to be a valued option for a range of Australasian corporates. One of these, Monash University, took advantage of the growth of increased interest in sustainable investment principles to price the first university-sector green bond in USPP format in December last year (see box).

Neither was Australasian-origin issuance a major feature of global benchmark markets in 2016. Limited funding requirements saw muted supply of both US and euro benchmarks from Australasia. The European market was also affected by the latest stimulus measures put in place by the European Central Bank.

One offshore funding option that gets special attention in the DMU is the emerging story of Reg S issuance denominated in US dollars to a predominantly Asian investor base. There were eight such deals for aggregate volume of US$4.7 billion from Australian issuers in 2016, according to CommBank data. All of these transactions came to market with 10-year tenor and were issued by corporate names.

“We have seen some early signs of success in the US dollar Reg S market as an alternative funding source for corporate clients in particular,” Kenna comments. “This could become even more appealing to Asian investors as we enter a rising US rate environment – we would certainly expect more funds to flow into US dollar fixed-income investments if rising rates eventuate.”

Kenna explains that Reg S appeals to issuers because it offers access to US dollars without the costly and time-consuming documentation required by US domestic markets. Issuers also do not have to print the benchmark volume preferred by the US 144A and public euro markets.

Supply prospects

Even so, taken together CommBank believes the factors identified in the DMU support an uptick in issuance in 2017, though likely not a spectacular one. In particular, refinancing requirements are likely to pick up ahead of a substantial maturity year in 2018 while the early-year signs are that issuers want to take advantage of the continuation of conducive market conditions ahead of possible turbulence ahead.

For instance, the DMU anticipates more securitisation volume in 2017, driven by a solid early-year deal pipeline, regulatory certainty from the final iteration of the new local regulatory guidelines for securitisation and the potential for credit-card-backed deals – likely initially from nonbank issuers, CommBank believes – to supplement supply.

Kenna also expects to see a more vibrant Australian dollar corporate market in 2017, albeit from a low base. “We expect 2017 will provide a better supply dynamic than 2016, supported by the corporate infrastructure sector. But realistically we have to say 2016 was quite an anaemic year, supply-wise.”

“We expect securitisation increasingly to be issued by newer participants, including some using it as a primary source of funding for M&A transactions. Securitisation has demonstrated its capacity to solve for the funding of large, complex asset portfolios.”

Again, how significant global events prove to be, and the nature of their impact on capital markets, will be critical. Venten tells KangaNews: “One of the key questions will be what global uncertainty will mean for companies looking at international M&A opportunities. We think there is a good chance companies will wait to see how event risk plays out before committing, and in fact that there will be a greater defensive focus in general."