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EUrOWEEKAustrAliA in the CApitAl MArkets

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August 2013

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Australia in the Capital Markets | August 2013 | EUROWEEK 1

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EUrOWEEK

2 economic overview The lucky country

4 Financial services ministry interview Punching above its weight

8 international capital markets Home and away

9 public sector borrowers investors stay the course

11 semi-Governments roundtable Confident states face up to fiscal squeeze

20 Financial institutions Fighting for retail

22 covered bonds Waiting for the moment

24 Financial institutions roundtable High quality assets, strong regs leave banks in fine condition

33 corporate issuers A slow evolution

35 corporates roundtable Corporates wrestle with credit question

44 us private placements US open for unrated Australians

45 corporate hybrids Corporate hybrids ready for retail homecoming

46 aoFm interview AOFM looks forward to life after RMBS programme

48 securitization/term loan bs A startling recovery

50 domestic capital markets Longer, please

52 kanGaroo bonds Ready to bounce again

54 superannuation Super-sized

56 proFile: the Future Fund Alternatives rule Future Fund roost

57 australia in FiGures An economic snapshot

Iron ore mine, Mount Whaleback, Pilbara region of Western Australia

Contents: AustrAliA in the CApitAl MArkets

Page 2

Page 50

Economic ovErviEw

2 EUROWEEK | August 2013 | Australia in the Capital Markets

On September 7, Australia will vote for its next leader in a general elec-tion. He — and it will be a he this time, after prime minister Julia Gil-lard was ousted in June — will inherit an Australia that is in a less advanta-geous position than has been the case for many years.

Australia has undeniably fared bet-ter than almost any developed world peer through the treacherous last dec-ade. It exited its last recession in 1991, getting through both the Asian and the global financial crises without slip-ping into another. Its financial system has been remarkably resilient, suffer-ing not one bank failure, while Ameri-can and european institutions fell by the wayside. that is largely thanks to the wisdom of smart, independent regulators and central bank.

And Australia has been a vital engine of Chinese urbanisation, a quarry and a breadbasket at a time when Asia has needed both. It still is — and, if anything, its commodity pic-ture gets better all the time. As well as its long-proven reserves of coal and iron ore, it is now set to become one of the world’s largest suppliers of liq-uefied natural gas, and is far closer to the energy-hungry nations of China, Japan and South Korea than its main rival, Qatar.

In fact, Australia has had so much on its side for so long — the lucky country, as Donald Horne, the Aus-tralian intellectual who died in 2005, had it — that it has been tempting to believe the party would never end. but while Australia still looks in much bet-ter shape than any european nation, it faces more headwinds than it has done for years.

One challenge is that Australia’s for-tunes have increasingly been hitched to emerging markets more than the developed world. that worked a treat when China was growing at 10% a year, but means the reversal in the last year of sentiment away from the brICs and Asia and towards a reviving US have actually worked against it.

Linked to this, the industrialisation of China and other Asian nations came at a time when industrial commodities had had years of under-investment, pushing commodity prices up in what economists call a supercycle, from 2000 onwards. the combina-tion of the two suited Australia perfectly, push-ing its currency up dra-matically through the last decade, from 48 US cents to the Australian dol-lar in 2001 to above par-ity with the US dollar last year, eventually touch-ing US$1.10 per Austral-ian dollar.

“All cycles eventual-ly come to an end,” says Shane Oliver, head of investment strategy and chief economist at Amp Capital Inves-tors. “Several factors are now driving a reversal in the longer term secular cycle of developed country shares rel-ative to emerging market shares and related trades.”

End of the supercyclethe developed world — chiefly the US, but also, to varying degrees, Japan and the eurozone — is looking bet-ter after painful structural reform. Chinese growth is slowing while risk within it is rising, while India, brazil and Indonesia are grappling inflation and South America and russia have been hit by falling commodity prices. those commodity prices appear to be falling from peaks, suggesting the end to the celebrated supercycle. And if, like Australia, 70% of your exports are commodities, this is something you are likely to watch very closely.

partly because of this, the Australian dollar has started to fall. At the time of writing, the Australian dollar buys 90 US cents, an 18% fall from its highs,

most of it in a five week period in may and June. As HSbC put it in its latest global currency report: “AUD: 0.90 the new normal.”

now that China takes 35% of Aus-tralian exports, compared to less than 10% in 2008, China’s decline is being felt in the currency. “I would say it’s the strength of China rather than domestic policy in Australia which is dictating the value of the Australian dollar,” says John Woods, chief invest-ment strategist for Asia pacific at Citi private bank.

It should be said, though, that the fall in the currency was largely engi-neered by the reserve bank of Austral-ia (rbA) through a series of rate cuts, most recently to 2.5% in August. Aus-tralian exporters away from commodi-ties hate the highly valued currency, and the reserve bank knows that the Aussie dollar needs to drop if those parts of the economy are to stand a chance — and if the mining boom is over, then the resilience of other exporters is going to be increasingly

Australia has ducked recessions through the Asian and global financial crises, buoyed by a stable banking system, good regulators, and plentiful commodities to ship to urbanising emerging neighbours. But are the good times coming to an end?

The lucky country

Rudd and Abbott: with no gulf in economic policy between them, Australia’s prospects remain firm

Economic ovErviEw


important to Australia. “When the rbA

announced an unchanged cash rate they said the cur-rency was high,” says Ste-phen Walters, chief econ-omist for Australia and new Zealand at Jp mor-gan, speaking before the August rate cut. “that’s code for ‘we’d love it to be lower’. Ask a manufactur-ing exporter and they’d like it to be in the 60s. A tourism operator, even lower.”

He suggests a realistic level of equilibrium for the economy in the mid-80s, not far from today’s levels.

but reducing the currency and the yield at the same time may have other consequences. the Australian dollar had reached such dizzy heights part-ly because of China and commodi-ties, but also because it had become a safe haven: a AAA-rated economy in a world which has less and less of them to choose from, and a high yielding currency to boot.

the combination of these funda-mentals and a trusted legal system, with low default rates on bonds and high corporate governance among blue chip stocks, made it a favourite of inbound capital flows on the debt and equity side.

but as rates have fallen, the yield differential between the Australian dollar and other currencies has nar-rowed too. there is a risk of capital flight as Australia’s advantages dimin-ish, which must give the country pause, since over 70% of the owners of Commonwealth government securi-ties are based overseas.

In an interview elsewhere in this report, the CeO of the Australi-an Office of Financial management (AOFm), rob nicholl, says he does not fear capital flight since so much of the investment in government bonds is from central banks who are invested in Australian debt as part of a long-term allocation rather than an opportunis-tic play.

bankers and economists tend to agree. “Over the next six to 12 months, we think the Aussie still has a lot of friends,” says Jp morgan’s Walters. “Our interest rates are still among the highest in the world. When you look at interest rates in Japan, the US and

europe close to zero, our cash rate and 10 year bonds yielding quite a bit more look very attractive.

“the pool of AAA government bond markets has been shrinking for quite some time,” he adds. “there are only nine or 10 left in the world that are still AAA-rated. And a lot of central banks and sovereign wealth funds are looking for these characteristics: high yield, moderate risk, AAA-rated, decent budget and debt positions. It’s simple arithmetic.”

RBA can still cutAustralian GDp growth is flagging. In August, the rbA cut its calendar 2013 forecast for economic growth from 2.5% to 2.25%. Amp’s Oliver says that is well below trend for Australia, which would be 3% to 3.25%.

“more significantly, demand in the economy has fallen for two consecu-tive quarters as a result of subdued consumer spending, subdued hous-ing investment and falling business investment,” he says. “Were it not for a bounce in exports and fall in imports, the economy would be in recession.” A worst case scenario being discussed increasingly in Sydney and melbourne is exactly that: recession and a col-lapse in house prices.

but it has to be remembered that the rbA has a lot more levers at its dispos-al than countries already at zero inter-est rates: there can be many more cuts to spur growth if necessary. Austral-ia has low public debt (indeed, until recently bankers spent years lobby-ing the government to borrow more in order to build a better yield curve to price other instruments off), low infla-tion, and fairly low unemployment.

Oliver argues that the combina-tion of rbA cuts, a falling Aussie dol-

lar aiding exports, a pick-up in housing construction and a pick-up in consumer spending “should be enough to avert recession and the much talked about house price collapse.”

most economists do not expect further rate cuts in the near term, while rec-ognising that the rbA has space to make them if it needed to. the rbA state-ment that reduced growth forecasts “emphasized the role of a lower AUD in sup-

porting the rebalancing of Australia’s growth and sug-

gested that the AUD ‘could appreciate further’,” said HSbC’s chief economist for Australia and new Zealand, paul bloxham, in a research note after the statement. “While the rbA has room to cut further, we still expect that they may not need, as the AUD may do much of the work for them.”

the rbA expects growth to pick up in 2014, to 2.5-3.5%; its inflation fore-cast for 2013 is a manageable 2.25%, while unemployment is expected to edge upwards in the next quarter, then stabilise and decline. Unemployment stood at 5.7% in July.

the outcome of the Federal election is unlikely to make a huge difference to Australia’s economic prospects, as so much of it is out of the country’s hands (and in, most obviously, China’s).

there is not a huge gulf in economic policy between opposing candidates Kevin rudd, the prime minister, and tony Abbott, though at the margins there are interesting commitments. Shadow treasurer Joe Hockey, for example, has pledged to encourage the AOFm to launch bonds as long as 40 or 50 years if he makes it in to power.

One suspects that Australia will duck recession once again, as it has for 20 years, making up for declines in mining with a revival in other parts of the economy boosted by a falling cur-rency.

And by then, the country’s great investment in LnG should be paying off, with export earnings from the liq-uefied gas expected to increase five times over from A$12bn in the last fis-cal year to $60bn by 2017-18, before becoming the world’s biggest LnG exporter by 2020. Donald Horne was right: Australia is, without doubt, the lucky country. s

Further interest rate cuts expected

Source: JP Morgan

Source: RBA

05 06 07 08 09 10 11 12 13

JP Morganforecasts

Australia: RBA o�icial cash rate

8

%7

6

5

4

2

3

FINANCIAL SERVICES mINIStRy INtERVIEw


EuroWeek: The superannuation industry, at over A$1.5tr ($1.38tr), is now one of the largest pension fund pools in the world despite Australia’s relatively small population. What’s the knock-on effect of that wealth on Australia’s financial services industry, and on the Australian capital markets’ relevance in global terms?

The large pool of relatively sta-ble and unleveraged superannua-tion assets adds depth and liquid-ity to our financial services industry and provides a source of finance for other sectors in the economy. Superannuation funds have been an important source of capital to banks and other Australian compa-nies over the period since the global financial crisis, when debt finance has become less readily available and leverage is perceived as more risky.

Australia has the third largest pool of funds under management, behind the US and Luxembourg, overtak-ing France. The World Econom-ic Forum’s Financial Development Report 2012 has ranked Australia fifth out of 62 of the world’s leading financial systems and capital mar-kets.

The size of Australia’s investment fund assets pool and its growth pros-pects have attracted global firms seeking to establish operations in Australia, helping to make it one of the most efficient and competitive financial sectors in the Asia Pacific region.

EuroWeek: As the super industry continues to grow, logically there will be a need for greater invest-ment outside Australia. How do you expect that to evolve?

Superannuation funds are already investing outside of Australia. For example, as part of its overseas infrastructure investments, Austra-lianSuper invests in assets located in the UK, US, Germany, Chile, Brazil and Poland. The growing size of Australia’s superannuation industry

will create additional investment opportunities across a diverse range of both domestic and international assets. I’d like to see superannua-tion funds build their capabilities to identify and manage international investments in more diversified as-sets and emerging markets, particu-larly in Asia.

EuroWeek: Australia’s banking industry came out of the finan-cial crisis in exceptionally strong shape compared to almost any other developed world nation. How robust do you consider it to be today, and what challenges does it still face?

In November last year, the IMF again endorsed the strength of our finan-cial system in our second Financial System Stability Assessment. Aus-tralia’s financial system has come through one of the most turbulent periods in the global economy in 80 years with flying colours. But it’s ap-propriate that after a global financial crisis, we find global solutions to the problems that caused it.

That’s why we’re working through the G20, the Basel Committee and the Financial Stability Board — with other like-minded nations like Cana-da and Korea — to get balanced out-comes on the new agenda for global financial reform. Australia is now well on track to implement its global reform obligations.

EuroWeek: What credit do Aus-tralia’s regulators deserve for the relative strength of the country’s financial services sector today?

It’s been said that in the Reserve Bank of Australia, the Australian Prudential Regulation Authority and the Australian Securities and Invest-ments Commission, Australia has some of the most highly regarded financial regulators in the world.

The culture of sound risk manage-ment, prudent lending, and safer liquidity and capital management enforced by our regulators played a major role in the performance of

our financial sector following the collapse of Lehman Brothers in late 2008, which held up very well in comparison to our peers. And this is a continuing strength for the Aus-tralian economy.

EuroWeek: Australia’s Com-monwealth bond issuance, while considerably increased in recent years, is still far lower than gov-ernment debt in many other de-veloped world nations. Would you like to see either more issuance, or longer-duration issuance, from the Commonwealth (or states) in order to support the development of Australia’s capital markets?

The government has been clear in signalling its view that there is an ongoing role for a liquid Com-monwealth bond market. Issuance will continue to be determined on the basis of financing needs and the Australian Office of Financial Management has responded to the opportunity to develop the market over the past few years by extend-ing the nominal yield curve and increasing the average maturity of the bonds it has been issuing. This has responded to market conditions and has been with the policy consent of the government.

EuroWeek: Bankers in Austra-lia tend to lament the relative weakness of the corporate bond markets in Australia — a lower-rated Australian corporate will still typically go to the US high yield markets for funds rather than attempt to raise capital domestically. What can be done to improve that market?

A vibrant retail corporate bond market will allow us to harness our national superannuation sav-ings so we can domestically fund more productive investment in our economy and reduce our reliance on offshore wholesale funding markets.

Current government reforms, such as simplifying the offer of simple corporate bonds to retail investors and allowing the retail trading of Commonwealth Government Secu-rities, will help to reduce the costs and provide the market with a more visible pricing benchmark for retail

Bill Shorten was, until recently, Australia’s Minister for Financial Services and Superannuation — giving him governmental responsibility for one of the world’s most resilient banking sectors, and one of the largest pension fund systems worldwide. Here he explains the country’s challenges and strengths.

Punching above its weight

FINANCIAL SERVICES mINIStRy INtERVIEw


corporate bond issuance, as well as help further encourage retail inves-tors to consider diversifying their savings through investments in fixed income products like government and corporate bonds.

These are important steps towards building a deep and liquid corporate bond market in Australia and we expect the Australian Parliament to pass the enabling legislation in the coming weeks.[At the time of pub-lication, the legislation had passed Australia’s House of Representatives and was awaiting second reading in the Senate.]

EuroWeek: The AOFM has formally ended its support of residential mortgage-backed se-curitization (RMBS) in Australia, apparently a sign that the market has returned to good health. Has it?

The RMBS market is now function-ing well and has actually had its best first quarter of issuance since 2007. Primary and secondary market pric-ing have converged, and investors have a renewed sense of confidence and appetite for the asset class.

Of course, we all know that RMBS pricing is unlikely to ever return to pre-GFC levels because there’s been a structural shift in investor appe-tite. But pricing is now much better than for most of the last five years.

EuroWeek: What is being done to make Australia a regional centre for funds management — again, building on that huge pool of superannuation wealth?

The government is committed to promoting Australia as a financial services centre in the region. We want to lead a more competitive, efficient and internationally engaged financial industry and increase its cross border activities within the Asia Pacific region and beyond.

The government is implementing an investment manager regime, a key recommendation of the Johnson report, which will make Australia more attractive as a destination for investment and encourage employ-ment in the financial services sector.

We are also committed to phasing down the interest withholding tax paid by financial institutions in Aus-tralia on certain offshore borrowings from July 1, 2014, working through APEC channels to develop the pro-posal for an Asia Region Funds Pass-port; and introducing legislation to cut red tape for businesses issuing simple corporate bonds in order to promote a deep and liquid retail cor-porate bond market.

EuroWeek: Triple-A ratings are gradually disappearing around the world, such as the US, France and the UK all losing the status with at least one agency — but do you perceive any threat to Austra-lia’s? Just how important is that rating and safe haven status?

Australia has a triple-A status for the first time ever and is one of only eight countries to hold a triple-A/stable credit rating with all the major ratings agencies.

Australia’s triple-A rating is a solid endorsement of the government’s fiscal management and underlines the attractiveness of Australia as an investment destination.

EuroWeek: Can Australia toler-ate the exceptional strength of the Australian dollar in the long term? (NB: the response came before the pull back in the Aus-tralian dollar discussed in greater detail in the chapter on economy.)

The current high level of the Austra-lian dollar reflects high world prices for our mining exports, the strength of the Australian economy relative to other advanced economies and the relatively high returns on Australian assets that are associated with this.

More broadly, the strength in the dollar should be seen in the context of the profound changes that are taking place in the global economy. Asia has for some decades been the region of the world enjoying the fast-est rates of economic growth and this seems likely to continue for some considerable time to come.

As well as generating huge and growing demand for energy and mineral commodities, this rapid economic growth is also delivering millions of people into burgeoning middle classes, in China, India and elsewhere in Asia.

In the longer term, the increas-ing numbers of people in the Asian middle classes, with disposable incomes to match, will generate ris-ing demand for a range of Australian goods and services — whether they be a range of foodstuffs, Australian tourist destinations, or educational, financial and other professional ser-vices in which Australia has a prov-en track record.

EuroWeek: More and more cen-tral banks and sovereign funds worldwide appear to be looking at Australian dollar assets. What impact is that having? Is there a point at which inward capital flows begin to cause a potential problem, particularly if they flow out again?

There are a range of factors that have underpinned the dollar’s strength over recent years, only one of which is increased purchases by official reserve managers. A more important influence has likely been inflows of direct equity investment, much of which has been directed at expanding productive capacity in the resources sector. Because direct equity investment is typically made with long-term business objectives in mind, it is regarded as a relatively stable form of capital inflow. More-over, it is also worth noting that of-ficial reserve managers are generally regarded as a more stable investor class than, for instance, foreign non-official investors.

Note: shortly before publication, Bill Shorten became Minister for Educa-tion and Workplace Relations.Australia will hold a federal election on September 7. s

Shorten: the financial system came through the crisis with flying colours

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international Capital markets


AustrAliAn issuers engage with a wide range of currencies and investors, from dollar and euro benchmarks to the us private placement and term loan B markets. But they are driven, ultimate-ly, by what they cannot do at home.

Capacity and tenor are improving in Australia, but they remain the key shortcomings of the domestic market.

“if you have an extremely large fund-ing requirement, the euro or us dol-lar market can provide tenors out to 10 years, with a favoured sweet spot for investors at 500m in each curren-cy,” says luke Gersbach, director, debt securities at Westpac. “in the Aussie market at that tenor, you would need to be the right credit, and even then vol-ume would be limited in comparison.”

the big Australian banks are sea-soned veterans of these issues, in dol-lars, euros, sterling and further afield, whether in mainstream senior debt or in covered bonds. Bigger corporate names are familiar internationally too: telstra, for example, raised €1bn in 10.5 year funding in March, building on long-standing relationships in that cur-rency and tenor.

Wesfarmers is another frequent issu-er, and more recently, sP Ausnet raised €500m in a seven year transaction in July, paying mid swaps plus 95bp, “roughly in line with what its costs would have been in Australian dollars,” Gersbach says.

this year, Australian borrowers have sought out swiss franc funding, finding familiarity in swiss investor behaviour. “the theme in the Australian market of investors moving down the curve is evident in other markets as well, par-ticularly swiss francs,” says Paul neu-mann, associate director at uBs.

“swiss investors are moving down the curve to pick up yield, but are still looking for issuers from jurisdictions that they understand, have stable polit-ical regimes and good growth pros-pects. Australia is one of those places.”

Boral, sP Ausnet and Amcor have all raised funds in swiss francs recently, with uBs involved in each of them.

Westpac’s Gersbach says swiss francs

make sense for deals up to sfr300m and up to seven years. sterling, he says, supports deals up to £250m, usually in 10-12 year duration.

