The long road back

The most obvious sign of renewed willingness to engage with risk assets is the brace of tier-two deals priced by National Australia Bank (NAB) and ANZ Banking Group. With total volume of A$3 billion (US$2.1 billion), these transactions almost doubled – in the space of a week – the total supply of triple-B profile issuance into the Australian dollar market since the emergence of elevated turbulence in late February.

In the nonbank financial space, securitisation deal outcomes have started to hint at a more positive tone as well. Securitisation volume has been, if anything, surprisingly high throughout 2022. But this speaks more to the larger number of nonbank lenders active in Australia and their greater aggregate funding needs. Actual deal outcomes have been peppered with size reduction, price widening and protracted execution processes – until recently.

La Trobe Financial’s residential mortgage-backed securities print in late July felt substantively different, featuring as it did an upsize, final pricing at the tight end of the marketing range and a significant offshore bid. In a market that has found price discovery and investor diversity hard to come by in 2022, this looks like forward progress.

There has also been a notable change in sentiment in the secondary market. After a protracted period of minimal transaction volume and, if anything, even less risk appetite, traders have started to report a constructive market tone and signs of emerging two-way flow. Dealers have marked in credit books, seemingly for the first time in months, and new issuance has tended to perform well in secondary trading – with fixed-rate notes the clear outperformer.

However, it is worth noting the caveats to viewing the return of tier-two issuance as a sign that risk appetite is back in play. For one thing, NAB and ANZ clearly had to ‘meet the market’ on pricing: in paying 270-280 basis points over swap for their tier-two deals, the banks registered nearly 100 basis points of widening since the last such transaction, by Commonwealth Bank of Australia (CBA) less than four months earlier.

This is hardly unique to the Australian market. Westpac Banking Corporation accepted an even wider all-in cost of funds on US dollar tier-two issuance in the same execution window that NAB and ANZ used for their domestic deals, for instance. But there is clearly a long way to go before market pricing reaches levels that make issuers approach financing with a spring in their step and a song in their heart.

The newly constructive credit tone also largely applies to financial sector issuers and deals. True corporate issuance has been dismal in Australia throughout this year and intermediaries say the pipeline is still thin even moving into H2 reporting season. All in all, there is every chance that 2022 will end up as a deeply disappointing year for the local corporate market, with total volume more likely to challenge the worst post-financial-crisis years than the best ones (see chart).

Source: KangaNews 25 August 2022

Again, there is nuance beyond a straightforward read of market sentiment in the story of low corporate issuance. For one thing, it is not as if corporate Australia has been pouring trades into international bond markets – which suggests, at least, that there is not an idiosyncratic problem for domestic liquidity or pricing conditions.

Euro flow has been almost nonexistent, 144A issuance has with one or two exceptions come from natural US dollar funders such as resources companies, and even the US private placement (USPP) market has only persuaded a handful of Australian issuers to print in 2022.

Instead, when corporate borrowers have had debt funding needs this year they have overwhelmingly headed to the loan market – in which margins, bankers say, are yet to reprice in line with more expensive capital markets. It is hardly surprising that corporate treasurers have gravitated to a market that offers both sound liquidity and the optimal pricing outcome.

Meanwhile, investors’ journey back out in tenor is still in its first steps. Even the emergence of demand for five-year bank senior paper – as seen in CBA’s recordbreaking August deal and another large transaction by HSBC Sydney Branch – marks progress for a market that had previously only developed any real comfort in the short end. Again, the tier-two deals are significant: at 10-year non-call five-year tenor, they represent real demand for higher-yielding mid-curve paper.

But five years is not especially exciting for most true corporate borrowers as they can get this tenor fairly easily in the bank market. It was only when the Australian dollar market started offering relatively reliable liquidity at seven and, most significantly, 10 years that it really found its USP for corporate borrowers – filling a useful point in the funding curve between bank and USPP debt.

Assuming the tentative recovery gathers momentum, a key question will come to be how corporate borrowers perceive the Australian market after the woes of 2022. It has been a long road to persuading corporate treasurers that they can rely on domestic bond funding enough to make it a component of their long-term plans, and the fear has to be that these hard-won gains will be washed away by months of uncertain liquidity, unattractive pricing and limited tenor.

There are certainly grounds for the doubters to say ‘I told you so’. It might not be entirely fair to do so, but it would be hard to outright deny a claim that the Australian market has once again proved its proclivity for evaporating in the face of negative sentiment and for only returning slowly, tentatively and with ultra-cautious pricing.

The counterargument would start by noting that the status of domestic liquidity was never really tested. In fact it was corporate issuers rather than credit investors that withdrew from the capital market in 2022. This perspective can happily acknowledge relative pricing. The loan market maintained appealing pricing as the domestic bond market widened, but bond repricing has been a feature of all global jurisdictions.

Even loan market bankers acknowledge that loan and bond pricing differentials will normalise in time. When they do – or even when they get close enough that the value of funding diversity starts to outweigh any lingering margin gap – it will be important for the Australian issuance option to match any price compression seen in global markets, including USPP. Until that point, it cannot realistically be accused of performing any worse than global comparison points.

Another factor will be how quickly demand breadth returns. While not a direct comparison, securitisation issuers have noted how narrow the investor base for their deals has been for much of 2022. Corporate issuers will want to see a wide investor base from the off.

The local real-money market still feels like a relatively vibrant sector, much as it has suffered significant pain from mark-to-market moves this year. There is also positive commentary about the return of offshore demand for Australian dollar credit, particularly from Asia. Investors from Hong Kong, Korea, Singapore and Taiwan have at various times been at least significant complementary supporters of Australian dollar corporate deals. Their bid could provide a useful catalyst to a market rebound.

The most significant factor, though, is likely to be tenor. Even by late August, the market just does not feel ready to welcome significant single-A or triple-B corporate flow in seven or 10 years. University of Melbourne’s seven-year green bond, priced on 12 August, was a positive step but the issuer is rated AA+ and is viewed as a quasi-government credit in at least some investor circles – especially offshore.

All in all, it feels like a long road ahead for a corporate issuance revival even if the financial institution market continues its return to health through the remainder of 2022. Corporate intermediaries privately admit that their attention is already turning more to the possibility of building a pipeline for H1 2023 than the rest of this year, and it is hard to argue with their logic given the limited time left to demonstrate market conduciveness and bring transactions to fruition.