Market grapples with wider spreads and new-issue concessions

Wider spreads have coloured the primary issuance market in 2021, as rejuvenated bank supply and volatility influence pricing. Investors and issuers share their challenges navigating the market’s new normal.

O’LEARY Given bank new-issue spreads are close to pre-pandemic norms, is it possible we are experiencing the correction the market had to have given how tight spreads had got in the term-funding facility era?

MEDEIROS There is not much science behind the level of new-issue concessions – it is a combination of many forces, including supply and demand and investor risk appetite.

For example, in the US the range since mid-February to last week was 2-35 basis points. Overnight it was around 14 basis points in the US. In Australia, we had the AusNet Services transaction a week ago on which the new-issue concession was 22 basis points. It would be a bit tighter today as markets have improved since that transaction.

MASON Spreads must go wider with the return of rising rates and the unwind of central bank balance sheets. This was always going to happen and the conflict in Europe has expedited it. We have seen a rally recently, but I do not think spreads will keep rallying over the longer term. They will widen further, but this is just part of normal market operations.

Before this period, spreads were getting pretty tight and there was a lot less compensation for the risk we were taking. This said, I am comfortable with where we are from a corporate fundamental perspective. There are also technical factors driving new-issue premia – for example AusNet has a lot of outstanding debt so there was naturally going to be a larger new-issue premium. Other infrastructure names would also fall into this category.

VAN KLAVEREN QE compresses credit spread liquidity and volatility premium. As central banks unwind or stop QE and bring in QT, this naturally has to come back to the marketplace.
I look at the US as a barometer of value and I believe 120-130 basis points is where credit index spreads should be in a normal market. The Ukraine-Russia conflict pushed the US to 146 basis points and Europe to 160 basis points. Spreads are now rallying.
With tightening fiscal conditions and weaker growth, spreads should naturally be wider than these levels. Our market was late to widen and has not had the same rally as other markets. Being more defensive, our market probably looks cheap from a global perspective.

SWISS Could this not also be because there has not been a lot of corporate issuance in the Australian market?

VAN KLAVEREN Our market is self-regulating. In the US, issuers keep printing deals whereas our market locks up when pricing gets expensive. Investors also tend to sit on their hands, so we do not see secondary or primary trading come through. Also, because we do not have TRACE [Trade Reporting and Compliance Engine] data like in the US, a lot of the marks are stale. There may be trading but we do not know where the marks are.

This makes it more challenging for our marks. But in a broad context we are a little wider than where we should be. Tier-two and 10-year triple-B issuance is back to levels that were there prior to and just post COVID-19.

After COVID-19, 10-year triple-Bs and tier-two were pricing at 180-225 basis points and they have got back to these levels. There is a fair bit built in and central banks have yet to start tightening. Spreads have widened ahead of where we would naturally think they should be based on the macro and credit cycles.

BAYLEY The difficulty with the secondary market in Australia is whether the levels we see are real. This concerns investors because, as Tim van Klaveren has said, we tend to lag on the widening and tightening.

We question whether the marks we see are real and can be trusted. This makes it hard to tell what the clearing level should be for new issues. In the US, there is more primary issuance as well as a more defined and accurate pricing picture.

Here we have to price somewhat in the dark on the secondary curve, then we have to figure out where the primary comes in on top of this. This is a concern we have had with some of the new issues that have priced this year.

MASON Talking to brokers a few weeks back, when liquidity dried up for a few days, they were saying their traders were just marking names 10 basis points wider to avoid the risk they would be caught out. We cannot trust these marks when they are a guess mixed with fear.

We question whether the marks we see are real and can be trusted. This makes it hard to tell what the clearing level should be for new issues. In the US, there is more primary issuance as well as a more defined and accurate pricing picture.


EGGLETON Late last year, after the withdrawal of the committed liquidity facility (CLF) was announced, there was a lot of uncertainty about where banks spreads would land. This persisted for four months until Commonwealth Bank of Australia reopened the market at the beginning of this year. Why did it take so long for investors to provide certainty on demand to issuers when there was a good degree of clarity on where offshore spreads were throughout this time?

