Kangaroos hop out of the blocks in 2022
Supranational, sovereign and agency Kangaroo issuance started the new year at record pace and by late February remained on course for the busiest start to the year for a decade. Market users say a raft of supporting factors has made deal flow possible for a notably wide range of issuers and share a cautiously optimistic outlook for the rest of 2022.
Laurence Davison Head of Content KANGANEWS
To some extent, the positive start to 2022 in the Kangaroo market is unsurprising. Supranational, sovereign and agency (SSA) issuance in Australian dollars picked up notably in H2 2021 after a relatively slow start, to end with a respectable total print of just less than A$20 billion (US$15.6 billion) (see chart).
This represented an encouraging outcome for a market that saw a significant drop-off in supply in 2020. The biggest driver of the renaissance was the Australian major banks’ return to wholesale funding in the second half of the year, restoring the counterweight on the cross-currency basis swap that has historically provided Kangaroo issuers with a cost-of-funds kicker that is often sufficient to make deal economics work.
Daniel Wilson, Sydney-based vice president, DCM Asia Pacific at RBC Capital Markets, adds: “Last year was overall positive for SSA issuance in Australia. The thing that changed the outlook for 2022 was that it became evident by November that the Australian banks were going to become active again, including substantial foreign-currency issuance. Our commentary at the time was that the basis would trend back toward pre-COVID-19 levels.”
Indeed, the only reason issuance did not catch fire in 2021 was timing. “The problem at the time was that most issuers were fully funded for calendar 2021 – so it is no surprise there was little supply despite the emergence of attractive pricing,” Wilson confirms.
Even so, the rapid pace of new issuance at the start of 2022 surprised and impressed market participants. The first working day of the new year in Australia was 4 January – a Tuesday – but A$2.5 billion had priced in three new Kangaroo transactions by the end of a truncated first trading week, including a A$1.5 billion, market-opening print by European Investment Bank.
The first full week of the year saw even more activity: seven SSA issuers priced A$2.8 billion of Kangaroos. The range of active borrowers and the size of their deals might have been even more impressive than the outright volume.
BNG Bank, Kommunalbanken Norway (KBN) and L-Bank each brought A$500 million deals to market in the week of 10-14 January, matching the size of the former’s largest-ever Kangaroo print and surpassing it for the latter two. Kangaroo options remained available for less-frequent issuers: the A$650 million priced by NWB Bank on 24 February more than doubled the issuer’s pervious largest Australian dollar deal volume.
“We had high expectations for the SSA market going into 2022 but the orderbooks and trade outcomes we saw at the start of the year exceeded even those,” says Craig Johnston, director and head of DCM syndicate Australia at Deutsche Bank in Sydney.
This does not appear to be purely the product of a favourable basis swap offering pricing arbitrage for issuers. Australian intermediaries highlight factors that appear to be more structural in nature, or at the very least that stand a chance of lingering well into the medium term.
The first is that the basis did not just temporarily swing into range for SSA issuers. It opened 2022 at a conducive level and stayed there even as counterbalancing Kangaroo flow mounted.
Johnston tells KangaNews: “The basis has been very stable indeed, including holding in well even after fairly significant new-issuance flows in the Australian dollar market. This amount of issuance would historically have meant a relatively significant move in the basis, which was not the case for most of January.”
This stability was particularly helpful for smaller Kangaroo borrowers. Indeed, these issuers may be entitled to develop some confidence about the prospect of larger benchmark deals being available in future, at least periodically (see box).
“A stable basis is critical for a name like L-Bank – including convincing lead managers that we can be successful,” explains Sven Lautenschläger, international funding officer at L-Bank in Karlsruhe. “We can do A$100-200 million trades with a basis that is only temporarily stable but it needs to be extended to get to A$500 million. In the case of our latest deal the basis had been effectively unchanged for two weeks, which made us think ‘what more can we ask for?’”
Johnston adds: “The key advantage of basis stability is that it allows issuers to bring deals to market and build books with greater confidence on pricing and how it comapares with euros or US dollars. It gives issuers flexibility and removes the need to print in a tight window, which allows momentum to develop. L-Bank’s deal, for instance, landed on a price that worked for all sides.”
Critical mass for smaller borrowers
The size of Kangaroo transactions completed by names like BNG Bank, Kommunalbanken Norway and L-Bank at the start of 2022 might point to more reliable access to benchmark-sized issuance for smaller issuers. Careful execution is likely to be key.
These three agency issuers had completed a total of one Kangaroo deal of A$500 million (US$391.2 million) between them by the end of 2021. They added another one apiece in the space of a single week at the start of 2022.
In at least one case the deal could have been even bigger. KBN’s Oslo-based senior vice president, international funding, Evan Morgan, reveals the issuer capped its deal because it was also active in the US dollar market at the same time as its Kangaroo issuance. Instead, the excess volume allowed it to tighten pricing.
Some market participants believe this clutch of deals could be a sign of things to come. “The flow we saw at the start of the year may have started to shift the mindset to thinking A$500 million is the base case for a new Kangaroo line, where it would have been more like A$300 million before,” argues Daniel Wilson, vice president, DCM Asia Pacific at RBC Capital Markets.
Intermediaries believe a significant driver of basis stability is the expectation of ongoing significant offshore issuance by the Australian big-four banks. The domestic market has been supportive of these issuers since the second half of 2021 but it has nonetheless become increasingly clear they will have a large and ongoing offshore funding requirement.
