Guy Debelle: Some recent (and not so recent) trends in Australian debt
markets
Address by Mr Guy Debelle, Assistant Governor (Financial Markets) of the Reserve Bank of
Australia, to the KangaNews DCM Summit 2013, Sydney, 19 March 2013.
* * *
Thanks to Christian Vallence and Tom Williams for their help.
Thank you for inviting me to speak here again. Today, I'm going to talk about the local debt
market. I'll talk about the current state of play as well as a bit of history.
Market Developments
This time last year, debt markets globally weren't in great shape, though the local market
wasn't faring too badly. A year on, global debt markets are in a much better position, with
issuance strong across most parts of the market, spreads considerably lower and the
absolute level of yields very low by historical standards.
The market's assessment of the likelihood of extreme outcomes has declined. The risks in
Europe are still predominantly negative, but in China, the US and non-Japan Asia, the risks
are much more balanced - one can even conceive of upside surprises!
Australia's financial markets have been influenced by these global factors. At the same time,
domestic markets have benefited from strong international demand for Australian dollar
assets. Local issuers continue to be viewed favourably by offshore investors looking to
diversify credit exposures.
Yields on Commonwealth Government securities have moved in line with global government
bond yields. They are around post-federation lows, as this very long-run graph demonstrates
(Graph 1). Semi-government spreads have tended to move in a fairly tight range. Yields on
state government debt are also around their lowest since Federation, notwithstanding the
occasional ratings downgrade.
Graph 1
Demand for CGS from offshore investors remains strong (Graph 2). The share of foreign
ownership has come off its recent peak but net purchases have still continued, just not in line
with the pace of issuance. There have been reports of Japanese investors selling, in large
part because of the high level of the AUD/JPY exchange rate, but these sales have been
more than compensated for by increased purchases by other investors.1 The foreign
ownership of semis has been relatively constant, partly reflecting the preference the foreign
official sector generally displays for sovereign or highly rated supranational paper rather than
state or provincial debt. Instead, much of the increase in semi supply over the past couple of
years has been met by the demand from domestic bank balance sheets looking to boost their
liquid asset holdings.
Graph 2
For financial institutions, the cost of unsecured wholesale debt has fallen sufficiently to make
it economical for them to replace some of their government guaranteed securities. As we
noted in a recent box in the Statement on Monetary Policy,2 banks began repurchasing this
debt in large amounts towards the end of last year, and buybacks have totalled around
$19 billion since the end of September (Graph 3). As a result, the contingent liability the
scheme generates for the Australian Government has fallen more quickly than implied by the
maturity profile of guaranteed securities, and currently stands at $53 billion.
Graph 3
The ability to issue covered bonds has also helped in the repurchasing of guaranteed debt,
as banks can offer investors with AAA mandates an alternative asset to invest in. Covered
bonds have enabled banks to diversify their investor base, and have provided issuers with a
wholesale funding source less sensitive to risk events than traditional unsecured funding.
After strong issuance in the beginning of 2012 as the banks ramped up their programs,
covered bond issuance by Australian banks slowed as the year progressed, in large part
reflecting banks' desire to spread out the maturity profile. The major banks have utilised
around 30 per cent of their issuance caps to date. Spreads on these covered bonds have
tightened significantly since the first transaction in late 2011, reflecting not only the general
improvement in global risk sentiment, but also increased familiarity with the product and a
widening investor pool. Australian covered bonds now price at a level close to much longer
established covered bond programs (Graph 4).
Graph 4
Graph 5
The general decline in borrowing costs in the second half of 2012 has helped entice a
number of issuers back to the wholesale market, with volumes picking up across all markets
towards the end of last year and into the first quarter of 2013 (Graph 5).
In the unsecured market, banks continue to keep their stock of term debt relatively constant,
that is, issuance is broadly in line with maturities. This strategy is the result of a number of
different considerations, including the relatively subdued growth in balance sheets. But one
dominant cause is the desire to maintain a strong rating, with the latent threat of a
downgrade if wholesale issuance were to grow "too large". This reflects the somewhat
misplaced assessment of "deposits good, wholesale funding bad". As a result, banks are
currently paying about the same price for a 3-month term deposit as they are for a 5-year
debt issue.
