FRN and linker opportunities in a rising rate environment

Other than to fund a relatively small borrowing client need for floating-rate debt – centred on South Australian Government Funding Agency (SAFA) – semi-government floating-rate note (FRN) issuance has been minimal in recent years. This seems likely to remain the case – as does limited issuance of sovereign inflation-linked bonds.

DAVISON Has there been any change in demand conditions for SAFA’s FRNs as the market has started to contemplate rate hikes? Meanwhile, what is the latest regarding uptake of SAFA’s AONIA-linked issuance?

KENNEDY Late last year, we extended our FRN curve out to three-and-a-half years in AONIA format. The reception was not quite as strong as we have seen with some of the other issues we have done in the format but there were some challenging market dynamics around that time, including concerns that short-dated asset swaps were pricing very, very tight or negative out to 3-5 years.

Trying to do FRN issuance was a little problematic because – even though markets should view the asset swap level on a fixed-rate bond in the same way they do on an FRN – there is a very different psyche about the way the market interprets the two products.

FRNs, including issuing in AONIA format, remain a key component of our strategy. However, we need to continue to be aware of changing dynamics that will affect the ability to access markets.

DAVISON Do any other issuers have observations on FRNs? Might we see issuance pick up to some extent in a rising rate environment or to satisfy the liquid-asset needs of second-tier banks?

KELLY We are a fixed-rate borrower and our clients are generally funding long-term fixed assets. When we get into a rising rate environment, good portfolio management is to make sure we have adequate duration to protect the portfolio from rising rates.

However, there is always an optimal mix of fixed and floating so there is a role for FRN funding in our business. But it is a relatively small role – it is there largely to provide diversity.

KENNA We are also a natural fixed-rate borrower and that is the format we go to by default. FRNs are not at the top of our list but we will consider them from time to time. It is part of servicing the investor base.

We completed an FRN back in September 2021 and we were pleased with the result. The instrument has a role but it is a small portion of our programme.

CINQUINA Around 30 per cent of our lending portfolio is in floating-rate format and therefore FRNs provide a natural fit to our funding needs. We will continue to look at FRNs as an important component of this floating-rate requirement as long as investor demand remains evident.

DAVISON The Australian Office of Financial Management has consistently described its inflation-linked investor base as a small but devoted group – and this did not appear to change last year despite all the talk about inflation. Are there any more recent developments?

NICHOLL There has been no appreciable change yet, which continues to surprise me – I would have expected to have seen some uplift in linker interest running into the end of last calendar year. We continue to believe the amount of stock we have on issue is pretty much in balance with demand.

We will have to wait and see what lies ahead. We have a lot of issuance flexibility so we can respond to meaningful demand. But the first thing would be to try to find out what lies behind it – asking ourselves if it is something we want to respond to, in other words that we can be confident it will be sustained demand.