“We are still seeing extremely strong support for Australian credits,” says Grant Bush, head of capital markets and treasury solutions at Deutsche Bank. “it is still a preferred jurisdiction. in Europe and the uK the strength of Australia’s economic performance is often the key driver, and diversifica-tion away from local exposures; in the us, it’s more a market that differenti-ates between domestic and offshore, and when they look at offshore juris-dictions Australia is still strongly pre-ferred because of its fundamentals.”

Elsewhere in the world, nation-al Australia Bank made its dim sum debut on May 31 with an rmb400m two year deal. the amount of money — equivalent to us$65.6m — was not significant for a bank like nAB, but nevertheless it allowed it to make a strategic statement, showing the importance it places on the currency. nAB became the second Australian major to try the dim sum route after AnZ, which issued back in 2010.

“We’re seeing more dialogue around nAB,” says sean Henderson, head of debt capital markets for Australia at HsBC, a joint lead on the nAB deal alongside nAB’s own syndication team. “As deregulation continues and global trade re-denominates, we expect inter-est in funding in the currency to grow.”

Vibrant corporatesWhile the banks tend to do the biggest outbound deals from Australia, the most vibrant part of the market for new international issuance is corporate.

“One big change in the last two years has been the way corporates view their options for financing: which markets, what mix of currencies, should they do EMtns, should they do private place-ments,” says Henderson. “this year sP Ausnet went to euros, you’ve seen yen and Hong Kong dollar placements for names like GPt, private placement issuance is more relevant, and more

corporates are looking at the us high yield and term loan B markets.”

Each of those markets helps to serve the parts of Australia that the home-grown market will not reach: the unrat-ed, or the sub-investment grade. there is no high yield market in Australia, so rated issuers in that area have to cross the Pacific if they want an alternative to domestic lending.

“the high yield market is strong, with a robust pipeline of transactions following a period of some cash out-flows from high yield funds,” says steve Black in debt capital markets at Credit

suisse. “that has stabilised and even reversed. the asset class has benefited from central bank policies designed to force investors into riskier assets.”

Mining names dominate Austral-ian issuance in us high yield, because they work in dollars and therefore do not need to swap proceeds back again. Fortescue Metals, for example, has been a prolific issuer in us high yield.

Australia also has its successes in us private placements, such as Csl and Orica, and in the term loan B market, such as Pact Group industries, dis-cussed in more detail in other chapters.

At home, Australian bankers hope that the market will evolve to provide what borrowers need without leaving the country or the currency; doing so would save them from cross-currency swap costs, among other things. But progress is never as fast enough For the time being, when Australians do have to go overseas, at least they find a will-ing audience to buy their paper. s

Australian issuers find receptive markets whenever they venture overseas, from 144a and jumbo euro deals to smaller opportunities in Swiss francs and sterling, and specialist markets like US private placements and term loan Bs. But if the country’s own markets develop, will borrowers still go abroad?

Home and away

“One big change in the last two years has been the way

corporates view their options for

financing”

Sean Henderson, HSBC

public sector borrowers


AustrAliAn government paper, whether federal or state, is in great demand. Of the A$266bn of Common-wealth Government securities out-standing, 70.4% was held by non-Aus-tralian residents as of March 2013, and that figure has at times touched 80%.

there is a lot to like in Australian government bonds. the country is one of a shrinking elite worldwide to be rated AAA. its budget deficits, when they occur, are modest, certainly in comparison to any other developed world country. the legal system is tried, tested and trusted.

the securities are liquid — the more so since Australia committed to main-tain a CGs (Commonwealth Govern-ment securities, or Australian govern-ment bonds at a federal level) market equivalent to 12%-14% of nation-al GDP. they pay a far greater yield than treasuries of similarly developed nations. And, until recently, the cur-rency itself had been on an endless upward trajectory.

But there is always a risk when levels of foreign ownership are so high that it could all take flight once again. And while there is never any real danger of that while a country is thriving, lately there has been a feeling that Austral-ia’s economic time in the sun may be coming to an end.

A slowing China and an ending resources boom have removed the dynamo from the Australian economy, and the currency — partly by design of the reserve Bank of Australia, it

should be said — has fallen heavily from its highs, dropping more than 10% in a month and back below parity with the us dollar. At the same time, rate cuts by the reserve Bank have reduced the yield differential with other currencies.

Could it be enough to cause capi-tal flight? those in the market, from Australia’s debt management office to bankers and fund managers, tend to argue not. “We’ve given a lot of thought to this, because a large pro-portion of offshore ownership comes with risk,” says rob nicholl, chief executive of the Australian Office of Financial Management (AOFM) in Canberra, in an interview elsewhere in this report. “But any solution comes with risk. And we don’t see the cir-cumstances in which we would have a mass exit.”

nicholl says that the foreign cen-tral banks who make up the bulk of foreign ownership in the market — and, in particular, new ownership —

tend to hold Australian dollar paper unhedged, as a portfolio allocation rather than an opportunistic play on the currency. “We see plenty of turn-over at the margin, but we expect that as a healthy characteristic.”

Bankers agree. “the question we are constantly asked is: with the Aus-sie dollar falling, do reserve manag-ers exit the Australian dollar trade?” says Michael Correa, managing direc-tor, global capital markets at West-pac. “At the moment, we don’t see that occurring. Among the reserve

managers we talk to, the Australian allocation is now stable in their port-folios, with the only possible excep-tion to that being Japanese investors, because of what is happening post the Abenomics changes on monetary sup-ply there.

“it has now become a fixed alloca-tion of reserve portfolios, whereas before it was in the discretionary buck-et. it’s now seen as more of a reserve currency.”

Westpac is calling the Australian

dollar to remain at current levels or higher, and doesn’t think that will be a trigger to exit government bonds as it still sees the carry on an Australian government bond as attractive com-pared to other reserve currencies.

if investors do stay the course, then their questions about CGs issuance are likely to be threefold: supply, tenor, and inflation-linked product.

supply is the easiest to answer, because of the commitment to keep the outstanding debt in CGs at a con-sistent level to GDP; in fact, today it stands at 16%, so should be expected to drift back a couple of percentage points in the year ahead. But in aggre-gate, a market around today’s level is what investors should expect.

then there is tenor. Earlier this year, the AOFM put out its longest bond, due 2029, for a tenor of 16 and a half years at the time of issue. it went well, but viewed from a developed mar-ket perspective, it is strikingly short for the longest bond in a national armoury. in the uK, for example, Gilts have an established curve for 30 or even 50 years.

Many bankers would like to see the AOFM stretch itself out along the curve. “there is no 30 year govern-ment bond in this country because of the size and preferred financing struc-ture of the government’s debt,” says steve Black, working in debt capital markets at Credit suisse. “this lack of a benchmark makes it more difficult for issuers to raise very long-dated financing.”

the issue has become political. Ear-lier this year Joe Hockey, the shadow treasurer and almost certainly the new federal treasurer if the liberal party win september’s general elec-tion, called for longer-dated funding. “if there is a change of government, one of the first things i’ll be doing is meet-ing with the AOFM and asking them to start extending the maturity date of Commonwealth government securi-ties so that we can create a benchmark yield curve,” he said in April.

Australian government bonds are widely held overseas. Increasingly, state paper is too. But will foreign central banks continue to commit their capital as yields and the Australian dollar fall?

Investors stay the course

“Supply has diminished

compared to previous years, so

investors are looking for exposure in the secondary market”

Apoorva Tandon, ANZ

public sector borrowers


“i’m prepared to go 40, 50 years.”

Many in the market would like to see exactly that, for two reasons: one, it would help the corporate bond market develop greater tenor, as there would be govern-ment bonds to price off; and two, it would help the availability of long-dated infrastructure funding, which would clearly help the country.

But not everyone is keen. “i don’t see any real change in demand from domestic inves-tors in terms of tenor in the government curve,” says Correa. “the water has been tested — we’ve seen tCV [the Victorian state treasury] issue in the 32s, with a 20 year nomi-nal bond — but demand for tenor in Australia is driven more by offshore than onshore investors.

“i know there has been a lot of dis-cussion about whether Australia could issue a 30 or a 50, but for me, it’s more of a folly than a reality. i don’t think there is enough demand out there to push a full line of stock beyond 20 years, although we could certainly do more between 10 and 20.”

For his part, nicholl says that Hock-ey’s questions are “reasonable to ask and we should always be asking them”, but declined to put a timeframe on lengthening tenor.

the third question is around infla-tion-linked securities. Australia has A$18.52bn of treasury indexed bonds outstanding and has a mandate from the government to develop the infla-tion-indexed part of the portfolio to 10% to 15% of outstanding, from around 6% today.

Bankers say there is a market for more. “inflation-linked is probably on the nose a bit from the global inves-tor point of view, but it has a longer-term role to play in Australia,” Correa says. “Our advice to AOFM is to issue more inflation-linked. new Zealand is issuing double the amount compared to Australia.” specifically he suggests buying back some shorter-tenor bonds in this area and re-issue down the curve, “at a mid-2030s sort of tenor”.

Beyond the federal government, Australia’s states are sophisticated issuers in their own right, and are

gathering increasing attention from investors who might take their first look at Australia through common-wealth bonds and then move into semi-governments to diversify and pick up yield.

tim Galt, executive director, fixed income syndicate at uBs, says: “We are seeing an increasing number [of new buyers of government paper] rotate into the states as they look to diversify in Australian dollars and not only hold sovereign debt.”

uBs was, with AnZ, a joint lead on the longest benchmark transaction to date for the northern territory ear-lier this year, dated 2024, following a nine year deal for the Australian Capi-tal territory. “Both these transactions evidence the desire among investors to hold deeper and more diverse expo-sure to Australian dollar borrowers,” Galt says.

A A$750m trade for the Queensland treasury Corp was another standout, a syndicated offering of 11 year fund-ing which went 7% to Asia and 8% to Europe.

One challenge for investors, though, is that the states don’t seem to need as much money as they used to. “in the last six weeks, we have seen the states and treasuries come out and announce their budgets,” said Apoorva tandon, director, syndicate at AnZ, speaking at the end of July. “there appears to be a reduced funding need in the next 12 months because of the states’ fiscal positions, and some asset sales taking place at a state level.”

A look at Victoria’s funding require-ments, announced in May by the treasury Corporation of Victoria, demonstrates this. Having set its fund-

ing task at A$7.2bn for 2012/2013, its need for the year ending June 2014 is A$6.69bn; to June 2015, A$5.66bn; to June 2016, A$1.91bn; and to June 2017, just A$1.88bn.

“the biggest takeaway is that supply has dimin-ished compared to pre-vious years, so investors are looking for exposure in the secondary mar-ket, which has outper-formed,” says tandon.

Correa says that, besides Queensland, most of the semis are looking at either bal-

anced or surplus budg-ets within the next two years. He says investors — particularly bank balance sheets, a potent source of demand as regulatory requirements become more onerous for them — want more and more of this paper just as its availabil-ity is diminishing.

“We are very constructive on the semis, particularly the premium states of nsW, Victoria and WA,” he says. “We like that they are looking at Frn-type products; it helps bank bal-ance sheets in Australia to meet their reserve requirements. We much pre-fer that to fixed in terms of how they manage risk.”

Also, whereas Australian corporate issuers have benefited from strong interest from Asia, the states are gar-nering more and more attention in the west. “international participation in state issues has improved,” says tandon at AnZ. “recent transactions from QtC [the Queensland treasury] in particular have had increased par-ticipation and flows from Europe and the us.

“We have seen transactions go 30%-40% to central banks, and the bulk of that growth has been from Europe.”

One trend for the future will be retail participation in government securities through the stock market, since gov-ernment listed bonds started appear-ing on the AsX in May. initial take-up has been subdued, but “it’s relevant because of what it may become rather than what the impact is now,” notes Allan O’sullivan at Westpac. “the listed sector has gone from A$38bn to A$280bn just because investors can now access Australian government bonds.” s

Proportion of Australian Commonwealth Government Bonds held by non-residents

Source: Australian Office of Financial Management

Proportion of Australian Commonwealth Government Bonds held by non-residents

Jun

03

Jun

05

Jun

06

Jun

07

Jun

08

Jun

09

Jun

10

Jun

11

Jun

12

Dec

03

Dec

05

Dec

06

Dec

07

Dec

08

Dec

09

Dec

10

Dec

11

Dec

12

0

10

20

%

30

40

50

60

70

80

90

100

Jun

04

Dec

04

Australia in the Capital Markets EuroWeek 11

Semi-Governments Roundtable

Participants in the roundtable were:

Roger Bridges, head of fixed income, Tyndall Investment Management, Sydney

John Collins, chief executive officer, Western Australia Treasury Corporation (WATC), Perth

Tim Hext, general manager, funding and balance sheet, New South Wales Treasury Corp (TCorp), Sydney

John Hindmarsh*, chief executive officer, Tasmanian Public Finance Corporation (Tascorp)

Richard Jackson, executive general manager, funding and markets, Queensland Treasury Corporation (QTC), Brisbane

Andrew Koczanowski, head of debt syndication, Australia, HSBC, Sydney

Justin Lofting, general manager, treasury, Treasury Corporation of Victoria (TCV), Melbourne

Simon Masnick, global head of rates markets, Westpac Institutional Bank, Sydney

John Montague, assistant under treasurer (funds management), Northern Territory Treasury

John Powell, director, financial markets and client services, South Australian Government Financing Authority (SAFA), Adelaide

Debra Roane, vice president, senior credit officer, sub-sovereign group, Moody’s, Sydney

Apoorva Tandon, director, debt syndicate, ANZ, Sydney

Phil Moore, Moderator, EuroWeek

*participated remotely

Confident states face up to fiscal squeeze

Global demand for exposure to Australian semi-government debt is at an all-time high, with international investors attracted by the spreads it offers over Commonwealth Government Securities (CGS) and the sturdy credit profiles of the Australian states. While all are happy for overseas investors to play a greater role in their Australian dollar funding programmes, none seem likely — for the moment at least — to follow the example of the Canadian provinces by issuing in international currencies.

In the EuroWeek Semi-Governments Roundtable, funding officials from all the states and Northern Territory gathered to discuss the prospects for their economies and to compare notes on funding requirements and strategies.

12 EuroWeek Australia in the Capital Markets


EUROWEEK: Debra, how would you describe the overall credit quality of the Australian semi-government sector?

Debra Roane, Moody’s: We have a negative outlook on the states which reflects the continued deterioration of their financial performance and debt burdens. This is the product of current expenditure having outpaced revenue for the past six years and rapid growth of capital expenditure.

As a result, we’ve made adjustments to some of our ratings over the last 11 months, downgrading South Australia and Tasmania to Aa1 and we’ve put negative outlooks on Western Australia, Northern Territory and Queensland.

It does not look as though revenues will return

to the very strong growth rates that we saw in the past, which will require the states to slow the pace of their current expenditure if they want to narrow their deficits. The recent budget numbers for 2013/14 saw a further deterioration, and the combined deficits of all the states is now about A$19bn, equivalent to about 9% of revenues. As a result we anticipate that the debt burden will rise over the next couple of years. After that, the states are all predicting improvements leading to a reduction in the size of their deficits and a stabilisation of debt levels.

Despite credit weakening, the states retain inherent credit strengths including the supportive and predictable system of grants, relatively positive economic performance and location in a strong Aaa-rated country.

EUROWEEK: What are the individual states doing about this imbalance between revenue and expenditure?

Tim Hext, TCorp: On a relative basis New South Wales is performing better than many of the others, but that’s after a long period of underperformance. We have less direct exposure to the commodities boom so when it starts to come off we have less exposure to the downside.

A lot of people in the last 10 years believe the underperformance was due to structural reasons. But in our view it’s cyclical. Ten years ago New South Wales

had just finished a period of solid outperformance. House prices were a long way out of line with the rest of the country whereas today they’re not much higher than in other states. So we’ve started to see a convergence there, and the number of houses that are being built in New South Wales over the last 10 years has underperformed other states. So we were to some degree crowded out by what was happening elsewhere, and we will be a beneficiary as the crowding out is reduced.

From a structural point of view the government is focusing intensively on expenses growth, which it is aiming to reduce from 6% to below 4%. That’s against the backdrop of revenue growth being closer to 4% than 5% or 6% as we experienced previously.

John Hindmarsh, Tascorp: All Australian states are under pressure from a fiscal perspective, due largely to persistent deficits caused by lower than expected revenue growth. The majority of government expenditure is fixed, and when you have an outlook for lower revenue and a cost base that grows at or slightly above the rate of inflation, you quickly move from a surplus to a deficit position. That is what’s happening in all states in Australia at the moment, and Tasmania is no different to the others in that context.

I do, however, think that there is still a marked difference between the mining and the non-mining states, which I base not just on the numbers but also on anecdotal evidence. Slower revenue growth is having an impact on the mining states but the differences in their economies are still very visible.

EUROWEEK: What can you do to accelerate the process of balancing the budget?

Hindmarsh, Tascorp: For a state government that generates 60% of its revenue from the Commonwealth, all we can do is attend to the expenditure side of the P&L statement. That means addressing large expenditure items which are difficult to rein in. It’s not something you can achieve in 12 or 24 months.

EUROWEEK: John, what is the picture in Western Australia at the moment?

John Collins, WATC: The WA government is dealing from a transition from a business investment phase to a production phase and this is the third time in the last 25 years that we’ve faced such a situation. On each occasion we’ve seen roughly a 25% reduction of capital investment in the mining sector and an increase of between 25% and 50% in exports through these four year cycles. We’re expecting a similar trend this time.

But with that comes a reduction in domestic demand which weakens some of the revenues from payroll taxes and so on. But in this case royalty revenues should pick up as we see the volume increases ramp up.

In the last 12 months the government’s expense increase was 3.6% which is a 14 year low. So they have been successfully reducing expenditure. But WA’s challenge is that for the last three years we’ve had very high population growth of between 3% and 3.5%.

Debra Roane,Moody’s



Last year we had 75,000 people move to WA, and that requires health, education and transport infrastructure. So the challenge we have is providing an infrastructure for a rapidly growing population.

EUROWEEK: Does Northern Territory have similar issues?

John Montague, Northern Territory: It’s very different. For us the key driver is the Commonwealth in terms of our GST allocation, which following the most recent review saw a reduction of the best part of A$120m per annum.

We’ve also had a change of government recently which brought with it a focus on the outstanding level of debt and approaches for debt reduction. We are also seeing a shift in capital expenditure from the government to the private sector. We have one major project, being the Icythys gas project, which has a total cost of approximately A$34bn into what is still quite a small economy. We have 230,000 people in the whole of the territory, of which about 130,000 are in the Darwin region. So when you put a project of that scale into the economy it has a significant impact.

So we’re seeing a lot of adjustment from local businesses which are trying to find a niche for themselves within that project. In some cases they’re finding that the scale of the project has required them to change their expectations or seek out new partnerships.

In terms of government expenditure, we all share the same drivers which are to manage our finances carefully, move away from budget deficits and examine all avenues for finding savings. These are not easy things to achieve, but clearly there is a very strong desire among governments to do so, and some are looking at asset sales to assist in this task.

Richard Jackson, QTC: Like all the state governments in Australia, Queensland is adjusting to the relatively weak — by historical standards — pace of revenue growth. Recent weakness in commodity prices has presented challenges, but with the depreciation of the Australian dollar, there is greater scope for other sectors of the economy, such as tourism, manufacturing and education exports. And with almost

half of the state’s revenue coming from the Australian government, via GST receipts etc, that is another area where we’re seeing an adjustment.

In Queensland there is the added complication of responding to natural disasters, with associated costs of $9.3bn estimated for the period 2012-13 to 2014-15. So although 75% of those costs are reimbursed by the Australian government, in 2012-13 Queensland’s growth was negatively impacted by about 0.25%.

Like all the governments, expense control is a priority. In 2012-13 the general government expenditure growth rate was only 1.1% on 2011-12. This contrasts with average expenses growth of 8.9% per annum in the decade to 2011-12, the lowest growth since 1998-99. Between 2012-13 and 2016-17, expenditure is forecast to grow at about 2.6%, so this is a marked change from the past.