Banks have taken advantage of the increase in risk appetite by lengthening the tenor of their
issuance. The average tenor of unsecured issuance has been 5 years since the middle of
last year, compared with a little over 4 years since the beginning of the financial crisis.
Increasing tenor has also been a feature of other markets. For example, the Australian Office
of Financial Management (AOFM) extended the average tenor of CGS issuance in 2011/12
by over a year to 7.7 years,3 while over the past 12 months the tenor of corporate issuance
has increased to nearly 11 years, compared with an average of 8 years since the beginning
of the financial crisis.
The securitisation market has only recently caught up to these trends, lagging behind most
other segments of the debt market. Issuance has picked up of late and spreads have
tightened considerably following the earlier sizeable tightening in covered bond spreads.
Encouragingly, recent issuance has been completed with little or no support from the AOFM
due to strong private investor demand, and primary market spreads are at their tightest level
since 2007 (Graph 6). This spread tightening will lower the cost of mortgage lending for small
banks and non-bank lenders who rely on securitisation for a large part of their funding.
Graph 6
Conditions have also picked up in the Kangaroo market. Ten kangaroo issuers debuted in
the market in 2012. The diversity of new issuers was also a notable feature, and included
Asian names and non-financial corporates. Another positive development has been the
reemergence of some non-SSA issuers not seen since the start of the global financial crisis,
while more recently a number of European issuers have returned to the market after being
absent for much of 2012.
Kangaroo issuance has been supported by the broad-based reduction in spreads, the
attractive basis, and foreign investors looking beyond AAA instruments for Australian dollar
exposure. These foreign investors have been notably active and Asian investor participation
in particular continues to grow.
Some recent RBA initiatives in Australian debt markets
I will now briefly discuss two recent RBA initiatives concerning the local debt market.
Firstly, the Reserve Bank is in the process of signing two-way credit support annexes with all
of its swap counterparties. A number of these agreements are already operational, including
those with the Bank's largest counterparties, and we expect agreements to be in place with
all counterparties in the coming weeks. This move is in line with best practices in risk
management. As more market participants collateralise their exposures in both directions,
this should also free collateral for the system (in aggregate), and enhance liquidity and the
resilience of the Australian derivatives markets.
Secondly, late last year, the Reserve Bank announced new data reporting requirements for
repo-eligible RMBS. The information required by the Bank includes loan-level and other
transaction specific data that issuers must also make publicly available. These initiatives are
designed to help the Bank assess the quality of RMBS provided as collateral and will also
improve the transparency of the market as a whole. For investors, the data will be easier to
access and because the reporting templates are standardised, investors can better compare
the underlying credit characteristics of different deals, and also use the data in their own
analytics.
The consultation period for the proposed reporting templates closed at the end of last year.
The Bank is currently reviewing the consultation findings and will finalise the reporting
templates over the next month or so.
A long-run perspective on Australian corporate bond issuance
I will now turn to the corporate bond market. Non-financial corporate issuance has also been
robust, and was particularly strong towards the end of last year, led by some large deals from
the mining sector. The December quarter was the strongest on record for domestic activity,
with BHP's $1 billion transaction receiving significant interest. The deal is the largest ever
non-credit wrapped transaction in the domestic market by a corporate issuer.
To place these more recent trends in a longer-term context, I'd like to take a moment to
consider how Australia's corporate debt markets have evolved into their present form. The
current corporate bond landscape is the result of a number of significant developments over
the past century, outlined in a recent Reserve Bank Research Discussion Paper published in
late 2012.4 This paper was the result of a substantial data collection exercise and extends
our understanding of Australian bond issuance back to 1917.
Broadly speaking, trends in bond issuance by Australian corporations can be broken down
into three distinct periods (Graph 7). The first, which extended throughout the first half of the
20th century, actually saw the peak in the size of the corporate bond market relative to GDP.