There is also the unresolved question of how the end of the committed liquidity facility (CLF) could change Australian dollar demand dynamics. The banks themselves have played down the likely impact. But some market users continue to suspect the end of the CLF will structurally reduce banks’ demand for each others’ paper. This in turn could reduce domestic market liquidity for these issuers – forcing more of their wholesale funding offshore.
Domestic deals by the big four are not showing much sign of struggling to attract liquidity, however. The majors issued nearly A$11 billion in three domestic transactions in 2022 to late February, including a brace of A$4 billion deals that are close to the largest ever printed in the Australian credit market.
Offshore issuance by Australian banks will likely land somewhere between roughly the same as pre-pandemic and a paradigm shift upward. Meanwhile, an evolution of international investor engagement with Australian dollar issuance has also opened a new relative value window for global SSAs.
Deal sources universally acknowledge that the primary demand driver for early-year Kangaroo deals was offshore investors, with deal distribution figures suggesting 70 per cent placement outside Australia was par for the course. “There is an obvious uptick in focus on Australian dollars from global accounts early in 2022, which has been a driver of the number of Kangaroo transactions and their volume,” Johnston reveals.
Domestic investors were not absent from Kangaroo deals at the start of the year. But intermediaries say they were relatively quiet overall ahead of the Reserve Bank of Australia’s February meeting – a factor that also contributed to the lack of syndicated semi-government issuance at the start of the year. Australian investors are most likely to be spurred into action by sustainability-aligned issuance (see box).
Historically, the primary challenge for the Kangaroo market during periods in which it relies on offshore demand is that these investors were seeking the same relative value as issuers. SSAs are typically most interested in Kangaroo issuance when it offers funding levels inside their US dollar or euro curves – which is exactly the opposite of what global investors typically want.
But a growing cohort of global investors now have standalone allocations to Australian dollars that include Australian Commonwealth government bonds (ACGBs) and local semi-government issuance. Adam Gaydon, head of debt syndicate, Australia at ANZ, explains: “Investors are now willing to look at SSAs on a relative value basis specifically compared with ACGBs and semi-government names. The spread has been attractive of late, especially for some of the smaller SSAs.”
This marks a step-change for SSA issuers in the Kangaroo market. Instead of effectively having to compete with themselves – or at least their issuance in alternative currencies – for global investor attention, borrowers should now find periods of solid global demand for their Australian dollar deals that are not correlated with their pricing elsewhere.
It is not just relative pricing that is attracting global investors to Kangaroo deals. Yuriy Popovych, Singapore-based director, fixed income syndicate at TD Securities, tells KangaNews: “We saw accounts that had not bought SSA Kangaroos at all or had not been active for a long time participating in deals at the start of the year. Yield has clearly been attractive on a relative basis – to ACGB and semi-governments – but also outright. This has been sufficient to cause some funds to rotate back into Australian dollars, which is a very encouraging sign.”
There is no obvious reason to expect any of these supporting factors to be short-lived. While major-bank issuance in global markets may not hit the top end of plausible outcomes neither is it likely to retreat from consistent ongoing flow. Australian government-sector issuers have an elevated aggregate funding need that should keep the market on the radar of global investors and maintain the relative value equation.
These factors may not prefigure a step-change in Kangaroo issuance volume but they do support confidence that the market can reliably print its typical baseline level of A$20 billion or more, thus marking a relatively rapid recovery from the doldrums of 2020. With more than A$8 billion banked by late February a solid outcome for 2022 seems more likely than not.
“Overall, while it seems unlikely that the pace of January issuance will be maintained there is every reason to have a positive outlook for the year ahead,” Wilson says. “We have already seen good supply at three-, five- and 10-year tenor, all of which has performed well in a very busy market. Things can change quickly, of course, but it is certainly encouraging to see multiple points on the curve all working.”
Popovych adds: “We might see some diversification of tenor as we move further into the year – there has been a lot of five-year supply. The curve is quite steep from five to seven years but there are reasons to think seven-year issuance might start to work, while I also expect we will see more 10-year issuance on a reverse-enquiry or private placement basis.”
ESG drives Kangaroo liquidity but pricing benefit still small
Issuers and intermediaries universally point to environmental, social and governance (ESG) alignment as a tailwind for Kangaroo transactions. The pricing benefit of bringing labelled deals is small – incremental demand and investor engagement are the primary benefits.
The number of Kangaroo transactions claiming ESG alignment in their use of proceeds (UOP) was relatively small at the start of 2022 – just six out of the first 27 deals of the year – but they made a significant contribution to volume.
Headlined by European Investment Bank’s A$1.5 billion (US$1.2 billion) Sustainability Awareness Bond priced on 5 January, ESG bonds accounted for more than A$3.5 billion of the year’s first A$8.4 billion of new Kangaroo issuance.
“There is clearly strong underlying demand for ESG product in particular from domestic accounts and, increasingly, from central banks,” says Tim Pinchen, vice president, syndicate at J.P. Morgan in Sydney. “Central-bank investors do not typically have hard ESG mandates but they are certainly taking ESG increasingly into account when making allocations.”
At the margin, ESG-themed issuance in our experience is a great driver for engaging investors and building momentum in the book, and can ultimately lead to greater price tension throughout the process. The challenge is to manage the limited but growing green assets we have across a number of different markets.
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