The Queensland Government has made it clear that one of its fiscal priorities is to stabilise the level of outstanding debt, which now looks as though it will peak at A$81bn, instead of the A$85bn originally forecast. The government also indicated in its published response to the independent Commission of Audit report that it may consider seeking a mandate at a future election to sell particular businesses. Either way it has indicated that it will make greater use of the private sector to fund infrastructure in future.

John Powell, SAFA: If you look at the national economic statistics, South Australia is generally underperforming at the key levels, such as unemployment and retail sales. South Australia was probably hurt more than many of the states by the deleveraging cycle and the high dollar because manufacturing makes a higher contribution to the economy than it does compared to the other states. A number of industries are struggling, one of which is the car industry which South Australia is quite reliant on. So we face a number of challenges which are both structural and cyclical.

Our debt is increasing quite significantly, both in absolute and relative terms, whether you measure it as a proportion of revenues or GDP. Most of this debt is being used for infrastructure spending, as opposed to supporting operating deficits.

Justin Lofting, TCV: The Victorian economy has

Richard Jackson,QTC

John Powell,sAFA



benefited over a number of years from being very broad-based. Although we have a large manufacturing sector, we don’t have any dominant sectors, and this diversity has stood us in relatively good stead. Industries that have been in a cyclical decline for a long time such as autos are very stretched, so the priority is to move to the higher end of the manufacturing chain which the economy has been doing naturally.

We don’t have big resource exposures, but we do provide a lot of services into those sectors. The Victorian economy is currently growing at below trend, as the wider Australian economy is. Victoria’s housing market has shown some signs of a rebound. Prices have been holding firm for a couple of years now.

In terms of the government’s finances, our most recent budget was the first for a number of years where we didn’t see reductions in our revenue forecasts. In the past, we’ve continually had GST revenues coming in below forecast because people across the country have been spending less money, especially on GST-able items. But in the updates over the last six months we haven’t seen any downward revisions to our revenue forecasts.

Victoria’s governments have generally succeeded in keeping expenditure under control. Since 2009, when revenues have been about A$6bn lower than expected, the government has responded by cutting its cloth to fit in terms of expenditure. Victoria has been very successful in maintaining its credit ratings because of this fiscal discipline.

EUROWEEK: How does all this filter through into the states’ funding requirements?

Montague, Northern Territory: Our borrowing requirement has been relatively steady. We have approximately A$650m to raise this year, which is a relatively small amount compared to some of the states.

But it will keep us looking towards issuing in longer dated maturities, because the clients that we are lending to primarily use the funding for longer term projects. So where possible, we try to secure funding in the longer end of the curve.

Jackson, QTC: Our total requirement is rather larger, at A$12bn, including refinancings, with term debt comprising A$7bn. It is forecast to rise over the next couple of years, driven by a refinancing requirement, and then it will start to decline again in 2016-17, when the state’s new funding is forecast at only A$1bn.

Hext, TCorp: Our total programme this year is A$8.3bn, but A$3bn of that is rolling over short term debt, so we have about A$5.3bn of term debt. Only about A$3.5bn of that is new debt, with the balance being refinancing. So it’s a reasonably modest amount. Clearly the impact of the port sale recently has helped. But about half of our loans are to the regulated utility sector which are still expanding their balance sheets, but at a much slower rate than before. So a lot of the factors that pushed our borrowing programmes reasonably high over the last three or four years are starting to come back now.

Powell, SAFA: Our total borrowings this year will be A$6.2bn, and of that, A$1.6bn is new client loans, predominantly for the general government sector covering large infrastructure projects. Our forward estimates are that we’ll need to raise A$300m of new money next year and after that we’re due to have surpluses.

Hindmarsh, Tascorp: In terms of the demand we’ve seen from our clients, it is business as usual. The state government remains a net investor with us, rather than a borrower, and although there is a possibility that it will start to borrow from us in the foreseeable future, it has no plans to do so right now.

Most of our funding is refinancing of existing borrowings for the core electricity and water sectors. Our normal annual funding requirement is about A$1bn, but over the next 12 months it is only A$400m, which reflects the fact that we don’t have much refinancing to do in the next 12 months. Our next big refinancing will occur when our 2014 bond matures.

EUROWEEK: Has that reduced funding requirement been reflected in Tascorp’s spreads?

Tim Hext,TCorp

John Montague,NorTherN TerriTory



Hindmarsh, Tascorp: I don’t think the reduction in the funding requirement has affected our spreads. But over the last 12 months our spread to the other states has narrowed.

EUROWEEK: So the general trend is that financing requirements are modest and rising slightly over the short term, but falling over the longer term?

Lofting, TCV: Yes. Across the board we’re probably near the peak in terms of the level of semi-government issuance, which will be about A$10bn lower this year than we were last year. In Victoria we have a requirement of A$6.7bn in 2013-14, which is down slightly from A$7.2bn last year. The year afterwards we’ll be at A$5.5bn and the year after that we’re predicting A$2bn or A$2.5bn which is just refinancing client loans.

In Victoria the strategy is to build up budget surpluses which we can use to invest in infrastructure without increasing total debt. Over the longer term we’re looking to reduce debt.

We all have different numbers depending on our size and our starting positions, but ultimately all the states are aiming to move back to sustainable surpluses, which should mean less growth in debt going forward.

EUROWEEK: Is that also the case in Western Australia, notwithstanding the growth in the population and the infrastructure investment programme?

Collins, WATC: There are a couple of things going on in WA that make it different from most of the other states. Firstly, in spite of all the news about the commodity boom being over, it’s still growing quite significantly. Even four years out, capex plans are still higher than any other year prior to three years ago. So it’s coming off, but it’s still running at high levels, and we’re seeing production increasing.

Although estimates for WA’s GSP have been reduced from 5.75% this year, it’s still 3.25%, which is above the average and is still I think the highest level of growth among all the states.

We continue to face challenges arising from this

growth, and I’m glad a number of people around the table have mentioned GST and other taxes, because last year we generated A$3.5bn from GST, and in 2016-17 we’re projecting that we’ll get A$500m. But what’s really important is the aggregate support that WA gets from the Commonwealth, and including GST that’s going to drop by about A$2bn net between last year and 2016-17. So we have a higher population growth rate and a declining share in absolute terms of tax allocations, some of which is made up for by royalty income.

But we also have infrastructure requirements. In the last four or five years the infrastructure has been largely geared towards health and education. We have three new hospitals that are just about to open and over the next three to five years the emphasis will be on transport.

We expect to have about A$4.2bn of new funding requirements this year and we’re projecting approximately A$3bn a year for each of the next three years. The government is committed to spending 50% of the asset investment programme, which is about A$7bn a year, in cash, and the balance will be financed with debt.

WA has run operating surpluses for 12 consecutive years — before the asset investment programme — and is projecting a A$239m surplus for 2012-13. This year the projection is for A$389m and in 2014-15 the preliminary forecast is for a small deficit, although the Treasurer has said they have time to change that and he does not expect to be presiding over an operating deficit going forward.

This year we raised about A$8bn, of which A$2bn was in FRNs and the rest in term debt. Looking ahead we intend to extend our maturities. We’ve traditionally had one of the shortest weighted average terms of any of the states and we’ve made some small progress over the last few years to extend that average maturity by a little over half a year.

EUROWEEK: Turning to the bankers around the table, how would you describe the main features of the states’ funding programmes?

Andrew Koczanowski, HSBC: There is about A$200bn of semi debt outstanding, and the states are

John Collins,WATC

Justin Lofting,TCV



looking to issue about A$40bn per annum. The bank balance sheets are still the main buyers.

In rough numbers we think they hold about 40% of outstanding semi debt, most of which is in the four to five year tenor. So the trick for the semis is to increase that duration.

We think that if the banks are holding about A$80bn, then about 40% of the new issuance is also likely to be going to the banks.

In terms of offshore demand, most of the sovereign wealth funds and central banks would love to see the states issue in foreign currency. Yes, they have allocation to Aussie dollars but that is typically taken up by government bonds.

EUROWEEK: Roger, how do you position yourself in this market as an investor?

Roger Bridges, Tyndall: I think you need to treat semis as an asset class but look at them on an individual basis. About 18 months ago we were heavily invested at the short end of the semi market because we had credit limits on the major banks and semis were able to fill that gap.

I think semis have gone out as an asset class because of liquidity concerns and the market hasn’t really come back as much as one would have expected.

In terms of individual states, I wonder if Queensland has a credible deficit reduction programme. TCV and New South Wales have asset sales programmes but Queensland doesn’t.

The other point is that you buy semis because they have an implicit guarantee and because they will hold on to their ratings. The number one concern of overseas investors is their commitment to their ratings and South Australia put a little bit of a question mark over that last year when it said it would be prepared to see a lower rating in order to be able to spend on infrastructure. That’s all very well, but the trouble is that it puts the whole of the semis market under a bit of a cloud.

Simon Masnick, Westpac: I think about the market in supply-demand terms. The supply side is close to peaking because there’s not so much demand for new money any more, whereas demand is still there from

domestic ADIs who need to buy good quality assets to meet their liquidity coverage ratios. Semis very much fit that bill, so that demand base is still very strong, because if you’re a bank treasurer you want to avoid having a negative net interest margin on any product if at all possible.

Our experience offshore is that as Roger said people look at semis as a group or as an asset class. Given that the RBA has been easing and yields have generally been declining, people have been looking for the pick-up relative to governments, which is massive. So we’re seeing good demand offshore generally.

Also, investors offshore understand the semis story very well. As a result, when you meet an offshore investor today you don’t need to explain what fiscal equalisation means or what each of the states represents.

The demand side is still very strong but supply is starting to taper off, so structurally there are reasons to be constructive about the market, although of course there will be bumps along the way.

The market is quite efficient in pricing changes in credit quality quite quickly, as we saw after the WA change in outlook. Although Debra says she has a negative outlook on the sector as a whole, the weight of money argument suggests there is good reason to believe that spreads may have further to contract from here.

Apoorva Tandon, ANZ: I agree that bank balance sheets are the main buyers, but the depth of the offshore bid from central banks, and also from insurance companies and money managers from Europe and the US, has improved drastically.

From our side, looking at the way this demand has shifted, Asian participation for this asset class remains relatively steady. In Europe there are a number of key accounts that are making up a much more significant portion of demand than previously, and South American central banks also continue to participate steadily in select Australian dollar offerings. A number of key accounts have become sufficiently comfortable with the currency and with the semis’ credit profile, and to allocate into this market on a core basis. Clearly how they express that view varies on their current views around the currency and rates markets, but in

Roger Bridges,TyNdAll

Apoorva Tandon,ANZ



spite of the currency taking a hit recently and a lower rates environment, we are seeing those views being expressed in extension trades on a recurring basis. Australian dollars continue to be a more meaningful and steady component of investment portfolios globally.

In ANZ’s experience, there is no indication that demand for the currency or the product is starting to wane, so like Westpac we’re constructive on the prospects for this demand broadening over time.

Masnick, Westpac: One other important structural aspect that is sometimes overlooked is that these accounts are all buying the stock to hold. They’re not trading accounts that are constantly in and out of the market. They’re buy and hold investors who have made a long term allocation to the currency and the feedback we’ve had is that this isn’t likely to be reduced any time soon.

Lofting, TCV: Another attraction from an investor perspective is that there is probably more variety available in the semi market than there has been for a long time. Credit ratings range from Aaa to Aa2, so you can trade the sector versus supras and swaps and you can trade the semis against each other. Because we all have different issuance calendars and different maturity preferences, from an investor perspective I don’t think there has ever been more choice in terms of where they can invest along the semi curve.

Bridges, Tyndall: You also need to remember that credit spreads have come in considerably. In some cases and in certain durations spreads between Aaa and single-A have compressed a lot.

Koczanowski, HSBC: The willingness of borrowers to issue in floating rate format is also important. Although APS210 is still a year and a half away, demand for FRNs can only grow, not necessarily from the four majors but certainly from the foreign banks.

Powell, SAFA: We’re in an environment where the main buyers of semis’ debt are the banks, and the banks generally want floating rate exposure. At the moment we’re saying that because we want to issue fixed, the bank has to overlay a swap. But I think in the future we’ll see more and more borrowers issuing floating rates, because the bid is so much stronger. We’ve always been in the fortunate position of having a greater proportion of our debt in floating rates, which reflects the requirements of our clients. When you talk to the banks about fixed rate issuance in the five to seven year part of the curve they’re not very positive, but when you mention an FRN their eyes light up.

For the banks, unwinding a swap is becoming increasingly difficult. So it will be interesting over the next few years to see whether we will have to face the swap challenges as opposed to the buyer having to face that challenge.

Tandon, ANZ: That’s clearly very topical in terms of the challenges faced by SSAs in the global markets.

If you look at the US market, FRN issuance has been a huge component of Aaa supply this year. Again, the derivatives considerations and associated costs continue to drive growth of FRN format issuance.

Lofting, TCV: At TCV we’re largely a fixed rate borrower with very few floating rate loans. So we’ve only ever used FRNs when we felt they provided us with an advantage in terms of funding costs or liquidity. But the concern I have is that it still tends to be a short dated market. We’re building long term infrastructure so we want to have long term liabilities, whereas the FRN market is more of a five to seven year market, so we haven’t pushed it very hard. We prefer to issue long term fixed rate debt.

Hindmarsh, Tascorp: Part of our strategy over the last couple of years has been to borrow longer term, rather than maintaining the 80/20 mix of long and short term borrowing which we ran up until 2010. We’ve now pushed the average maturity of our debt out to 3.8 years which we’ve done by issuing in maturities of five years or longer over the last 12-18 months. When we ran the 80/20 mix the average was less than 2-1/2 years. Our expectation is that we’ll continue to concentrate our issuance in the five to 10 year range.

EUROWEEK: Could Tascorp issue 20 or 30 year debt if it chose?

Hindmarsh, Tascorp: We can issue longer dated debt, but there isn’t much client demand to go longer than 10 years. The electricity sector in Australia is regulated, the consequence of which is that very few companies want to take 20 or 30 year exposure. My guess is that that will remain the case.

EUROWEEK: On the subject of issuing long term debt, is there still a problem in Australia inasmuch as the CGS market is still relatively short dated?

Collins, WATC: There is liquidity in the semis market out to 10 years. The next phase is to develop a more consistent amount of liquidity in the 10-15 year sector of the curve, where there is some liquidity in the CGS market.

John Hindmarsh,TAsCorp



Victoria has issued one or two longer dated bonds, and other states are starting to do the same. It’s just a matter of developing the buy and sell-side liquidity out to between 10 and 15 years which will be a work in progress.

Masnick, Westpac: The AOFM has already identified extending the yield curve as one of its longer term objectives, and the semis are likely to be a close follower of what the AOFM does. There is demand at the longer end, although it is a lot more specialised, and the universe of investors becomes smaller the further down the yield curve you go. But in a low yield environment, if you’re prepared to pay a liquidity premium there will always be a market for that. Investors are looking for value wherever they can find it.

Bridges, Tyndall: One trend we’ve seen this year is the steepening of the yield curve, both from threes to 10s and beyond.

Roane, Moody’s: There is an active longer dated market in other countries. The Canadian provinces, for example, issue longer dated debt, as do US states and Japanese local governments.

Hext, TCorp: The problem is the superannuation system in Australia, which is not focused on achieving duration in fixed income. Everybody’s aware of the problem, and it’s discussed a lot, but progress is slow on that front. It’s not just that the cult of equities is stronger here than in most countries. It also has to do with the fact that there isn’t much institutional asset-liability management in Australia. You can see that in defined benefit funds and it’s even worse in defined contribution funds. If you try to have a discussion with anybody at a defined contribution fund about asset-liability management, the shutters go down.

The major reason we don’t have a long duration market here is that if you’re 50 years of age in Australia, apparently you don’t want a 30 year fixed interest bond.

Collins, WATC: A lot of that is due to the tax regime in Australia. Investors can get franked dividends

paying consistent returns that are preferred to the after-tax returns of fixed income. Franked dividends is one of the big differences between Australia and other jurisdictions. It changes the paradigm from the investor’s point of view.

Montague, Northern Territory: There is also more of a discussion in the superannuation sector about what sort of asset mix is most appropriate. Historically it has been 70/30 in favour of equities. Now funds are talking about ways of reducing that equity weighting as they approach retirement.

EUROWEEK: Debra, how important is diversity of funding sources to your ratings on the semis?

Roane, Moody’s: One of the factors we look at is the maturity of debt, and we regard it as positive for borrowers to extend their average maturities because it reduces their exposure to refinancing risk.

The semis recognise that they’re in a very low cost environment now and that there are benefits to be gained from locking in lower rates for a longer time. But the semis’ average maturities are still shorter than in most countries where we rate local government debt, which is a credit negative.

With regard to diversity, we view the states as having very strong market access. In addition to domestic demand for their paper, we have seen growing interest from central banks and sovereign wealth funds.

EUROWEEK: Going back to a comment made earlier by Andrew, is there any chance that we’ll see any of the semis issuing in foreign currencies?

Koczanowski, HSBC: The question as to whether the states will issue outside the Australian dollar market is one we’re asked very frequently.

The question is, what premium do you have to pay to issue offshore — and I suggest a good guide is what the major banks are paying. The premium they’ve paid for going offshore has probably been around 10bp-15bp. Is that a huge premium to pay in order to diversify your funding base?

Hext, TCorp: Our situation is very different to the banks, which need offshore markets because they can’t raise all their funding domestically. They couldn’t even try. Collectively, our funding programmes are much more modest.

It all comes back to investor preferences. Globally, investors’ preference for triple-A or double-A+ rated debt has been for Australian dollars, which has been reflected in our cost of borrowing. It’s not structural that it’s cheaper for us to borrow in Australian dollars than offshore; it’s cyclical. At some point, the cycle will turn and Australian dollars will become less attractive.

The banks’ borrowing needs are becoming more modest, driven by lower credit growth and higher retail deposits. So the basis swap will come in, and when it does, borrowers with US dollar programmes may well look at opportunities.

Simon Masnick,WesTpAC



Andrew says the premium may be around 10bp, which would be more interesting to us, because up until now it’s been more like 30bp or 50bp.

Koczanowski, HSBC: As new borrowers, the semis would probably have to start by paying 20bp or 25bp, but the premium would fall fairly quickly.

Lofting, TCV: We’re all interested in increasing our number of investors. The reason we’ve been able to achieve that in the last few years is because the universe of Australian dollars investors has just exploded. Just think of the number of central banks that never bought three or four years ago but buy Aussie dollars today because it’s now a reserve currency. Originally some of the big Asian central banks were buyers but they have now been joined by many of the Europeans.

Jackson, QTC: On the subject of diversification, two years ago we incorporated a 144A capability into our domestic Australian dollar bond programme so we can sell primary issuance on day one to qualified US investors. That has opened up a new market for us, and we have seen a big increase in the number of new names participating in our deals out of the US. That’s an area of opportunity that we see in Australian dollars. So far, we’ve issued three new Australian dollar benchmark bonds with that 144A capability.

Collins, WATC: We’ve had an EMTN programme for 15-20 years. We haven’t issued off it for six or seven years but we continue to update it every year, so if an opportunity were to come to us next week we’d be ready to go because we have all the necessary infrastructure in place. But for both short and long term issues we would always price off the Australian dollar curve, so like Quebec we would only use non-Australian dollar issuance as an opportunistic source of funding.

In very short term funding we do sometimes find funding opportunities internationally that are cheaper than the Australian dollar market. This gives us an exposure to investors in non-Australian dollar currencies in other parts of the world, which could potentially be EMTN participants if the premium came back to 10bp. But at the moment, when it’s

25bp-50bp, we haven’t felt the need to. And as Justin said, there are already so many diversification opportunities that we almost can’t keep up with them all in terms of marketing.

Hext, TCorp: I agree. Over the last few months we’ve seen sizeable net selling of our bonds by Japanese investors, but this has had no impact at all on our spreads. If we’d seen these levels of volumes coming back from Japan 10 years ago, it would have been very disruptive.

Today, it is having no impact because diversification opportunities for Australian issuers are stronger than they have ever been, by a country mile. We saw that in May when we priced a 10 year deal, about 40% of which went offshore with six central banks and a number of international fund managers participating. It was an extraordinarily well diversified book.

Hindmarsh, Tascorp: When we’ve done syndications in the past two or three years, we’ve also been seeing a growing level of interest from offshore. Some 16.5% of our most recent A$500m issue, for example, went offshore. Most of the offshore buying was accounted for by European investors, many of which were new to the Tascorp credit.