This period, particularly prior to World War II, was characterised by significant issuance by
government-owned Public Trading Enterprises (PTEs). Private investment, on the other
hand, was largely financed through internal funds, and the modest private bond issuance that
did occur was mostly to fund mining investment, much of it by corporations that later went on
to become BHP.
Graph 7
The bulk of the issuance by government-owned corporations took place in the 1920s. The
proceeds were used mostly to fund public works programs, with investment by these PTEs
accounting for as much as 7 per cent of GDP. Half of the bond issuance was by Victorian
water and sanitation boards alone. Public works projects undertaken here in Sydney, on the
other hand, including the building of the Sydney Harbour Bridge and Sydney's underground
railway system, were mostly funded directly by governments.
Over the 1930s and 1940s, the stock of corporate bonds outstanding declined as
governments reallocated resources away from the PTEs to finance war-related expenditure.
By the end of the Second World War, the corporate bond market had shrunk to around
18 per cent of GDP.
As the economy expanded following World War II, the stock of corporate bonds remained
relatively small as a share of GDP. At the same time, the corporate bond market began to
shift towards a larger share of private issuance, in part to fund mining investment, and as
corporations looked to source capital from outside the heavily regulated banking system
(Graph 8).
Graph 8
Graph 9
Bond issuance trends changed significantly from the early 1980s onwards as the Australian
economy and financial system underwent large structural changes. Financial deregulation
and liberalisation in the late 1970s and early 1980s saw banks rely less on deposits and
instead turn to the capital markets to fund balance sheet growth. As we know, bank bond
issuance has since grown rapidly, and banks have become the largest issuers of Australian
bonds (Graph 9).
Some other notable trends since the early 1980s have included the large number of
privatisations, which has resulted in the share of quasi-government bonds falling to close to
zero, and the growth of the asset-backed market. On the investor side, compulsory super
and increased offshore issuance caused a shift away from direct holdings by households
towards indirect holdings through superannuation funds and non-resident investors.
Another important development was the abolition of capital controls and the floating of the
Australian dollar. Prior to the 1980s, there were a range of constraints on capital flows that
were intended to prevent or discourage firms from undertaking foreign borrowing. Since
these controls were relaxed, banks and other corporations have obtained a significant
proportion of funding from offshore bond markets. Since 1986, the stock of bonds issued
offshore by Australian residents has exceeded the size of the onshore market (Graph 10).
Graph 10
The liberalisation of the capital account also contributed to the development of the
"Kangaroo" bond market. Kangaroo issuance was also encouraged by, and contributed to,
the development of an active cross-currency interest rate swap market in Australia.
I will finish with a few thoughts on the current state of the domestic corporate bond market.
There is a fair amount of discussion about the size, liquidity and functionality of the local
market. Let me raise three issues worth considering:
•
Is the local corporate sector too banked? The US is often held up as the comparator
here, but in some respects the US is the exception, with the size of the Australian
corporate bond market similar to that in Europe and the UK for example. That
doesn't mean the local market shouldn't be bigger, just that it's not that unusual.
• In many of the recent discussions about the state of the local market, I have been in
the room with both issuers and investors. The issuers say there is not enough
demand for their paper. The investors say there is not enough supply. But what
actually seems to be going on here is that the bid-ask is too wide. It is basically an
issue of price. Ironically, those very same discussions are often chaired by
investment banks, whose mandate, I would have thought, would be to intermediate
between the issuers and the investors.
•
Finally, there is a nascent level of activity in developing different means of financing
for sub-investment grade corporates other than traditional bank financing. Banks
would still do the credit process but then potentially package a pool of
subinvestment grade loans into a security that would be attractive to investors. Two of
the issues around this strategy are: first, whether the margin would be attractive
enough to the investor, after the bank has charged for its credit process; and
second, whether the investors, particularly in the super sector, have the credit skills
to appropriately assess the risk and price of such a product, given the super sector's
corporate skills have traditionally been confined to the listed corporate sector.