VAN KLAVEREN We knew spreads were tight, and that issuance would come from the banks and spreads would push wider. We did not want to add credit risk at those tight levels. Also, the risk is always that offshore will go harder, so when a deal prints here, and we buy it, the next thing we know it is based on offshore curves and we are 30-40 points out of the market.

BLACKSTOCK I like Tim van Klaveren’s comment that the Australian market is self-regulating. There are times when a lack of certainty and transparency stays our hand. When we can’t see where the marks are we tend to wait until we see secondary flow come back, which gives us the confidence that marks are real and we can identify fair value. If we can see those flows going through, so can investors.

The amplitude of moves in the Australian market has been a lot less than we have seen in other markets. This is a good thing as it means there is more stability here. This is a core market for us but we want to issue when we start to see flow so we are not pricing into a vacuum. This is really where we were at the end of 2021, post the CLF, when there was a complete lack of visibility.

MEDEIROS Spreads are relatively wider in Australia and yields are rising. However, overall funding costs are still modestly higher than during the 2015-17 period, for instance, and materially lower compared with levels before then.

If we use five-year yield as a proxy for the base rate, all-in costs are currently around 4 per cent. This is much higher than where they were a year ago – at around 1.8 per cent – but lower than the circa 7 per cent observed following the financial crisis, when yields were materially higher than currently.

From a corporate issuer point of view, funding costs may not necessarily be high if one considers that central banks are normalising policy and, more importantly, inflation remains at a high level and rising. We do not know yet what the terminal rate will be.

The amplitude of moves in the Australian market has been a lot less than we have seen in other markets. This is a core market for us but we want to issue when we start to see flow so we are not pricing into a vacuum.


SWISS How do issuers navigate finding the right pricing level in the primary market?

LARKIN It can be hard to find reliable secondary prices, especially as the Australian market does not see the programmatic corporate bond issuance the US does. It is not so much that issuers decide they are going to sit on the sidelines. It is just that when we do not have programmatic needs and markets are uncertain, we have the flexibility to wait.

It is amazing how this market has developed over the years, but I still think it is a bit unfair to compare it to the US. There will always be periods where volumes will either slow down or dry up. To me, this is normal.From an issuer’s perspective, if we are funding something for a specific purpose, we will issue. If we have flexibility, we might decide to wait. If so, what is the cost of waiting?

What I find interesting is the discussion about bank pricing uncertainty – because I see that kind of issuance as programmatic, and therefore it should be clearer.

We have talked about trying to work out new-issuance concessions, or what secondary spreads are, and whether the marks are real for a corporate issuer like Lendlease. This is where the decision of whether or not to issue can be challenging.

FENNELL Diversification of markets is important for issuers and, as we have heard today, programmatic issuers have a lot of options at their disposal. Corporate issuers can also benefit from having access to the bank lending market, which is typically slower to react to market moves.

If we work on the basis that markets have a tendency to overshoot, and if we look at it from the perspective of the Australian housing market and interest rate sensitivity, there is an argument that interest rates will peak well inside current market expectations.

As a result, the timeframe before spreads and rates start to come back in again is actually rather short. It is worthwhilefor issuers potentially to consider a short-term, 18-month bridge offered by the loan market, especially when we have yet to observe any material drop in demand among market participants.

LARKIN We quite deliberately try to maintain access to a range of markets. It is never a good position for a treasurer to have to tell management, ‘sorry, we can’t do this deal or activate this project because we can’t fund it’. We need to be able to fund the business, so we need to maintain flexibility. We are always keen to look at opportunities to get additional tenor and improve diversification, especially in our funds platform, because we create and invest in assets that have long economic lives.

VAN DER GEEST One of the reasons Melbourne Airport was keen to go to market for 10-year money last year was to get ahead of the refinancing task. If we face volatile markets, we can either access global markets or shorter-dated bonds or loans. With the current volatility, and the move in both base rates and margins, we will consider each of these options.

We are also trying to play an active role in private placements and we are establishing good relationships with investors who have longer-dated interest. Flexibility in current markets is a critical factor. The long-term investor engagement work we have been doing will stand us in good stead over the next 12-18 months.

We have gone through periods of widening spreads before. We are an infrastructure asset and we look for duration and flexibility so when we are in volatile periods we are able to adjust our funding duration.