The offshore interest wasn’t represented by one or two investors ramping up their exposure to Tasmania; it was more investors joining the existing group that has been buying Tascorp since 2009 or 2010. Tasmania did not issue offshore at all prior to 2008, when legislation was changed, so in five years we’ve gone from zero to 16.5%.

Jackson, QTC: We all have the facilities available to access these markets if an opportunity arises for us to do so. But I’d be interested to hear how Roger would feel as a domestic investor if we were to issue in foreign currencies and pay a premium.

Bridges, Tyndall: I don’t think anyone would worry about that, because there’s still plenty of supply out there. The market’s not like it was five years ago when there was very little supply. I personally think the Australian dollar corporate market is going to grow because of the cost of the basis swap, so there will be no shortage of supply. If that changed, I wouldn’t be happy. The banks would stand to lose the most if the states started to issue offshore in a major way, because they would have a shortage of liquid assets. I’d probably be happy because spreads on my semis would be coming in.

Hext, TCorp: The credit market will probably be the growth area going forward. There’s much more potential supply in the triple-B/single-A space than there was five year ago. More local issuance should take some of the pressure off the basis swap.

We did over $1bn of 30 year issuance in 2009-10 when the basis was inverted, so opportunities do appear for various micro reasons and it’s just a question of taking advantage of them. But as we collectively have smaller programmes, why would you issue offshore if you only have A$5bn to raise? s

Andrew Koczanowski,hsBC

financial institutions


Bank issuance in australia has been curtailed by one thing: banks just don’t need the money. in stark contrast to other developed world nations, aus-tralia’s banking sector is well capital-ised, healthy and secure.

Moreover, the trend of recent years has been for banks to bolster their bal-ance sheets through amassing retail deposits rather than by looking for funding. indeed, there has been lit-tle short of a bidding war over retail deposits in recent years.

“Banks are happy to pay over the money for retail deposits: they are paying a lot more than they would for wholesale deposits,” says John chau-vel, head of debt capital markets at Westpac.

“The wholesale funding require-ment of the australian major banks is driven by the interplay between deposit growth and asset growth,” says Paul neumann, associate director at uBs. “Over the past few years banks have experienced a slowdown in asset growth and have funded the assets with a greater share of deposits. as a result, australian banks are less reliant on wholesale funding markets, and this has enabled them to become more opportunistic and price-focused when assessing their funding options.”

This is the main reason that austral-ian bank issuance of domestic covered bonds appeared to vanish between March 2012 and august 2013 until anZ re-opened the market (see sepa-rate article for more on covered bonds).

Banks simply have no inclination to pay up for funding that they don’t need.

“credit growth remains pretty sub-dued overall, and what credit growth there is, is largely funded by deposits,” says steve Black, working in debt capi-tal markets at credit suisse.

still, australian bank deals remain the most significant bond issues around. according to Dealogic, of the top 10 global australian dollar denomi-nated deals in 2013 up to early august, eight were from the banks, either in senior debt or mortgage-backed issues, with the only two exceptions being the new south Wales Treasury corp and the commonwealth of australia itself. Westpac and commonwealth Bank

of australia have launched deals of a$2bn or higher this year, and inter-nationally all four have been active across a range of currencies.

Active againThere has been a sense of banks pull-ing themselves out of torpor and look-ing more closely at the markets again in recent weeks. “Very recently, we have seen a small tick up in mortgage lending, and after a very quiet period, the banks have taken the opportunity of a stronger market backdrop to raise

some term funding both domestically and offshore,” says Black.

This has manifested itself in interna-tional issuance in particular. since late July, Westpac and naB (with a $2.6bn three and five year deal) have issued in dollars, naB in euros (€650m three year floater), and cBa and naB in ster-ling (a £300m and £500m three year FRn, respectively).

“There has definitely been greater activity for the majors recently in off-shore markets,” says adam Gaydon, director, syndicate at anZ.

also, as the banks report their results and move in to new fiscal years, they are likely to move to new issuance pro-grammes. “Three of the australian bank majors have their full year-end at the end of september,” says Duncan

Beattie, managing director, debt capi-tal markets at JP Morgan. “These banks are typically more active in the first half of their fiscal years, so we expect them to be quieter in august and september and then more active post-results in late October, early november.”

choice of market will, naturally, depend on cost. “australian banks con-sider a variety of factors when choos-ing which trades to do, and in senior funding right now, the clear standout remains the us dollar market,” says Beattie. “However, some trades make sense in other markets,” he says, point-ing to the cBa sterling and naB euro FRns, which both worked well. “else-where, yen is pricing at a level that makes less sense.”

australian banks may also find their hands forced as it becomes harder for them to offer high rates on retail depos-its as the Reserve Bank of australia cuts rates. if that in turn leads to retail money leaving deposits and going into other investments, banks will have to reconsider their funding mix.

“it’s going to get harder [for banks], as yields come down and retail inves-tors reallocate back into equities to maintain the returns they need to fund their retirement,” says chauvel.

Meanwhile, issuance in austral-ian dollars by foreign banks has been robust. This is covered in greater detail in the kangaroo bond article elsewhere in this report, but recent examples have included successful deals from RBc, Goldman sachs and OcBc, while standouts earlier in the year includ-ed Wells Fargo, Bank of america Mer-rill Lynch, citi and — most striking of all — national Bank of abu Dhabi. Gaydon says that by the end of July there had been 30 financial institution issues from 21 issuers this year: eight domestic, 13 from overseas. Those 13 broke down as six from the us, two from europe, four from asia and one from the Middle east. One of the most interesting parts of the domestic market for financial institu-tions is retail, which has shown a hun-

Australia has one of the world’s strongest banking systems. Its leading banks are in good shape, fattened by retail deposits, so have not needed as much wholesale funding as in previous years. But will this change as falling interest rates cause retail to flee deposits? And where do new Basel III-compliant hybrids fit in?

Fighting for retail

“Investors have been very comfortable

with the underlying credit and regulatory

oversight; that’s what’s supported patronage of the

issues”

Allan O’Sullivan, Westpac

financial institutions


ger for hybrid securities. Hybrids in general hit a record a$13bn last year, and all but a$3.5bn was from financial issuers. in particular, as Basel iii rules have come into effect in australia, retail has proved by far the most will-ing market to provide regulatory com-pliant bank capital.

early in the year Westpac and naB issued close to a$3bn of Basel iii com-pliant tier one securities between them, but the most significant deal came in april when suncorp launched a Basel iii compliant tier two deal.

“That was the first time we had a prudentially regulated australian bor-rower issue compliant tier two,” says allan O’sullivan, director, syndicate at Westpac, who specialises in these secu-rities. since then, Macquarie and anZ have followed with tier one deals, and Westpac with an a$850m tier two.

While institutions are not exclud-ed from these deals, the fact that they are listed has lent them towards retail. “What’s linked these issues is that investors have been very comfortable with the underlying credit and regula-tory oversight; that’s what’s support-ed patronage of the issues, rather than investors understanding all the nuanc-es of non-viability and conversion con-ditions under the Basel iii landscape,” O’sullivan says.

That is partly because australian retail is quite used to hybrid bank capi-tal issues; by 2008, every major bank, and several not-so-major banks, had issued regulatory capital. But it does lead to some concern about whether investors fully understand what they are buying. There is a fear that they simply like the yield and trust the names. “There isn’t a consensus among investors that prescribes what a non-viability premium should be,” says O’sullivan. “investors assess the quality of the name and its balance sheet.”

With such willing buyers in retail,

australian institutions have not yet engaged with tier two. “it’s fair to say that in australia, institutional partici-pation in tier two Basel iii-compliant securities is marginal,” says O’sullivan. “For many that’s because their price expectation is wider than any borrower is prepared to pay.”

consequently, it may be a while before anyone sees tier two issues out-side the retail market. “i wouldn’t rule it out for the second half of this year, but it will more likely be 2014 before the banks raise tier two in the new style with equity conversion if banks have become non-viable,” says Beat-tie at JP Morgan. “My sense is that off-shore investors have rationalised the new approach more than the domes-tic market. Here, the only new-style trades have gone to the retail market, avoiding having that conversation with institutions.”

Tier one focusin the long term, Beattie thinks that’s counterintuitive. “i think if you are going to sell sub debt to retail, you should focus on tier one. That’s the most expensive form of capital, so you should raise it in the cheapest mar-ket. There is a finite capacity to retail demand in australia, so tier two might go offshore.”

Rupert Daly, head of hybrid capital at Deutsche Bank, is thinking along the same lines. “Do the majors attempt to issue all their capital instruments domestically or see them also as an offshore product?” he asks. “clear-ly they are going to issue hybrid tier one here — and have been doing so — because it’s cheaper to do so versus offshore. is there sufficient demand in the domestic market to absorb tier two capital requirements from all four majors as well? Time will tell.”

The differences Basel iii brings will be digested in a different way to else-

where in the world. “capital instru-ments that have been issued in aus-tralia have been different from most european transactions,” says andrew Buchanan, head of hybrid capital at uBs, which was structuring adviser on the suncorp tier two deal and an arranger on Westpac.

“all australian capital transactions that have included the non-viability triggers convert into equity rather than being written down if the non-viabil-ity trigger occurs.” investors should receive ordinary equity in those cir-cumstances, rather than being writ-ten off as they probably would be in europe. it is unlikely that any austral-ian major bank will hit a non-viability event, Buchanan argues, but if it did, “investors should get some value back.”

anZ’s Gaydon points out there were around $19bn of australian dol-lar redemptions coming up in august, many of them in the financial institu-tion sector, and there is clearly still a buoyant market to support issuance. He says there is a strong bid between three and five years for financials — typically floating in the threes, with good balance sheet support, and either floating or fixed on the fives, with more real money — and notes that inter-national participation in aussie dol-lar issues from the banks is robust too. “it’s a yield play for many private bank investors, as australian interest rates are still comparatively high on a global basis,” he says.

and issuance ultimately will be dic-tated by the changing nature of the banks themselves and their balance sheets. “One trend we are seeing here is the migration of investment grade borrowers in the capital markets,” says chauvel. “Here, a lot of borrowers who used to rely on bank markets for their core funding are now looking to the capital markets for funding instead; they use the banks for liquidity, work-ing capital, hedging and underwriting.

“That will force bank balance sheets to go down the curve a little bit into more sub-investment grade, and to play more aggressively in acquisition financing and infrastructure financ-ing. and while banks might tilt their balance sheets towards infrastructure, i also see a lot of brownfield infrastruc-ture projects with a proven track record that can start shifting their fund-ing into capital markets themselves.” When balance sheets change direction, so too will funding mixes. sSource: Westpac

Basel III requires all forms of regulatory eligible capital to absorb losses

Subordinated Tier 2 Dated Mandatory (subject to At the PoNV

debt Solvency), cumulative

Deeply sub ADT1 Perpetual Optional, non- At the PoNV or

ordinated cumulative at a pre-specified

(e.g. convertible trigger breach

preference share) (minimum trigger

of 5.125% CET1)

Security type Regulatory Maturity Coupon Loss absorption capital obligations - Timing

covered bonds


The launch of the covered bond market in australia was a long time coming, and a source of considerable fanfare when it did. Odd, then, that in the first half of this year it vanished as fast as it had arrived.

Well, not so odd, on closer inspection. Between mid-January and mid-March 2012, commonwealth Bank of austral-ia, Westpac and anZ raised more than a$10.5bn between them in the domes-tic covered bond market, to get their issuance programmes underway. Since then, they haven’t really needed the funds — from covered or unsecured markets — and so haven’t rushed back.

“If you can issue unsecured into a competitive market you will always do that first,” notes John chauvel, head of debt capital markets at Westpac. “Only when senior unsecured becomes more expensive, during a moment of illi-quidity, do you bring out your covered bonds programme for funds.”

adam Gaydon, director, syndicate at anZ, agrees. “There has been a pla-teauing of issuance,” he says. “We do expect over the second half of the year to see some issuers look at opportuni-ties in australian dollar covered bonds. There’s strong demand for the product, as three of the domestic banks raised more than a$3bn each last year with oversubscribed books. So it’s not a question of demand, but what time it is appropriate for them to come.”

Speaking in early august, he has since turned out to be right, as on august 9 anZ brought the first domestic covered bonds from an aus-tralian bank for a year and a half, issuing a$700m of 5% notes maturing 2023. This was a striking deal: 10 years is twice the maturity of the longest tranches in the early

2012 deals, and unusual for bank capi-tal markets funding in australia. Doing so cost the bank 100bp over swaps.

This opportunistic dipping into the market is likely to remain the pattern.

“covered bonds have become a fun-damental part of banks’ funding, but there is a limit on how much they can do because they have a capacity con-straint from aPRa,” says Steve Black, head of bank capital at credit Suisse. “Banks have plenty of headroom to keep going and it will take years before they bump up against these limits.”

Grant Bush, head of capital markets and treasury solutions at Deutsche Bank, calls the process “a balance between attractive funding today and keeping some powder dry for a product that works through the cycle if we do see a deterioration in markets.”

The locals apart, the covered bond market has offered funding to a range of foreign issuers, most recently Royal Bank of canada, which issued a$1.25bn of three year floating rate notes in July. Before that, issuers have included Stad-shypotek (for Svenska handelsbanken), cIBc, Bank of nova Scotia and DnB.

Time healsThe other side of the question is aus-tralian banks issuing in international

markets, chiefly europe. “The euro cov-ered market is the deepest historically: it’s where the covered bond markets started,” says Duncan Beattie, manag-ing director, debt capital markets at JP Morgan. “In the uS the covered mar-ket is also available, mainly in the three and five year parts of the curve, but euros offer a deeper market.”

The australians arrived with some gusto, in late 2011, coinciding with mis-erable market conditions in europe.

anZ and Westpac raised $2.25bn between them in deals which went well but quickly sank in the secondary mar-ket, prompting one banker to accuse them of “blowing up the market before it even started” among bitter recrimi-nations about inappropriate aggression and overconfidence.

Still, time heals, and cBa and naB — both of which immediately postponed deals in the fallout — were able to come back successfully in January 2012, rais-ing €1.5bn and €1bn respectively in consecutive days.

Just as in the domestic market, issu-ance then dropped back, as the banks contented themselves with having set their programmes up and waited for the time to be right to issue again.

cBa in particular made use of the market, issuing again in euros in april

2012 and then in sterling that august, raising 7£50m in a 14 year bond that remains the longest-dated australian cov-ered bond.

The most recent addition was a €750m 12 year deal from naB in May.

australian use of interna-tional versus domestic mar-kets will depend on tenor and pricing, but they might do more abroad than at home.

“It could well be that deals happen more offshore than onshore,” says Steve lam-bert, executive general man-ager, global capital mar-kets at naB. “It depends on demand.” s

Covered bonds from Australian issuers arrived first in Europe in late 2011 and then domestically in 2012. Since then, issuance has quietened as the banks have bedded in their new programmes. Future deals will be opportunistic because, right now, the banks don’t need to pay up for funds.

Waiting for the moment

Issuer Deal value Deal Pricing Deal Bookrunner Parent $m DateANZ 635 09 Aug 13 ANZ

Royal Bank of Canada 1,155 30 Jul 13 NAB, RBC, ANZ

Suncorp-Metway 621 01 Nov 12 Deutsche, ANZ, Citi, Macquarie

Stadshypotek 471 21 Sep 12 RBC, HSBC, CBA, Westpac

Stadshypotek 314 21 Sep 12 RBC, HSBC, CBA, Westpac

Suncorp-Metway 492 30 May 12 UBS, Deutsche, RBC, Barclays

Suncorp-Metway 1,083 30 May 12 UBS, Deutsche, RBC, Barclays

ANZ 1,049 16 Mar 12 ANZ

ANZ 2,098 16 Mar 12 ANZ

Westpac Banking Corp 535 17 Feb 12 Westpac

Westpac Banking Corp 1,471 24 Jan 12 Westpac

Westpac Banking Corp 1,786 24 Jan 12 Westpac

CBA 2,060 17 Jan 12 Commonwealth Bank of Australia

CBA 1,545 17 Jan 12 Commonwealth Bank of Australia

Covered bonds in A$ issued — Jan 1, 2012-August 12, 2013

Source: Dealogic

Focus on What MattersAs markets evolve and sources of risk change, Moody’s helps you keep pace. Our credit experts put events in context, combining unparalleled service with timely research and insight that provides through-the-cycle perspective on credit. The result? More time to focus on the decisions that matter for your business and investments.

For more information visit moodys.com or call +44.20.7772 1900.

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Financial Institutions Roundtable

Participants in the roundtable were:

Peter Dalton, head of syndicate, debt capital markets, Westpac Institutional Bank, Sydney

Andrew Duncan, director, financing solutions group and debt capital markets, HSBC, Sydney

Natasha Feder, senior credit analyst, Colonial First State Global Asset Management (CFSGAM), Sydney

Adam Gaydon, director, syndicate ANZ Global Markets, Sydney

Tim Hughes, treasurer, Suncorp Bank, Brisbane

Matthew Macreadie, investment manager, Aberdeen Asset Management, Sydney

Simon Maidment, head of group funding and liquidity, Commonwealth Bank of Australia (CBA), Sydney

John Needham, head of capital and structured funding, group treasury, ANZ, Sydney

Tano Pelosi, portfolio manager, Antares Capital, Sydney

Guy Volpicella, head of structured funding and capital, group treasury, Westpac, Sydney

Patrick Winsbury, senior vice president/team leader, financial institutions group, Moody’s, Sydney

Phil Moore, Moderator, EuroWeek

High quality assets, strong regs leave banks in fine condition

Australia’s leading banks emerged from the global financial crisis in better shape than many of their international peers. But some analysts still question the banks’ perceived over-dependence on wholesale markets and their exposure to a housing market regarded by some observers as frothy.

To date, local and international investors in the senior unsecured, covered and subordinated bond market remain relaxed about these potential vulnerabilities, which were discussed in the EuroWeek Australian Financial Institutions Roundtable, which took place in August.

EUROWEEK: Why are Australian banks in such fine fettle?

Simon Maidment, CBA: The standout differentiating factor of the Australian banking sector since the global financial crisis has been asset quality. The further improving trend in loan impairment expenses has been beyond what people expected six to 12 months ago.

Forward indicators like mortgage arrears, which for most of us is our biggest risk, are still show some improving trends — which is encouraging given that unemployment has ticked up over the last six months.

This has partly been driven by the fact that monetary policy has been easing, which takes some of the pressure off in terms of mortgage repayments, but also reflects the Australian mantra of pay off your mortgage as soon as you can.

From a wider perspective, one of things that has tended to got lost in the midst of the recasting of the regulatory environment, be it in the focus on capital or liquidity risk, is that ultimately banking is about writing good quality assets. The Australian banking sector has continued to write good quality assets, and hence profitability has remained robust.



Guy Volpicella, Westpac: The quality of the assets is also determined by the type of assets banks hold on their balance sheets, and Australian banks’ predominant holdings are residential mortgage assets.

When you also take into account the regulatory and legal framework of those assets, being a full recourse market and regulated by the National Consumer Protection Bill, creates a backdrop where speculative investment is limited and where the quality of those residential mortgage assets are of better quality than you see offshore.

John Needham, ANZ: The economic environment has been benign and credit growth has been relatively flat. So conditions for the banks have been pretty good. Looking ahead, the threat of rising unemployment is perhaps the key issue. But in the Australian economy there is scope for using monetary policy to allow the currency to weaken, which is very helpful for the SME and non-mining sectors. So we should see a pick-up in the rest of the economy to counter those negatives.

EUROWEEK: How much would a Chinese slowdown impact the Australian banking industry?

Patrick Winsbury, Moody’s: There is a link at the macro level between growth in China and in Australia, and there is no doubt that the Chinese stimulus pulled us through the global financial crisis to some extent.

But a floating currency is an enormous stabiliser. It worked very well for us during the global financial crisis and we have seen it starting to work again.

There will be some challenges in the economy as we move from an investment-intensive phase to broader economic development. Yes, we still have some room to move on interest rates. But it has taken a lot of interest rate movement to create a very small housing stimulus so far. The impact of interest rate movements has been far smaller than in previous cycles.

The good news is that the banks are entering a period of slightly more subdued growth.

The key credit issue for the banks is that they are still quite reliant on wholesale funding, although this has been reduced, especially offshore.

So the question arising from the housing market is whether if it experiences volatility, it will have any

effect on foreign investor confidence.

Tano Pelosi, Antares: We’ve had a set of fortuitous circumstances in that we had a household sector that delevered into a terms of trade shock with China that is perhaps one of the best terms of trade shocks this country has ever seen.

This allowed the savings rate to rise to 10% without creating a major contracting impact on the economy. The bigger question going forward is, what happens when your major driver of growth predominantly comes from one narrow sector of the economy? This is the issue that the RBA is now grappling with as we make the transition to the non-mining sector acting as the future engine of growth.

From a negative perspective, you do wonder how much more ammunition the central bank has, given that it has already cut by more than 200bp. So the question arises about what happens in a crisis if China comes off the rails very quickly. Will the central bank still be able to get us out of trouble?

Natasha Feder, CFSGAM: I think the real challenges are yet to come. Hopefully we won’t see a 1990s style crisis, but with a rising unemployment rate and an RBA rate as low as it is, there isn’t that much leverage left to use.

Matthew Macreadie, Aberdeen: We’re at a low in the credit cycle, and our concern is negative flow-on effects from a weaker China may mean that banks’ loan loss provisions are slightly understated. Given headwinds in light of Basel III and the need to maintain dividends for shareholders, pressure could be put on asset quality some time down the track.

Volpicella, Westpac: Going back to the comparison with the 1990s, the types of issues that caused the crisis then are very different to the ones we see today. In the 1990s there was a vast increase in commercial property lending, a substantial portion of which was speculative investment, with valuations assuming near full occupancy, despite there being little or no pre-letting. You don’t see that any more in Australia.

One of the questions we started with is why the banks are in such a good position today. One of the reasons is that we learnt so many good lessons in the 1990s. The reason the assets on our books are performing well is not just because of their quality. It is because of the solid underwriting foundation behind them, and because of the amount of equity that is required to be injected into any housing or property development. That will naturally create a buffering effect if there is a downturn in the economy.

Feder, CFSGAM: I take your point about the 1990s. But each crisis is unique. The banks have all studiously reduced their commercial property exposure over recent years. But the next black swan will be something else.

Maidment, CBA: Banks in Australia have incurred losses not on their secured mortgage portfolios but on

Guy Volpicella,westpac



their unsecured books. We’ve talked about deleveraging in the household

sector, but the more significant deleveraging in Australia from a credit risk perspective has been in the corporate sector. Corporates delevered in 2008 and 2009 and they haven’t relevered. In many cases they have come out of a challenging period in good shape because of their low level of leverage.

One challenge for the economy at the moment is fiscal policy. We have large pressures on all political parties to turn a deficit position into a balance. Post-election it will be interesting to see how this plays out — in other words, will automatic stabilisers be allowed to work? If the economy is slowing then it’s natural for the fiscal position to weaken, which takes some pressure off the monetary side.

Volpicella, Westpac: More easing in monetary policy will probably lead to a further reduction in the exchange rate as well, so there is a double benefit there. The weaker currency should help to rebalance the economy, and if China continues to slow down there should be a further reduction in the exchange rate which will also support the rebalancing.

Maidment, CBA: The point we make when we visit investors overseas is that mining directly accounts for only 8% of GDP. Clearly it accounts for a lot more on an indirect basis, but Australia is a diversified, services-based economy. We do have a manufacturing sector, although parts of it have been stretched by the strength of the currency.

Many people offshore tend to think all we do is dig holes in the ground to sell resources to China, which clearly is not the case. There is a challenge coming in terms of the run-off of mining investments, the share of which as a proportion of GDP is probably not sustainable. But once that investment slows, production will start to kick in.

If you look at export we’re not seeing a significant decline and the Australian dollar income from this is boosted by the weakening currency. Moreover, LNG exports are coming in to replace some of the coal and iron ore exports, so the story is more robust than people give it credit for.

Tim Hughes, Suncorp: Putting the China story into perspective, it’s still looking at 7% growth. The rest of the world is desperately trying to achieve half that rate. The Australian economy is still going to be doing relatively well on the back of China. But it is important to recognise our economy is more diverse than mining and China. Yes, it may be a bit slower, but I’m sure we’ll see a stabilisation in the mining industry and growth in other sectors over the next couple of years.

But I agree that there is a misunderstanding offshore that everything in Australia revolves around China. As Simon said, we have many other businesses that aren’t linked to Chinese demand for mining products.

For example, with the reduction in the value of the dollar we’ll start to see demand for education programmes coming back. We’re starting to see that in Queensland, where we’re a big educator of overseas students.

Andrew Duncan, HSBC: I agree that Australia is more diversified than people think. But focusing on commodities, let’s not forget about the importance of Japan, which is a key trading partner that is now going through an expansive fiscal phase. Japan clearly has issues with nuclear power and is a massive importer of LNG. Much of the production capacity will go naturally into the Japanese market. In the short term at least that will help us rebalance our exports.

And we expect what’s happening in Japan and China to fan out and have a major impact on Korea, Singapore, Malaysia and the rest of the Asean region, which is our biggest export market. It’s not just a China story.

Peter Dalton, Westpac: Just to add to what Simon said about overseas investors underestimating the diversification of the economy, I’m undecided about that. We’ve been talking about this for years. I’m probably a bit more bearish about the diversification of the economy.

Macreadie, Aberdeen: Some of our manufacturing industries haven’t managed to be cost-effective, so perhaps we need some structural reform in those industries to increase their efficiency before they can offset the weakening mining sector.

Simon Maidment,commonwealth Bank of australia

Peter Dalton,westpac



Pelosi, Antares: The issue is whether there are other parts of the economy that are able to fire at this time. If this was an eight-cylinder motor vehicle, it looks as though only one or two cylinders are firing at the moment.

The two key drivers of growth in recent years were essentially the terms of trade, and the capex in the mining sector. If you argue that they are unlikely to hold up, you need to have other parts of the economy to come back and make up the shortfall.

Adam Gaydon, ANZ: We’re clearly going to have to see an increase in productivity over the course of the next few years. Productivity growth over the last five to 10 years has been flat to negative versus the improvement in the late 1980s and early 1990s.

If the mining sector slows down, it will create an opportunity for some other industries. Some of those sectors such as manufacturing will be helped by the weaker Aussie dollar but we still need to make improvements in productivity growth, so that the cylinders that aren’t firing can reach their maximum potential.

EUROWEEK: What about the outlook for unemployment and its impact on the housing market, which some economists fear is vulnerable to a correction?

John Needham, ANZ: The key fundamentals in the housing market are robust. Vacancy rates are low; rental activity is strong. Other than in a few pockets of weakness in some areas where there have been higher levels of supply such as apartments in the docklands area or southeast Queensland, there is a shortage of housing stock. This is underpinned by continued population growth, both natural and immigration driven, which feeds through to supporting the fundamentals of the property market.

With interest rates continuing to fall, you’d expect the property market to remain relatively strong, notwithstanding what’s happening with unemployment.

Gaydon, ANZ: Since 2010 we’ve seen a softening in

the Australian residential market in terms of prices and auction clearance results. However, we have recently started to see monetary policy have a positive impact on the housing market nationally, and in certain markets like Sydney we’ve seen auction clearing rates of above 80%, which is a level we haven’t seen in recent years. It’s all about confidence, and I believe successive reductions in official interest rates are making consumers more confident.

Dalton, Westpac: As soon as we see unemployment rise, rates will fall further, and confidence will improve.

Volpicella, Westpac: People will only sell their house if they’re forced to. The amount of equity they have and the residual amount of their mortgages provide an important buffer preventing that from happening.

If a reduction in the mining sector creates a retraction — as opposed to slower growth — in the Australian economy, such as we end up with a deep recession, then yes, it will hurt, just as it is hurting in Europe. But one of the things mitigating that is that we don’t have an overheated market with a flood of new housing supply.

Another positive factor is that we don’t have households levering themselves up. We’ve had the exact opposite, which is healthy. Consumers have been behaving conservatively in spite of the strength in the economy and the mining sector.

Maidment, CBA: This goes back to the correlation between arrears and employment, which hasn’t behaved as you would expect it to. We haven’t seen materially large increases in unemployment, but over the last two years we’ve had an interest rate cycle that has made it easier for borrowers to pay down their mortgages. Some 80% of our borrowers are ahead of their scheduled amortisation by an average of seven payments. Combined with conservative origination LVRs, that’s a significant amount of embedded equity.

Feder, CFSGAM: I don’t think it has been sufficiently explained to overseas investors how far Australian borrowers are ahead in terms of paying down their mortgages, and the speed of the prepayments.

You only need to look at how popular Australian RMBS are to see how significant this is, and how much equity we have in our homes because of our behaviour. That needs to be sold more to international investors.

Needham, ANZ: When we’re overseas meeting investors we spend a lot of time talking to them about the nature of the Australian mortgage market. We explain that most of them are floating rate mortgages, which means that in a falling interest rate environment scheduled repayments fall. However, most people keep their repayments constant so amortise their principal more quickly. Effectively, the extra cash flows straight through to borrowers’ pockets.

That also means that monetary policy can have a very rapid transmission effect on the economy.

John Needham,anZ



Volpicella, Westpac: It’s true that it has a direct effect on the resilience of the economy. But the other point is that our tax system encourages us to put money into our home loan equity, which is also positive.

There is a big difference between the environment here and in the US where there’s no tax incentive for people to pay down their mortgages. There is every incentive in the US to gear up to the maximum, which almost gives borrowers a free option, because if prices don’t rise and rates go up you just hand the keys back to the bank. We don’t have that backdrop in Australia.

EUROWEEK: Why do some commentators argue that the Australian housing market is heading for a crash?

Pelosi, Antares: They base their argument on comparing Australia with other property markets. They look at debt levels as a proportion of household income and question whether levels of 150% can be sustained indefinitely, which is a valid question when you look at what’s happening in other jurisdictions.

But whether by good luck or good management, we didn’t have a sub-prime crisis in Australia, which is one of the reasons we came out of the global financial crisis in a better shape than many economies.

Hughes, Suncorp: During our recent roadshows there has been much less discussion about the Australian property market. Offshore investors are starting to understand that arrears remained stable and in some cases improved at a time when the economy was slowing. We explain that most people have their mortgage payments automatically deducted from their bank accounts. When interest rates are reduced by their banks they don’t normally adjust their repayments, so the majority of people do get ahead.

We’ve also found in our roadshows that for all these reasons, international investors are very comfortable with buying Australian RMBS.

EUROWEEK: Has this been reflected in pricing of RMBS?

Hughes, Suncorp: We find pricing tends to be driven predominantly by what’s happening in offshore

markets. There has been a substantial positive correction in the Aussie RMBS market over the last 12-18 months. Is there more to go, or should there be more to go? I think so. At current levels, any Aussie issuance is extremely well supported from offshore, which suggests that our spreads are attractive and offer the yield play that overseas investors are looking for.

Volpicella, Westpac: Across the board, you probably won’t see any investor not invest in Australian RMBS because of the credit quality. None of the European, US or Japanese investors has any concerns about credit quality. They base their decisions on relative value of the pricing.

This is why there are now so many more investors buying Australian RMBS than there were 12 or 18 months ago. We’re seeing more than double the number of investors coming into deals compared to a year ago.

EUROWEEK: Domestic and overseas investors?

Volpicella, Westpac: Both. An unintended positive consequence was that as many new investors came into the Australian dollar covered bond market they analysed the RMBS pools by osmosis. As a result, they realised that behind the covered bonds were portfolios of very good quality mortgages.

It typically takes a lot of time and effort for investors to analyse an RMBS pool’s track record, and determine whether or not they want to buy Australian mortgages. But they’ve been able to set up that infrastructure because of their investment in covered bonds, and as the prices of those covered bonds came down more and more, they began to recognise that they could get a good yield pick-up by investing in discrete RMBS transactions.

So as a result of Australian banks being able to issue covered bonds, we’ve ended up with a broader universe of investors that are more and more aware of the resilience and quality of the RMBS product we’re issuing.

Gaydon, ANZ: As from the beginning of last year when the first Aussie dollar covered bonds were issued, we saw a very strong rally in the performance of covered bond spreads and then correspondingly in senior unsecured spreads for Australian ADIs.

The one asset class that lagged this rally was Aussie dollar RMBS. We started to see a correction around last September which was driven in part by offshore investors who believed Aussie dollar RMBS were very cheap compared with where structured asset classes — RMBS and ABS — were pricing in their domestic markets.

At that time we saw a large uptick in offshore investors’ participation. But it wasn’t just offshore investors. We also saw a lot of real money domestic accounts that had been sitting on the sidelines for some time buying in size and there was also strong demand as there always is from bank balance sheets. So we encountered strong demand from those three investor bases at the same time, which led to a 60bp

Tano Pelosi,antares capital



contraction in RMBS spreads between August last year and Q1 this year.

As a result, the majors were issuing RMBS in the low 80s. It still offered a pick-up over three year senior unsecured and obviously over three year covered, but there was a strong compression in the spread premium for RMBS versus the other two asset classes.

However, from late-May to mid-July, when the domestic market was shut after Bernanke’s comments about tapering, we saw a re-pricing of risk, with major bank senior unsecured spreads moving out by around 20bp and RMBS moving out by about 15bp for regional bank issuers.

If a major bank were to come to the market now I suspect it would price 10bp wider than where the market was pricing in February, but that is consistent with what we’ve seen in the senior debt market. NAB priced a five year senior at 78bp in mid-May and CBA came two months later with a four year at 85bp which would imply 100bp for a five year. So we saw a 22bp spread widening in senior.

ANZ issued a four year senior in August at 85bp which shows that the spread level has held constant over the last few weeks. So although RMBS has recently moved wider, it is still significantly tighter than it was in the middle of last year.

EUROWEEK: How strong is domestic appetite for Aussie dollar covered bonds?

Gaydon, ANZ: ANZ recently printed a A$700m 10 year which started off on the basis of reverse enquiry. We thought it would be a smaller transaction and started with a minimum planned size of A$250m. It went exceptionally well and there were more than 35 investors in the book. Some 85% went to domestic investors, and 15% offshore. Ninety five percent of placement was with real money accounts, so it was a very high quality order book. The prior week we also executed a three year A$1.25bn covered bond for RBC with 70% allocated to domestic investors.

So our recent covered bond experience has been very positive, with strong demand from both domestic and offshore accounts. When we put an Aussie dollar covered bond out there, domestic investors

will support it. ANZ had priced a four year senior unsecured the day before at 85bp, so it achieved a six year extension for which it paid 15bp, but there was very strong demand from asset managers, insurance companies and lifers who want duration in their portfolio. So from a syndicate’s perspective we were very pleased with the support the transaction generated from the domestic investor base.

Needham, ANZ: To have got that tenor at that price was an outstanding outcome.

Feder, CFSGAM: What are your views on the 8% cap on covered bond issuance.

Needham, ANZ: Eight percent of our Australian assets means that we could have just over A$33bn of collateral, so we could issue about A$30bn of bonds off that cover pool. At the moment, we have just under A$12bn on issue, and we have been active in managing the maturity profile across that pool — we’ve issued threes, fours, fives, sevens and 10s and a 15 year. As these bonds mature, we get more of our cover pool back, so we effectively have a very large limit available to us, given the size of our Australian assets.

Feder, CFSGAM: How close to the A$30bn are you comfortable with?

Needham, ANZ: You always want to keep some back for a rainy day, if markets become reasonably difficult.

Maidment, CBA: About 85% of our issuance in the first half of this year was senior unsecured, whereas 85% in the first half of the previous year was covered bonds, which was just a function of the market dynamic at the time. We have covered bond capacity that we want to preserve if spreads widen or markets dislocate, or to put duration on to the balance sheet at an efficient cost.

It’s great that we’ve seen 10 year covered bonds printed in the Aussie market. The largest trade we’ve ever done in senior unsecured in Aussie dollars in 10 years has been A$150m or A$200m. It’s just not a point on the curve where there’s very much appetite in Australia because of the way the asset management industry is structured here.

Winsbury, Moody’s: From a ratings perspective, we see the cap as hitting a sweet spot, because it gives banks the ability to tap markets when senior unsecured is looking tight. When the cap was first announced we looked at the capacity relative to the amount of government-guaranteed paper that needed to be refinanced, and you could more or less swap one for the other which we thought might have been handy.We also view the cap as being useful because it prevents effective subordination of senior bondholders. One of the interesting things to watch over the next couple of years will be what the attitude of regulators will be if the banks are incentivised to get more assets off their balance sheets through a variety of secured funding techniques.

Adam Gaydon,anZ



We’ve always been quite conservative on ratings for institutions that have high levels of secured funding. It’s not just a loss given default issue. It’s also a market access issue. In tough times, having a high level of secured funding can be a bit of a concern for senior unsecured investors.

Volpicella, Westpac: If you look at a market like New Zealand where balance sheets are much smaller, banks still want to be regular issuers. So if the issuance cap is too small it prevents them from issuing regularly. One of the last things you want to do is only issue when you absolutely have to. You want to create a curve and ensure that investors are very comfortable with what you’re issuing across that curve, so that in times of stress you can still readily issue.

Maidment, CBA: We’re all using covered bonds to access markets that would be expensive in senior format, or where liquidity in senior format is scarce.

Our philosophy about how Aussie dollar covered bonds would play out in Australia was absolutely that we had to put out the message that at times when we weren’t doing senior, investors wanting CBA exposure would have to buy the covered bonds. Over time, we’ve seen some of those bonds rotate into the hands of offshore Aussie dollar buyers.

In a benign credit environment it is going to become an increasingly rates-style product with traditional triple-A investors buying more of the product. There are definitely more people we can sell Aussie dollar covered bonds to offshore than there are Aussie dollar buyers offshore. It’s an interesting phenomenon, but central banks, for example, will buy CBA in US dollars as an AA- senior unsecured credit because their mandates extend to that. In Aussie dollars their mandate might only allow triple-A, which means they can buy our Australian dollar covered bonds but not Australian dollar senior unsecured.

Duncan, HSBC: One of the patterns we’ve seen emerging is that when Europe has become challenged the default setting is covered bonds. That’s the functioning market that tends to come back first.So in terms of access to funding, covered bonds

have been an invaluable source of diversification for Australian banks for the last 2-1/2 years.

Also, away from the public market we’ve seen alternatives such as registered covered bonds, and private placements in currencies such as Swiss francs, Norwegian kroner and yen. This all adds to the story of access across a range of markets.

Hughes, Suncorp: As the smallest covered bond issuer in the country, I’d reiterate that for us it’s all about diversity and duration. We’ve only issued in the domestic market, and we’re likely only to issue in the domestic market. However, never say never. Our covered bond programme opened up a substantial new investor base for us outside covered bonds. We now have a number of senior unsecured investors in Asia, Japan and Europe in our paper.

We’ll also keep a significant amount of our powder dry for a rainy day or disaster scenario. We probably won’t do any covered issuance this year but we will probably aim to do one transaction a year from 2014.

EUROWEEK: This brings us on to the subject of capital. Can you talk us through Suncorp’s recent Basel III-compliant tier two transaction?

Hughes, Suncorp: It was the first transaction of its type from any of the banks, which was unique for us because we tend to be a follower rather than a leader in the market place.

The timing was right. However, there were a lot of unknowns out there in terms of non-viability and how the traditional tier two investor base was going to treat PONV and possible conversion. But we took the view that that wouldn’t matter because we felt strongly that retail investors would support this type of transaction and they certainly did. We were very pleased with the transaction and surprised at the amount of institutional support we had, not just domestically but offshore as well.

Feder, CFSGAM: Investing in capital securities is all about relative value. As institutional investors, there remain issues with documentation on point of non-viability which affects how we can price these

Tim Hughes,suncorp Bank

Andrew Duncan,hsBc



securities. I understand APRA’s reluctance to give us clarity on PONV, but it makes it difficult from an investor’s point of view to assess relative value.

Macreadie, Aberdeen: There are also mandate considerations to bear in mind. If at some point these securities convert into equity, how will they fit into your portfolio? A cash settlement will be viewed as an equitable interest by the trustee, thus breaching some fixed income mandates.

Pelosi, Antares: In some structures we’ve seen overseas, PONV seems to be based on tier one ratios. In that case, from our perspective as investors it’s a question of assessing the probability of an issuer breaching whatever that ratio would be. So we would want a reasonable cushion over and above that threshold.

The other thing is that in a lot of these structures you can potentially get written down to zero, which means you could find yourself in a junior equity position at the worst possible time.

So the regulators need to be very clear first on the definition of non-viability and then the market needs to get its head around how much cushion investors need over the so-called threshold — not just the capital adequacy threshold, but other leading indicators of solvency.

Feder, CFSGAM: With a writedown, on a theoretical basis you could end up with equity, which you may or may not be able to hold, depending on your mandate. In the meantime, normal equity holders will have remained whole. So it’s difficult to justify an investment where you might end up holding something that you didn’t want in the first place which has a limited value.

Winsbury, Moody’s: On the topic of hybrids and bail-in, the FSB is now advocating that a good resolution regime should have bail-in all the way up to senior debt and unsecured deposits. We haven’t seen Asia Pacific regulators actively pushing that agenda, which has been driven very much by politics in Europe. Whether you choose to use bail-in as the first tool in

your policy box is primarily a political issue.Developments in this part of the world will depend on how the crisis-hit countries design their resolution mechanisms.

Ministers in Europe have put their weight behind bail-in, but they’ve also given themselves a number of opt-out clauses. This debate is far from over, and it has important implications for bondholders. Clearly, bail-in represents a new risk for bondholders. But to the extent that you’re bailing-in junior securities first, it’s also a support for senior bondholders. So working out how all this washes out is probably going to take another couple of years.

Pelosi, Antares: We’re in a state of flux with regard to regulation, which also applies to capital ratios. We don’t know where capital ratios are going to end up, and if the capital ratio is your threshold or your key parameter, it makes it very difficult to understand where you sit in terms of security.

Volpicella, Westpac: I don’t think we’re ever going to get clarity on PONV. But PONV is exactly what it says it is — i.e. the point at which you’re not viable. My view is that there is very little difference between this and insolvency, and insolvency risk is not a new risk for fixed income investors.

The key difference is the what-happens-if question. This is driven by the key theme that regulators around the world are saying, ‘never again will there be sub debt or tier one holders walking away with their entire investments while at the same time governments inject capital to save the bank. These instruments will form loss-absorption in these circumstances.

But in respect of the what-if scenario, it comes down to investors focusing even more on their assessment of each individual issuer in determining the strength of that issuer and the likelihood of that issuer defaulting. From a technical perspective, expected loss is a function of the probability of default (PD) and loss given default (LGD). PONV should not have significantly changed the PD assessment which, for a highly rated bank, should still be minimal.

Regarding LGD, even old-style tier two instruments would have had a significant percentage allocated

Matthew Macreadie,aBerdeen asset management

Patrick Winsbury,moody’s



to the instrument, such as 50%-70%. In the new world that number may be something higher than 70%. Despite a higher LGD, the aggregate expected loss for new-style instruments should not materially increase from old-style instruments because of the low probability of default.

So the key point is that if the issuer is strongly capitalised, has a good funding mix and sufficient liquidity, then the likelihood of a default (and thereby expected loss) should still be minimal.

On the mechanism of loss-absorption for tier two issuance we have to go down the conversion route because of APRA’s current interpretation that could reduce the amount we can allocate as regulatory capital if write-off was selected as the primary source of loss-absorption.

There is a lot of noise around these instruments. What is amplifying that noise is that you have old and new-style hybrids competing with each other. This will pass after time.

Needham, ANZ: These questions all came up when we did our recent tier one issue which has PONV documentation and a conversion feature. We spent a lot of time talking to the various distribution channels about what the size of our buffers were, based on the difference between our core tier one ratio and the trigger. And in our case the difference amounted to about A$10bn. ANZ’s annual profit has been in excess of A$6bn a year, and that’s after provisioning and tax. So in the case of tier two the buffer is something like A$20bn.

Maidment, CBA: Over the last three months the differential between offshore pricing for some of these tier two instruments versus domestic pricing has started to converge, and some of these are institutionally-driven markets.

It would be unfortunate if the whole tier two capital regime in Australia moves from domestic retail to offshore institutional with the domestic institutional investor not being part of a new phase of the market, which has happened before.

Pelosi, Antares: It’s important to make a distinction between the instrument and the underlying credit. There is no debate here about the strength of the underlying credit, but there are arguably some structural weaknesses in the instruments which do become relevant as you move up the risk curve.

If you think about banks which have very large investment banking operations or trading activities, for example, they can be vulnerable to overnight events that can wipe out the capital base. In that case I’d want to be adequately compensated for that black swan risk. It’s horses for courses. If you have a profile that’s very stable and a business model dominated by residential home loans, where risk-weighted assets don’t shift around too much and the regulators don’t keep tinkering with your minimum capital ratios, then this sort of structure should work.

Duncan, HSBC: When we talk to international investors about buying higher yielding instruments

from Aussie banks they are very excited at the prospect, based on the underlying issuer, the economy, rating, the low probability of default and loss-given default.

They say if they can get an Aussie bank with a 50bp or 100bp pick-up over what they’re currently seeing in senior unsecured or covered, that would be a natural buy for them.

Asian liquidity is looking for higher yielding instruments in Singapore dollars, CNH, US dollars and Aussie dollars, all of which are circling around Asia in abundance. These investors want to buy Australian risk and there hasn’t been a huge amount of supply from the Aussie banks. I agree that there are some wrinkles that need to be worked through in the market for capital securities in terms of writedowns, conversions and so on, but there is a natural buyer base out there in Asia which is very well-established and has been comfortable buying instruments such as European Cocos. We need to navigate our way into that buyer base before the European issuers saturate that market.

Asian private banks are definitely a market for this product. We’ve also seen a lot of tier two capital issued in the 144A space. That investor base has moved up the learning curve on Basel III-driven instruments very rapidly, and in addition to Asian investors that have already been buying these instruments from both European and Asian issuers.

Volpicella, Westpac: When we talk to offshore investors, one of the first things they ask us is, when are you going to do a capital deal offshore?

PONV always also comes up in our discussions. One thing investors appreciate is that APRA is never going to say an institution is non-viable lightly. APRA is well-regarded by offshore investors who recognise that APRA triggering PONV would likely create a run on the bank. Triggering PONV lightly is therefore counter-intuitive.

Feder, CFSGAM: I agree. The problem is we just don’t know. For example, there may be a small bank that is struggling with liquidity. If that bank does not have access to funds, it could technically be a point of non-viability. As investors, we’re not privy to that and we’re likely to find out much later in the game. s

Natasha Feder,colonial first state gloBal asset management

corporate issuers


Will AustrAliA’s debt markets ever provide the range of funding options for its corporates that is offered by other developed world debt markets? the answer is a familiar one: the situa-tion is improving, but slowly.

the overall picture for corporate debt in Australia looks pretty good. “2012 was a healthy year in the cor-porate bond market,” says ron ross, executive director and head of bond origination Australia at ANZ Global Markets. “We had $11bn of issuance, 45-plus issuers and a number of off-shore issuers coming to our market”, among them Korea Gas, Fonterra, BP, ABB and Holcim.

“then there was the A$1bn deal from BHP. For many reasons, it was a fantastic year for the domestic cor-porate bond market.” For investment banks, too: ANZ was a lead on all of those deals.

the year 2013 kicked off looking just as strong, until hit by global worries over indications from the us Federal reserve that it planned to reduce the pace of its quantitative easing if the us economy continued to recover.

“it only took [Fed chairman Ben] Bernanke to say QE will one day come to an end and it rattled the markets for the next seven weeks,” says ross. “the feeling now is of cautious opti-mism.”

Dealogic data for Australian dol-lar domestic corporate bond issuance show issuance of A$2.18bn domestical-ly and A$6.42bn internationally from the start of this year until August 12, compared to A$7.78bn and A$14.5bn, respectively, for the whole of 2012. that pattern suggests a full year with lower volumes than 2012 but better than the two years that preceded it.

the crucial point, beyond domestic volumes, is just how much of the total corporate funding is being done at home rather than overseas. “One sta-tistic we look closely at is the total vol-ume of bonds done by Aussie corpo-rates,” ross says. in 2011, he says, that

total was $30bn — excluding BHP and rio tinto, which he considers multi-national despite their Australian dom-icile. Of that total, only A$6bn was raised in the domestic markets, just 20% and a level that ross describes as disappointing and unhealthy.

last year showed a marked improvement, however, he says, with almost half of funding done domes-tically. this year is so far showing a similar picture.

Australian corporates resort to over-seas markets chiefly because they can’t get the funding they need at home. Historically the main reason has been tenor, and for the bigger issuers, scale. it may also be rating, as Australia has no high yield market to speak of. But on all three grounds, there are signs of improvement.

On tenor, it was notable that the two deals that re-opened the Austral-ian markets after the turmoil caused by Bernanke’s QE remarks were cor-porate, and seven years — for Port of Brisbane and Perth Airport.

Westpac was a lead manager on Perth Airport. Bankers there saw great significance in the deal. “Perth Airport re-opened the market,” says Mark Goddard, head of debt secu-rities. “to my mind, that reflects a greater desire for the corporate sectors than for others. Perth Airport is BBB/Baa2 rated, and we are seeing domes-tic investors want to buy more of those BBB corporates to get yield.”

His colleague Gary Blix highlights tenor. “Perth Airport was a seven year transaction. What we are now see-ing is an acceptance by the market to move further out along the curve. this year, ten corporate issuers have been able to print transactions for seven-plus years.”

there is a widespread sense that this improvement in tenor is here to stay. “seven years is the new five years in the local market,” says Will Farrant, head of debt capital markets at Credit suisse.

At ANZ, Edwin Waters, executive director, debt capital markets, says: “Five years in Australia is always the most liquid and largest part of the market. six and seven are certain-ly open, and there have been highly successful transactions in 10 as well. Extending tenor is just a product of confidence in the market.”

He notes, though, that the absence of longer-tenor deals is not just because investors aren’t interested in them, but because issuers may not need them. “remember that a lot of tenor decisions are driven by issuers and what they decide they need,” he says. “A lot, especially on the property side, don’t need 10 year funds.”

in terms of market depth, last year’s

A$1bn deal for BHP Billiton was clear-ly a landmark, but the country’s big-gest names, like telstra, are likely to continue to get the bulk of their benchmark funding in dollars and euros, as they always have.

More risk, but not muchOn ratings, there is clear evidence of an desire to go a little further down the curve than used to be the case. “there is a growing willingness to look at lower rated credits,” says ross. “lend lease is BBB-, Qantas has come to market, Holcim is a BBB issuer from switzerland, and Downer EDi is the lowest credit, at BBB- from Fitch. there is a good sprinkling of BBB credits.

Australia’s corporate bond market still falls short of serving all the funding needs of the country’s corporations: there is no high yield and only scarce availability of tenor beyond seven years. But there are signs of investors becoming more enthusiastic about longer tenors and credit further down the curve. While it develops, many needs are being met in the US instead.

A slow evolution

“There is a growing willingness to look at

lower rated credits”Ron Ross,

ANZ Global Markets

corporate issuers


“Obviously when we’ve had this period of very low base rates, it’s encouraged investors to find incre-mental yield by going down the cred-it curve. i wouldn’t say we’ve been knocked over in the rush by BBB issu-ance, but there is more confidence in the market.”

the Downer deal he mentions has been widely remarked upon in Aus-tralia, partly because of the BBB- rat-ing, but in particular because it is only rated by one agency, and the least widely followed of the three — Fitch. some find this more interesting than the headline heavyweight deals of 2012.

“this year we haven’t seen as many jumbo trades from the corporate side like telstra and BP last year, but we have seen trades getting away for names that might not have succeeded in previous years, particularly for BBB corporates,” says sean Henderson, head of debt capital markets for Aus-tralia at HsBC. “Our deal for Down-er, for example, had eight domestic investors and 32 accounts from off-shore, for a BBB- name.”

this last point is crucial: it wasn’t, by and large, Australians who bought that deal. international participa-tion appears vital for further progress down the curve.

“there are multiple pockets of demand in Australia, but for corpo-rate credits like Downer you need the institutional bid to come to the fore, and historically that hasn’t been deep or consistent enough for many cor-porates to rely on, with the notable exception of the largest names,” says Henderson.

“the big development in recent years has been the growth of the A$ bid from offshore — Japan, Asian pri-vate and commercial banks, central banks and Europe. Many recent issu-ers with name recognition offshore have seen 50% plus going to these off-shore accounts.”

Downer EDi is an engineering and infrastructure service provider, Aus-tralian but with significant Asia Pacif-ic business. in some other names, the Asia connection is easier to see: a deal earlier this year for sP Ausnet, in seven and 10 year maturities, saw more than 50% placed offshore. that’s partly because, although the company operates in the state of Victoria, it is owned by singapore Power.

“the Asian bid has been critical on

many trades, providing great size and price tension, and filling order books out from 10 to 20 investors up to 40 or 50,” Henderson says.

ross at ANZ says that “every deal we bring to market sees a certain level of Asian participation” and that 10%-30% of books will typically now come from Asia, especially on BBB deals which appeal to the private bank space.

Westpac’s Blix cites the same range. “the domestic investor base is still the driver, but the addition of the investor base from Asia can provide price ten-sion,” he says.

And Waters at ANZ suggests that visiting Asia will pay dividends. “those issuers who have travelled to Asia and conducted investor updates have found their transactions have been successful and well supported.”

High yield, anyone?Whatever the progress represented by Downer’s deal, however, few peo-ple seem to have much faith in a high yield market. “taking one step fur-ther to a sub-investment grade mar-ket here? i wouldn’t be holding my breath for that,” says ross.

there is a circular debate about why this is. some argue that Australia’s big institutions won’t buy high yield paper, some that they don’t because it doesn’t exist. Waters at ANZ takes the first view. “A lot of that is governed by the mandates from investors and super funds that don’t allow them to buy sub-investment grade.”

But Mark Goddard at Westpac thinks there are long-entrenched fac-tors at play in the institutional mar-ket. “Would fund managers buy more sub-investment grade paper if it was available? Perhaps, but other factors, including the low allocation to fixed income, are also a factor in further development.

“A move into sub-investment grade paper doesn’t happen overnight. it may need mandate changes as well as a cultural shift. in the same way as the local market is built on an overall investment culture that has an equity bias, the fixed income market is built around an investment grade bias.”

some are more positive, though. “We can see the buds of an A$-denom-inated high yield or unrated wholesale market,” says Farrant, pointing to his Healthscope deal, covered in the cor-porate hybrids section of this report,

as a first sign. “We feel that the glo-balisation of the Aussie dollar as an investable currency will drive this and it is likely that Australian dollar high yield will initially be mostly an off-shore phenomenon.”

Meanwhile, issuers who cannot meet their needs at home head for us private placements, us high yield or the term B loan market (see elsewhere in this report).

if retail investors want to partici-pate in vanilla corporate debt, the pro-cess has historically not been easy. “For retail investors we barely have an investment grade corporate bond market in Australia that they can readily access,” says Paul Donnelly, global head of equity capital markets and debt capital markets for Macquar-ie Capital.

instead, they have bought more complex listed structured hybrids, dominated by bank hybrid capital (see separate article on financial institu-tions).

But the inaccessibility Donnelly complains of may be about to change. “there is definitely a move from the government, treasury and AsiC to make it easier to issue to retail inves-tors in listed form,” says Andrew Buchanan, head of hybrid capital for Australia at uBs. the legislation is already through, but there is a chal-lenge in creating demand, he says. “investors will assess a corporate bond return against a government guar-anteed term deposit, and therefore a bond will need to offer a premium to attract attention.”

it will take time to find a level at which issuers and retail can meet, but the idea has potential. As John Chau-vel, head of debt capital markets at Westpac, says: “retail corporate debt is definitely an area we want to see growing. there would theoretically be huge demand there.” s

“Retail corporate debt is definitely an

area we want to see growing”

John Chauvel, Westpac


Corporates Roundtable

Participants in the roundtable were:Gary Blix, head of corporate origination, debt capital markets, Westpac Institutional Bank, Sydney

Michael Braude, general manager, treasury, risk and insurance, Coca-Cola Amatil, Sydney

Vincent Chin, head of treasury, Goodman Group, Sydney

Ian Chitterer, portfolio manager, credit markets, AMP Capital, Sydney

Ian Duncan, group treasurer, APA Group, Sydney

Sean Henderson, head of debt capital markets, HSBC, Sydney

John Kite, deputy chief financial officer, Sydney Airport Ltd

Ian Lewis, senior vice president, corporate and infrastructure finance, Moody’s, Sydney

Tim van Klaveren, head of credit strategies, UBS, Sydney

John Sorrell, head of credit, Tyndall Investment Management, Sydney

Joanna Wakefield, group treasurer, Asciano Ltd, Sydney

Edwin Waters, executive director, debt capital markets, ANZ, Sydney

Moderated by Phil Moore, EuroWeek

EUROWEEK: Ian, how would you describe the credit profile of the Australian corporate sector today?

Ian Lewis, Moody’s: The outlook for the rated sector is strong across the board. We have stable outlooks in sec-tors such as telcos, retailing, and AREITs, and while there are some material challenges in the base metals sector, where we have a negative outlook, resources remain broadly stable at this time.

Our expectation is that GDP growth will be in the range of about 2.5%-3.5%. Even that lower growth rate ought to support ratings across the sector.

Although there are still quite a few headwinds, the corporate sector in Australia is lowly levered, with aver-age leverage in the low twos for the companies we rate publicly.

The other factor underpinning the rated portfolio is very high cash balances at Australian corporates which were about A$25bn at the end of last year. And that total has been heading higher over the last few years.

We’ve seen a lot of term loan ‘B’ issuance in the first half of the year for high yield names, and we see more of that happening in the second half, although possibly not to the extent that we saw in the first half. More generally, we see an ever increasing trend towards disintermedia-tion, which has also been happening for some time.

EUROWEEK: Isn’t it the case that in spite of these decent fundamentals, business confidence remains low?

Michael Braude, Coca-Cola Amatil: I think that’s true. I

Corporates wrestle with credit question

The credit metrics of the Australian corporate sector are fundamentally sound. Today, their funding requirements are low. But when their capex plans pick up, will they look to access the domestic corporate bond market, which is still regarded as being very under-developed relative to the size of the economy and to the pool of domestic institutional and retail liquidity?

Or will they choose, as many Australian corporates have in the past, either to fall back on the bank market, or to explore funding opportunities in the deep and liquid US dollar market?

These were some of the questions raised in EuroWeek’s Australian Corporates Roundtable, which took place in Sydney in August. Participants were:



saw a chart last week looking back at business confidence during the past several interest rate easing cycles. This is the only time when 20 months after the first rate cut business confidence has been at a lower point than where it was when the first rate cut occurred. Normally you’d expect business confidence to be higher 20 months into a rate cutting cycle.

This is partly because a lot of industries have been adversely impacted by the Australian dollar. But I think Government policy uncertainty and policy about-turns during the hung parliament have also been a factor. However confidence may improve somewhat if one side has a decisive win in the September 7 election, as it will enable that party to govern with a clear mandate.

EUROWEEK: Is this affecting companies’ capex plans?

Braude, Coca-Cola Amatil: Yes. It has been more chal-lenging for companies in general in the political and post-GFC environment to plan with as much certainty. Contin-ued weak business confidence and below-optimal capex plans may be one reason why the RBA may cut rates fur-ther at some point than it would otherwise like, particu-larly as business investment in sectors outside mining will be important to offset the peak mining investment.

Joanna Wakefield, Asciano: We have pulled back on a lot of our capex. We are seeing a number of projects being delayed by our customers, which impacts our vol-ume as well. In that sort of environment you’re not going to aggressively increase your capex.

John Kite, Sydney Airport: In terms of capex, we make investment decisions to ensure we’re providing suffi-cient infrastructure in line with demand, as our airline customers expand and passenger numbers continue to grow. The timing of that investment is related to the propensity of inbound and outbound passengers to travel. There is a relatively low correlation between this and the Aussie dollar. It’s more influenced by how indi-viduals feel about their financial circumstances, their views on job security, real airfares and local GDP going forward.

EUROWEEK: Are high labour costs also a problem?

Wakefield, Asciano: For us, yes, because we have a high-ly unionised workforce. The wage agreements we’ve had to sign recently in no way reflect CPI.

Ian Duncan, APA: APA’s business is gas infrastructure, much of which services the mining sector — which has attracted people with lucrative job opportunities. If the heat comes out of the mining sector there may be a drift backwards, which would relieve labour costs in non-min-ing sectors.

Sean Henderson, HSBC: From a global perspective, the knock-on effects of how people perceive what is going on in China and in Europe naturally sets a backdrop for com-panies’ investment plans.

Over the last 18 months we’ve seen the resources sec-tor driving sentiment elsewhere in the economy. But in the global context it’s fair to say that a lot of corporates here are very strong and well positioned, although they are in an environment that makes them quite cautious about the prospects for global growth.

The corporate sector is keen to grow, but having more clarity about the outlook for the global economy as well as political leadership domestically would leave compa-nies better positioned to invest.

EUROWEEK: Is there a tendency to exaggerate the impact of China on the Australian economy?

Edwin Waters, ANZ: I think it gets rather more press time than it should. There is no doubt that there has been a knock-on effect in Australia. But I agree that Australian corporates are very well positioned to compete.

Gary Blix, Westpac: We’ve been in a low credit environ-ment for a number of years now. We haven’t seen any meaningful M&A activity driving issuance in the corporate market.

Volumes of issuance in the core markets that corporates have been accessing in recent years, which are our loan market, our domestic bond market and the US dollar mar-ket, are off circa 30%-40%.

Michael Braude,coca-cola amatil

Joanna Wakefield,asciano



I’d agree that corporate Australia is well positioned to take advantage of any upswing and has good funding opportunities across a number of markets.

Vincent Chin, Goodman: The slower growth in the domestic Australian market is slightly beneficial for us, because we’ve been seeing companies looking for increased cost-efficiencies by moving from smaller to larg-er distribution centres.

EUROWEEK: For investors in the Australian corpo-rate bond market, is lack of supply the main problem?

John Sorrell, Tyndall: I don’t think lack of supply is a problem. Nor do I think this is a completely non-existent market. We’ve seen a broader range of issuers recently than we have for a long time.

It is a changing market and one where there are oppor-tunities, and I think investors have become more aware that we are competing with other markets such as the US.

We are still a little bit limited by supply, but we’re also limited by mandates and the fact that many Australian issuers come in the triple-B sector and many mandates are still confined to buying single-A or better.

We’re also limited by the fact that there is still not enough money assigned to fixed income compared with equities. So there is still a lack of support for this market. But we’ve been actively buying a range of different names and trying to diversify away from the financials where it has always been easy to find supply.

Waters, ANZ: The media tends to over-focus on relative issuance volumes vis-à-vis the US and overlooks much of the progress that has been made over the last two or three years.

Tim Van Klaveren, UBS: I agree that the market has moved on a long way in recent years. Diversification has improved among domestic issuers. We are also seeing more offshore issuers coming to our market.

There have also been changes on the investor side. Historically when a new issue came to the market you had to get at least three of the big five domestic investors on board to ensure a successful deal. I agree that there are still some fund managers who are restricted to issues rated A- or above, and for those deals you can probably now get 140 or more accounts participating. For lower rated issues the number of participants drops off, but the investor base in that market has also expanded in recent years.

We don’t have any ratings constraints and can buy triple-B issues, and most of the recent triple-B deals have been well oversubscribed.

The market has been criticised in the past for not offer-ing longer tenors. That has been a function of issuers’ preferences rather than investor appetite. But again, a number of seven year deals recently have been very well supported.

The pipeline of new issues is fairly thin, so there is still a supply-demand imbalance but that is due to the corpo-rates not having the need to issue rather than investors not having the appetite to buy corporate bonds. One of

the problems for investors is the competition from banks that are looking to grow their loan portfolios. Recent evi-dence suggests that banks have started to lend at uneco-nomic levels, which squeezes the capital market in terms of realistic pricing for new deals.

Where the capital market has an advantage over the banks is in the tenors it can provide.

EUROWEEK: Wasn’t Basel supposed to put an end to uneconomic bank lending?

Van Klaveren, UBS: That was what we all hoped. But Australian banks are already very well capitalised and continue to attract deposits, and they are find-ing it tough to invest their surplus capital. But it’s true that Basel III should also have an impact on the cost of cross-currency swaps which ought to make longer-dated offshore issuance less attractive to Australian corporate borrowers.

Chin, Goodman: I certainly agree that the Australian market has evolved tremendously over the last two years. Without a doubt, the triple-B issuance space is much big-ger and tenors are longer.

But I still struggle with volumes. If I wanted to get A$500m in 10 year funding here it would be hard to do on an oversubscribed basis ensuring that the issuer and the investors are both happy. I can still only do that relatively easily in the 144A or the US private placement market, which is where most Australian borrowers con-tinue to go, notwithstanding the cross-currency swap. And there are a number of ways in which borrowers can access cross-currency swaps relatively economically from the Australian banks.

Also, from a lending perspective, a lot of the Austral-ian banks have told me that they’re Basel-ready, but their pricing relative to the capital markets for three and five year money is still cheaper. The banks are losing market share at the moment because corporate balance sheets are lowly geared and companies aren’t borrowing as much as they used to.

Van Klaveren, UBS: That’s one of the reasons why there is so much investor appetite for credit.

Vincent Chin,goodman group



But I disagree with what you say about volumes and tenor, because we are seeing large, longer dated deals being done. My experience in the US dollar and euro market is that issuers in those markets will offer investors a 5bp or 10bp new issue premium over their existing credit curves to make sure a deal goes well. Here, issuers tend not to do that, and I often tell them that if they offered an extra 5bp or 10bp they may be surprised by how much volume may increase. It’s a volume-price game.

Chin, Goodman: The other considerations for us are deal liquidity and execution certainty, which are also very important for investors and issuers.

I don’t think we’ll see a deep and liquid market until we start seeing investment mandates and allocations change materially. But I don’t see that changing until there is a change to the franking system that gives inves-tors better returns on equities over time.

Ian Chitterer, AMP Capital: If you look at the number of new issuers there have been out of the utilities and the airport space since 2010, investors have clearly ben-efited from the demise of the wrapped bond market.

In terms of the wider corporate market, we would like to see more issuers coming to the market. This links in to the discussion about liquidity, because we need more diversification and differentiation to give us more relative value opportunities based on our analysis of the companies. This in turn would result in more switching and hopefully better liquidity as currently the bulk of issuance tends to get locked up, with little sec-ondary trading.

In terms of tenor, we were a big supporter of the 10 year BBB APA deal in July 2010. I realise that BBB issues may not be favoured by all investors, but we see it as a sweet spot in the market from a risk/return per-spective.

I agree that it is a price-volume game. In September 2010 DBNGP issued A$475m in a mix of fixed and float-ing bonds at 300bp over BBSW. To do A$475m for a BBB- name shows that if the price is right you can do the volume, and as we saw with the APA 10 year, you can also do a longer tenor of up to 10 years.

Blix, Westpac: I agree. In the seven year tenor, I don’t believe any Australian corporate could achieve better terms in the offshore market than they could domestical-ly in the current environment.

Henderson, HSBC: The market has changed massively in the last two to three years. But I still think there is an issue with regard to diversity of domestic investors.

If you look at the BBB- issue done recently by Down-er, it was very successful, but eight domestic investors took up the majority of the deal from onshore, com-pared with 32 taking up 45% of the deal from offshore. That was in the triple-B area, so it was always going to be attractive to overseas buyers and private banks, but I’d like to see the Australian dollar market for BBB names generating a more diverse and broader set of domestic investors. It was a great transaction which created a lot of price tension, but the granularity of the

book came from international accounts.Domestically we rely too often on 10 or 12 inves-

tors to drive new issues. There has been a huge amount of progress, but we still have to rely on any meaningful investor diversity coming from the offshore buyer base for BBBs in particular.

Chin, Goodman: I agree. This is still a difficult market for triple-B names to generate the same price tension they can get overseas.

I can go to my board and say, ‘I can get A$300m in the Australian market in a deal that will probably be slightly oversubscribed as long as I leave something on the table for investors’. Or I could go to the US, pay 35bp-40bp for the cross-currency swap, print $500m and get demand of $700m-plus from a very well diversified investor book with very low execution risk. It’s the execution risk which is the dilemma I have when I go to my board.

So we’ve decided that if we want five to seven year funding we’ll go to the domestic market, but if we want 10 or 12 year money and low execution risk we’ll do a USPP or a 144A trade.

It’s hard work and the documentation is a killer, but it’s sometimes worth the pain.

Van Klaveren, UBS: I think execution risk is a mis-conception. Most deals are already fully subscribed in advance. Very rarely will a deal be launched where the banks haven’t already gone out to the investors and made sure they’ll support it. So execution risk when it comes to printing the deal is very low.

In terms of liquidity, this is deteriorating in all markets across the world, and the gap between the US and Aussie dollar market is narrowing. The premium for illiquidity is becoming bigger in all markets — equities, infrastructure, credit. And when QE is withdrawn this will become even more apparent.

Waters, ANZ: On the subject of execution risk, I’d agree that banks have a reasonably good view of how the books are looking before a deal is launched. However, corpo-rates often have a six to 12 month planning cycle and there are board approvals required. Some Australian treas-urers can respond to reverse enquiry straightaway, but for

Edwin Waters,anZ



others the process can take a very long time. Those cor-porates with higher flexibility will achieve better funding outcomes over time.

Van Klaveren, UBS: We see that from the investor standpoint. We get asked if we’d like to buy a potential new deal at a state price, and I’ll often provide a positive response and then hear nothing back. Six months later I’ll receive a phone call talking about the same deal at the same price, ignoring the fact that pricing in the market has moved wider.

The capital market is dynamic, and pricing changes from day to day. It’s very different from the bank market where you can get a price from your bank today, then you can potentially borrow at that rate six months later.

Sorrell, Tyndall: I remember a major issuer who said they wouldn’t approach the Australian market because they couldn’t get the deal done on time. That was their excuse for years and years.

In every market you need to give investors time to form an opinion. But Australian investors have become much more responsive than they were.

I’m also surprised to hear people worrying about whether investors are domestic or offshore. The question should be, ‘is demand strong enough for that security?’ Not whether that demand happens to come from an onshore fund as opposed to a Swiss bank.

Not all US dollar securities sit in the US. If you look at Asian issuers, they will issue mainly in US dollars because most investors holding their dollar bonds are sit-ting in Singapore or Hong Kong.

I’d agree that execution risk in the Australian dollar market is a bit of a misconception.

Duncan, APA: We didn’t have material concerns about execution when we completed our transaction in 2010. We did a lot of legwork six months before the deal, which gave us a good feel for where the market stood and how much demand there would be for 10 year issuance, so we were quite comfortable about that. I think a borrower would have to be fairly naïve to ask for a price at Christmas and expect to issue at that price the following June.

On John’s point about the overseas investor base, it is important to build a core investor base in Australia, because the Asian demand we see comes and goes, since it will be influenced by different short-term factors to those that affect domestic demand.

When we completed our 10 year issue there was virtu-ally no Asian participation. More than 90% was placed in Australia. We issued for 10 years at a fixed rate in Aus-tralian dollars which only appealed to a limited number of mandates, so there was a raft of legitimate reasons why Asian investors could not participate.

But we found strong enough demand among onshore investors to issue A$300m, and we were very satisfied with that. We’d like to do a similar issue again, but if my board came to me and said, ‘we want to issue A$500m of 10 year bonds every year for the next three years’, we would not be as confident of getting those volumes done in the Australian market as we would in, say, the 144A market, or even in sterling.

Henderson, HSBC: My point on the offshore market is that it is valuable and helps to add price tension and sec-ondary market liquidity. But ideally it shouldn’t be neces-sary for issuers to rely on the offshore bid.

As a bank when you’re asking, ‘does this trade work in 10 years for A$300m-A$500m’, you’d prefer to be able to take a view across 30 domestic investors, where 10 might say no, 20 might say yes, and off you go. It is not always possible to take that view in this market and you’re reliant on a relatively small sample, although things are improving.

Chitterer, AMP Capital: The problem seems to be an expectation both from management of some corporates as well as from the banks that if a new issuer comes to the domestic market we as large investors should and will always be there for them. But for us it still comes back down to factors such as credit analysis, pricing and market conditions.

Sean mentioned that only eight domestic investors par-ticipated in the Downer deal. While I don’t cover Down-er it was launched in a week when there were companies in the mining services sector that had issued profit warn-ings and the equity was down significantly. As a result, it was no surprise that the deal was not well supported by

Sean Henderson,HsBc

Ian Duncan,apa group



domestic investors.Even in a relatively small market with limited supply,

we’re still responsible for trying to ensure the best out-come for investors in our funds, and that means making those calls.

Kite, Sydney Airport: I think size is a decisive factor here. For smaller deals execution risk is not a problem in the domestic market. But at Sydney Airport we have a debt book of about A$7bn, and we generally refinance about A$1bn per annum. When you’re talking about that sort of volume there is higher certainty of execution in offshore markets.

We’ve now tapped the 144A market twice and we have $1.3bn outstanding there. We haven’t touched the European market yet, but we run parallel processes so that when we come to execute deals we check conditions in each individual market on a daily or weekly basis, looking at a range of considerations. Execution certainty is one; tenor is another; and pricing is of course another.

But funding diversification in terms of markets, inves-tors and tenor is also very important for us. We still have a number of wrapped bonds outstanding in the Aussie dollar market and we are aware that may act as a dampener for domestic demand for exposure to Sydney Airport on an unwrapped basis. That’s one of the reasons why we are focused on diversifying our funding sources offshore.

Chitterer, AMP Capital: When you did your US dollar deal in October last year, there was talk of doing an Aus-sie dollar issue at about the same time. At AMP Capital we would have been very supportive of an Aussie dol-lar issue in volume to add to the 2018s which is only an A$100m line.

Kite, Sydney Airport: Yes. That was a classic example of where we ran this parallel process literally up until the last minute. It was a very tight decision and we eventu-ally opted for the US dollar market.

Chin, Goodman: The first time we went to the dollar market we raised $325m and we had approximately 20 investors.

The second time we had over 30 investors and the

third time we had more than 50. So the depth and diver-sity of our US investor base has grown over time.

The other feedback I get from some domestic investors is that they like our credit and they’d like to see us issue more, but they are full on our name.

Chitterer, AMP Capital: That is a valid point. Because of the limited number of issuers in the market investors may well reach exposure limits for individual names.

Another issue which we sometimes come up against with some of our mandates is that we are required to aggregate our exposure to the parent company. Within the utilities sector, for example, companies like Singa-pore Power, CKI and Duet are the parent companies for a number of entities, so if you were full on SP Ausnet you might not be able to play in any other assets owned by Singapore Power.

Waters, ANZ: Diversity is an important point. During the global financial crisis a lot of borrowers came to recog-nise that it’s not just about funding. It’s also about ensur-ing you have access to a good spread of investors across a range of different markets. The Australian dollar market is not centred only around Sydney and Melbourne. There are also big holders of Aussie dollars throughout Asia and Europe, and it’s important to maintain access to those investors.

Van Klaveren, UBS: This comes back to the question of liquidity. We manage a lot of Asian client money. These clients always have interest in investing into the Austral-ian credit market, but the market isn’t big enough for them.

They usually have billions of dollars to invest, but there simply isn’t enough stock out there to invest those proceeds. If I wanted to increase my allocation to Austral-ian corporates and rung around the market for A$100m of bonds, it can be impossible to find the stock.

Sorrell, Tyndall: At times even A$20m can be a chal-lenge.

EUROWEEK: How important is debt investor rela-tions to Australian corporates?

John Kite,sydney airport

John Sorrell,tyndall investment management



Kite, Sydney Airport: We’ve improved considerably in recent times. We’ve focused more attention on giving regular investor updates. Every six months we arrange bondholder meetings in Sydney and/or Melbourne which are generally very well attended. It’s good to see that bondholders are interested in our credit story, and we also provide dial-ins for our 144A and Canadian Maple bondholders to participate at a time that suits them.

Chitterer, AMP Capital: It’s critical to build long-term relationships with issuers. We were very supportive of APA’s 10 year deal but also of their dollar and hybrid deals. We have good access to senior management, and I know I can pick up the phone any time to a compa-ny like APA, Sydney Airport or Wesfarmers and I’ll get access to senior management.

Braude, Coca-Cola Amatil: We’ve made a conscious decision in the last three years to borrow in local cur-rencies. Anyone who’s had to deal with the increasing accounting and disclosure requirements, particularly for cross-currency swaps and their related basis swaps and credit value adjustments, will appreciate the incredibly complex nature of this and potential greater P&L vola-tility swings that cross-currency swaps may generate. Furthermore, increasing credit charges associated with cross-currency swaps have increased the cost of swapping foreign currency denominated debt into local currencies in some instances.

Maybe in a rare scenario we could have borrowed in foreign currency cross-currency swapped into local cur-rencies marginally cheaper, but tying up credit lines with counterparties and going through 20 audits if it’s a 10 year deal would not justify the heartache unless the sav-ing was significant. I’d need a compelling reason to bor-row in foreign currencies in the current climate, which is why all our issuance recently has been in Australian and New Zealand dollars and Indonesian rupiah. Having said that, in virtually all cases local debt has been at least the same cost or cheaper than fully swapped foreign currency denominated debt into local currencies, and without the issues associated with cross-currency swaps outlined above.

EUROWEEK: How active is the market beyond seven or 10 years?

Wakefield, Asciano: For longer dated issuance there is still no alternative but to look at sources beyond the domestic market, such as the US, sterling or European market.

Duncan, APA: And then you face the challenge of the cross-currency swap. You can always get access to foreign currency markets — the constraint is the cross-currency swap. In our business, a 30 year dollar issue would be ideal, because we have assets with very long lives and up to 25 year contracts. But to get a 30 year cross-currency swap would be prohibitively expensive.

EUROWEEK: What does Australia need to do to encourage the development not just of the fixed

income market, but also of longer dated fixed income product?

Van Kleveren, UBS: The Australian population is still fairly uneducated when it comes to fixed income. One of our biggest challenges is that to most private clients and private client brokers, fixed income tends to mean bank deposits.

Henderson, HSBC: To me, a retail bond market would be a no-brainer, but why invest in a bond when returns on term deposits are so high and when there are tax incentives for buying equities? Also, there isn’t a very well developed private banking sector in Australia, which makes access to retail investors difficult.

Van Kleveren, UBS: Term deposits these days offer between 3.5% and 4%. Investment grade corporate bond funds typically pay 4.6% and if you go to a higher yielding fund you can expect a lot more than that. Our Diversified Credit Fund currently yields 6.5%. It’s highly diversified and there’s no Australian interest rate risk.

Sorrell, Tyndall: Education is the biggest single prob-lem. Very few people in Australia understand the fixed interest market.

EUROWEEK: How helpful are initiatives such as the release of the Corporations Amendment Bill on “Simple Corporate Bonds and Other Measures”?

Waters, ANZ: It hasn’t gone through yet but the idea as I understand it is to separate the term sheet from a base prospectus and simplify the approach to disclosure. It’s a more sensible disclosure and issuance framework for Australian dollar issuers to consider going forward.

Sorrell, Tyndall: It’s hard for us to invest in many of these retail bonds because the ratings agencies are not permitted to publish their ratings to the retail public.

Blix, Westpac: We see room for further improvement in process and education to make it easier for retail

Gary Blix,westpac



investors to access fixed income product, especially cor-porate bonds.

Sorrell, Tyndall: Investors in Asia can easily buy corporate bonds in small denominations, whereas here the minimum is A$500,000 or more.

Blix, Westpac: There’s no doubt that if wholesale and retail investors could be accessed through the same channel, that should improve liquidity. We shouldn’t have documenta-tion separation for wholesale and retail investors.

Henderson, HSBC: The way the Asian market has evolved is an interesting model. Five or 10 years ago it was also a very equity-oriented private banking market, but the market for fixed income products grew out of the perpetuals which took off following the 7.75% issue from Pemex in 2004. That market evolved gradually from there, and largely through the private banks which put a lot of time into explaining fixed income to their clients. The selling of the product to high net worth also gave reg-ulators confidence that fixed income products were being distributed to appropriate individuals. Maybe Australia needs a similar model to create a safe harbour for the dis-tribution of fixed income bonds to individuals, and at the same time institutions can play a similar role in educating high net worth investors about the fixed income market.

Duncan, APA: I don’t think that preparation need be an obstacle to participation in the retail bond market. We’re updating three different debt programmes twice a year anyway, so it’s not much extra work for us. But there seem to be so many rules from the regulators dictating what you can and cannot do in terms of offering bonds to retail investors.

We need to forget about this retail-wholesale separa-tion. After all, there is nothing to stop retail investors trad-ing equities or foreign exchange or playing poker online. But in the fixed income market we’re talking about an instrument that has been prepared carefully and has gone through extensive accounting and legal due diligence.

When we issued the prospectus for our subordinated notes last year it was a very heavily vetted document because it was thought that it would be picked up by retail investors. As it turned out, there was more whole-sale than retail participation.

EUROWEEK: On the topic of issuer diversity and the number of names in the corporate bond market, is Moody’s seeing more companies applying for ratings for the first time?

Lewis, Moody’s: Definitely. The first half of the year was very busy and we saw a lot of names coming through the door, especially in the sub investment grade space, with their eyes on the US term loan ‘B’ market.

And we are still getting a fairly steady stream of invest-ment grade companies.

EUROWEEK: And to what extent is having access to a diversified range of funding sources a rating consid-eration for Moody’s in the corporate market?

Lewis, Moody’s: Liquidity for us is a key consideration. So access to diversified markets is very important. Our view is that the Australian dollar market is a useful part of that diversity. But we also see the US market as the deepest and one of the most reliable in the world, so depending on the size and scope of the company, access to the US market is also very important.

Van Klaveren, UBS: Offshore demand for Australian corporate issuance in US dollars and other foreign cur-rencies has historically been very strong. However, if off-shore investors become more concerned about Chinese growth and subsequently the outlook for the Austral-ian economy, will the offshore markets still be there for Australian issuers?

If the offshore market is shut, where will Australian corporates go for their funding? It’s great having oppor-tunities to issue offshore, but as we have seen histori-cally, if sentiment turns negative US dollar bonds can widen substantially which can flow through to domes-tic pricing. If issuers don’t have a domestic funding curve, the foreign funding tap can be turned off very quickly.

Chitterer, AMP Capital: We’ve seen that in the case of some companies with large emerging market exposure, especially into Latin America, as the Brazilian story has unfolded over the last six to eight weeks. Both in the

Tim van Klaveren,uBs

Ian Chitterer,amp capital



cash bond and in the CDS market we’ve seen those names widen significantly.

Sorrell, Tyndall: The other risk you’re adding in offshore markets is your exposure to the swap market. It’s not clear cut that the swap market is going to be open to you when you need it. Most Australian entities won’t want to end up with an unhedged US dollar exposure, and if the swap market is closed or prohibitively expensive, they will run that risk.

Kite, Sydney Airport: Whenever we do an offshore issue, before we appoint our joint lead managers we ensure that we also negotiate a good balance sheet commitment in terms of lending. And we’ll also insist on the provision of clean swap lines for the tenor of the bond.

Henderson, HSBC: I think we’re talking here about some fairly extreme scenarios here. It would take a lot to see all the offshore bond and swaps markets shut to Australian corporates.

Lewis, Moody’s: It’s exactly what we saw during the global financial crisis.

Henderson, HSBC: Sure. But the trend in the global funding markets has been very positive over the last few years in terms of the resilience of the dollar, euro and sterling markets. The basis has settled down and we’ve seen Australian corporates like Telstra and Brambles accessing the euro market again on top of the US dollar markets remaining open through the crisis. And on top we’ve also seen a very good bid out of Asia for Australian corporate names, with opportunities in US dollars, yen as well as Hong Kong and Singapore dollar private place-ments.

So I think global markets have been much more sup-portive in terms of providing diversification opportunities than they have been for many years. But I do agree that it’s important to build a solid domestic market as well. One of the reasons Asia was resilient during the global financial crisis was that borrowers were still able to fund themselves in their local currency markets. The structur-al elements of having a strong domestic bond market is good not just for local borrowers and investors, but also for the economy.

Van Klaveren: I agree. One of the reasons why markets are so liquid at the moment is QE. If the Fed or the Bank of England or the BOJ weren’t so committed to QE there would not be such a strong bid for assets. At some point QE will stop and liquidity premiums will increase, mean-ing corporate funding will become much more expensive.

Kite, Sydney Airport: When we did our last refinanc-ing we also closely tracked the euro and sterling markets, and over the course of last year the all-in costs of those markets swapped back into Australian dollars became quite attractive from time to time compared to US pricing. Because of our commitment to funding diversification we had a number of internal discussions about what sort of premium it would be reasonable to pay to diversify into

new markets and how to balance that with the increased execution risk with a new market.

Braude, Coca-Cola Amatil: How much you’re prepared to pay to diversify depends in some part on who you are, your credit rating and capital structure. As we’re part of the global Coke system it may not be as critical for us as some others. There are other Coca-Cola bottlers that also issue debt in a range of global markets so issuers are generally familiar with the Coca-Cola name, which gives us some added flexibility. Having said that, CCA generally does maintain diversity in funding across a range of capital mar-kets, investors and financial institutions.

Waters, ANZ: The question of putting a price on fund-ing diversification is also a relative one. When the seas are calm and the skies are blue, borrowers put a small pre-mium on diversity and don’t worry too much about. It’s only when the storm clouds appear that my phone starts ringing from issuers saying they want a bigger investor base. So the answer is probably linked to the timing within the cycle.

EUROWEEK: Joanna, you’ve mentioned the need to look at markets like sterling. Is that a market you’d be prepared to pay up in to access?

Wakefield, Asciano: The discussions we have aren’t so much about paying up for diversity. They’re around paying up for tenor, and out of necessity funding in longer tenors is going to involve diversification.

Chin, Goodman: Learning from the crisis, the way we look at diversity is to ensure that we have plenty of liquid-ity available by keeping our bank lines relatively undrawn, and having the vast majority of our drawn debt in the capi-tal markets in the five, seven and 10 and 12 year buckets.

Lewis, Moody’s: We do an exercise based on hypotheti-cally shutting down all borrowers’ facilities to debt capital markets. The majority of Australian corporates would still have the ability to survive for between 18 and 24 months even if access to foreign capital markets was cut off because they have so much cash and undrawn bank lines. s

Ian Lewis,moody’s

US Private PlacementS


You are an australian corporate and you need long-term funding. The domestic bond market won’t provide it, and you don’t have the rating or the following to do a senior deal in the uS or europe. What do you do? You follow an increasingly well-trodden path to the uS private placement market.

“australia has historically been favourably disposed towards uS PPs,” says Sean Henderson, head of debt capital markets for australia for HSBC. “Documentation is much easier than public 144a issuance, being more loan-style in nature. also this market doesn’t require large benchmark issue sizes, and offers long-dated funding that can be spread across a range of tranches, reducing refinancing risks.”

and issuers don’t need public ratings to access it. “It adds a relatively easy option for borrowers without public bond and ratings platforms, and it has often been the market of choice for australian credits with more modest financing needs,” he says.

ron ross, executive director of debt capital markets at aNZ, likes to champion the domestic debt markets, but recognises there are needs the home market can’t meet.

“Corporates head overseas for several reasons: usually for tenor, which is where the uS PP market kicks in,” he says. “Last year we did a 30-year bond there. No other market is going to go that long.” For unrated corporates in particular, it can be the only option. “only the uS PP market is going to allow that,” he says.

So what are the arguments against? “one of the main challenges issuers face in this market is the use of maintenance covenants,” says Henderson. Maintenance covenants are more onerous than incurrence covenants, which commonly apply in markets such as high yield and term loan B. “You’ve got to adhere to them at all times, and that doesn’t work for all businesses.”

Then there’s the cost of longer-dated funding and, for most issuers, the need for cross-currency swaps to bring funds back to australian dollars.

“The uS private placement market is definitely there for project and infrastructure borrowers, particularly those who are more corporate-looking,” says John Chauvel, head of debt capital markets for Westpac. “The only problem is that most non-resource-related borrowers need the cross-currency swap. I’m always optimistic the domestic market can step up and meet that need in australian dollars.”

Cost effective dollarsBut can it? Gary Blix, head of corporate origination at Westpac, says uS PPs have a competitive advantage over domestic issuance for maturities of 10 years or longer. “But anywhere between three and seven years, the majority of transactions, if not all, will be done domestically.”

every borrower will have a different point at which one market becomes more cost-effective than the other. In theory, though, as tenors develop in the domestic market — and they do appear to be gradually doing so — the appeal of going to the uS for a placement will dim, particularly if banks continue to rein in their swap lines and make them more expensive.

Where the uS market makes a great deal of sense is for borrowers who need dollars anyway. Consequently, mainstays of this market tend to be in the resources sector where the dollar is the functional currency, eliminating any need for the swap.

There’s certainly no shortage of enthusiasm from the uS buyside.

“uS investors are keen on australian corporates,” Henderson says. “They offer a good mix of good corporate governance, access to a developed economy with low sovereign debt levels, a robust legal

system and diversity from their existing portfolio.”

In 2011, for example, australia and New Zealand made up 16% of the entire $46.5bn uS private placement market, according to data from JP Morgan.

Borrowers in recent years have included CSL, Melbourne airport, envestra, Metcash and Transpower from New Zealand.

Two typical transactions this year demonstrate what these deals normally look like: split into a range of small, long-dated tranches, with reasonably modest coupons. CSL’s $500m placement on March 27, for example, was split between five, seven, 10 and 12-year bullets, with coupons from 2.07% to 3.32%.

Then orica’s $600m placement on august 10 was split between 10, 12, 15 and 20 year notes with Bank of america, Westpac, JP Morgan and aNZ as agents. Coupons on the tranches ranged from 4.53% to 5.9%. orica provides explosives and blasting systems to the mining and infrastructure markets, demonstrating once again the link the market historically has to resource-related sectors.

The uS PP market offers funding that fits the development of infrastructure, likely to be a theme for many years in australia. “We expect the uS private placement market to have a very solid year. There is a lot of interest for infrastructure-style deals,” says Steve Lambert, executive general manager, global capital markets at National australia Bank. “as we think about refinancing infrastructure post-construction, there will be an increasingly interesting market for australian infrastructure borrowers in uS private placements. Swaps are an issue, but borrowers can normally get around that.”

and if the domestic market can’t offer an alternative, then these credits will continue to cross the Pacific to find it. s

The US private placement market has long shown enthusiasm for Australian borrowers, and gives them opportunities they can’t get at home: long-dated funding without the need for a credit rating. But will high swap costs and greater depth in the domestic Australian markets reduce their allure?

US open for unrated Australians

corporate hybrids


AustrAliA hAs long been a market in which the marriage of hybrid securities and retail investors has thrived. the popularity of the instruments, listed on the Australian securities Exchange and paying a steady yield, is still growing and the dynamics are in place for them to gain still greater traction.

“the last two years in particular have been prolific for listed debt and hybrid issuance,” says Allan O’sullivan, director, retail syndicate, at Westpac institutional Bank. there was over A$13bn of issuance from 18 transac-tions in 2012. By late July, 2013 had recorded A$6.4bn. “We’re on course for A$10bn plus,” he says.

in recent years, though, issuance has been heavily dominated by financial institutions, with non-financial cor-porate issuance largely dormant. But in 2006, for example, half of all hybrid issuance was corporate. in 2012, only A$3.5bn of the $13bn was, and in 2013 there has been just one deal: a A$305m subordinated issue from healthcare firm healthscope in March.

healthscope didn’t want for appe-tite. “On a deal where some were wor-ried about whether we could print $125m, we ended up with $305m and could have printed more,” says Will Farrant, head of debt capital markets for Australia for Credit suisse, a book-runner on the deal. healthscope had to pay up to do it — a 10.25% coupon — but it was in considerable demand.

Australian corporate hybrids are often thought of as a phenomenon purely for domestic, yield-hungry retirees. With health-scope, that was not the case.

“We have seen increas-ing interest in that sort of product from offshore pri-vate banking clients, partly because investors in Asia look at Australia as a sophis-ticated economy with a strong legal system,” Farrant says. “healthscope is also in the right sector, which is very well followed in Asia.”

there are, though, many reasons to expect the domestic buyer base to con-tinue to grow too.

Depositors look for more“the growth in the hybrid market started in the last quarter of 2011 with an increasing retail bid,” says steve lambert, executive general manag-er, global capital markets at National Australia Bank. “We think it’s because there has been a lot of deposit raising from the banks, whose big focus is on the balance sheet and loan to deposit ratio.” But now, as yields have started to fall on those deposits, retail inves-tors have looked for other outlets.

“some people think that is just a case of rotating back out of cash or fixed interest into equity, and that may be true, but there has also been a struc-tural change in Australia,” he adds. “A large chunk of Australians have just retired, and there are going to be more people who want fixed income as part of their retirement investment. that is a genuine driver for these retail fixed income products domestically.”

lambert is not alone in this view. “term deposit rates have fallen while investors remain risk averse and are still focused on yield,” says Andrew Buchanan, head of hybrid capital at uBs. “hybrids strike the balance between higher yield, and greater capi-tal stability than equities.”

in particular, they appeal to self-managed super funds, which now account for one third of the A$1.5tr

superannuation industry. A separate, related theme involves

bringing more vanilla senior bonds to the listed market. Government bonds were listed on the AsX in May and some bankers believe that listed corpo-rate bonds are the future. “We see a tip-ping point here, where deposits are no longer the disincentive [for investors to buy bonds] they once were,” O’sullivan says. “the ability to bring vanilla sen-ior bonds to the listed market is where many of us put our faith.”

But why aren’t there more corporate hybrid deals already? Why is it only the banks which are issuing? Perhaps the main reason is a controversial review by standard & Poor’s on its hybrid cap-ital methodology around equity con-tent and credit assignment, published in April 2013.

it took action that applied retrospec-tively, hitting some existing issues — particularly a deal issued by oil and gas firm santos. “We were all gobsmacked that s&P did what they did, after issu-ers had paid hundreds of thousands of dollars to get confirmation that their structures were OK,” says a banker.

rupert Daly, head of hybrid capital at Deutsche Bank, says only two broad types of instruments now qualify for high equity content under s&P’s new methodology: short-dated mandato-ry convertibles, which price and trade like equities and don’t appeal to fixed income investors, and true perpetu-als. “the Australian retail investor base stopped buying true perpetuals 10 plus

years ago,” he says.still, others feel s&P’s chang-

es will only have a mild lasting impact. “While achieving 100% equity credit is now more diffi-cult, we don’t think the changes will affect hybrid supply,” says Buchanan at uBs, who notes that APA, Caltex and Crown have all issued 50% hybrid securities in the last 12 months. Bankers hope that, with clarity re-established, corporate issuers will return. s

Hybrid securities, long popular with Australian retail investors, are finding a new fan base in Asia, even as domestic buyers redouble their interest in the high-yielding product. Why, then, have corporate hybrids been eclipsed by financials?

Corporate hybrids ready for retail homecoming

Retail issuance by security type (A$m)

Source: ASX/Westpac, as of July 2013

0

3

6

9

12

15

18

21

0

5

10

15

2005 2006 2007 2008 2009 2010 2011 2012 YTD 2012

YTD 2013

Issu

ance

(# D

eals

)

Vo

lum

e (A

$bn)

ASX Listed Interest Rate Securities Issuance

Corporate, Property & Infrastructure Domestic Banks and Related Subsidaries

Insurance/Diversified Financials Number of deals

Bank Tier 1 4,490 (4)

Insurance/FI

Tier 2 770 (1)

Bank Tier 2 850 (1)

Pre - IPO Note

305 (1)

Source: ASX/Westpac, as of 29 July 2013.

Retail Issuance By Security Type (A$M)

Full doughnut represents total 2012 retail issuance. Source: ASX/ Westpac, as of 29 July 2013.

YTD 2013 CY 2012

Senior 422 (2)

Bank Tier 1 3,759 (4)

Insurance/FI Tier 1

938 (2)

Bank Tier 2

4,350 (3)

Pre - IPO Note 155 (1)

Corporate Hybrid

3,497 (6)

AOFM IntervIew


EuroWeek: What did the RMBS programme achieve?

The AOFM’s involvement on behalf of the government was critical in pre-serving the securitization infrastruc-ture when it looked like the market was in seizure. We provided investor access to issuers at a time when they had nowhere else to turn. It was par-ticularly important that the govern-ment focused on small issuers.

The government made it clear this was a temporary measure and it was our responsibility to be consistent with that. We achieved that, particu-larly in the last year or so, by when-ever it looked like we were to be the sole investor in tranches, setting out pricing expectations at a level that would draw other investors. I think we’ve invested well on behalf of the government and community.

EuroWeek: What’s the message at the end of the programme?

The securitization part of the market has recovered. We have seen substan-tial price adjustments in the Australi-an market, and we are seeing increas-ing interest from offshore investors. That is a strong signal that the mar-ket is… not back to where it was, but I don’t think anybody had an expec-tation that the securitization mar-ket would return to pre-2008 levels. We don’t know whether this is what it looks like forever, but we’ve seen plenty of evidence that smaller issu-ers are capable of getting paper away without our involvement. It’s a much healthier market.

EuroWeek: Speaking to bankers, there is widespread agreement that the programme had worked and that recent issues from non-banks had not required your involvement. But they wonder why you not kept it open in case it is

needed again? Is the message that it’s time to stand alone?

The programme’s served its purpose, so why wouldn’t you close it down? The Treasurer has said it will look at it again if things change, but why not draw a line in the sand now? If it’s served its purpose, it should end.

EuroWeek: Total Commonwealth Government Securities (CGS) out-standing are far higher than they used to be, but still small on a world scale. Where is the market going in terms of size?

In terms of scale relative to other markets, we’ll see what we see now. We know from budget forecasts that there’s no fiscal plan to continue to borrow at the rate that we had in the last few years. Because our issuance is directly linked to budget deficit funding, it stands to reason that we would see a market around the same size. You wouldn’t expect large mar-ginal changes relative to the size of the market.

EuroWeek: This brings us to a central question: the tension between the lack of need for a lot of funding and the need to offer a liquid, developed benchmark. How do you handle that tension?

Two budgets ago, the government dealt with it by saying it would con-sider a policy proposal to maintain a CGS market at around 12%-14% of GDP. This year it will be around 16%, and even if we have very mod-est issuance in the next few years it’s three to four years away from drifting back down to that 12%-14% of GDP level. The government’s indication to investors was that it was conscious of the need to maintain liquidity in the market, but was prepared to consider a proposal to maintain the outstand-

ing stock of debt relative to the size of GDP. That has been more than suf-ficient in signaling to investors that their participation in the market is warranted, that the market is and will be resilient, and that AOFM is focused on maintaining and building liquidity in the market.

We have various ways we are attempting to do that. The feedback we get is that liquidity is good so we are focused on trying to maintain bigger bond lines than the past, with regular supply and as much trans-parency as we can in our operations. Diversity in our investor base also helps so we don’t see the bulk of our paper on a buy-and-hold basis. All those things contribute to liquidity.

EuroWeek: Do you still come up against a fear that the market might shrink again in the future?

Not specifically, not in the last two years, we haven’t had anyone raise this specifically as a fear.

EuroWeek: Are there any patterns in offshore participation?

Over the last four years we have seen a steady increase in public sector investors in our market, and that has resulted in a geographic spread of interest. There is strong interest from North and South America, through-out Asia, Europe, even in Africa now.

The majority of our investors by volume and number are public sec-tor, but we are also seeing quite a lot of real money coming into the mar-ket. We will continue to see central banks coming in because the reserve management mandates will require them to diversify into other curren-cies, and Australian dollars are going to be an obvious one.

EuroWeek: When you have such a high level of foreign participation, there is always a concern about the potential for outflows. Are you confident that money will stick?

Yes. Look at the central bank mar-ket: they are very conservative. Most of those core investors holding Aus-tralian dollar paper are holding it

The Australian Office of Financial Management is responsible for the management of Australian government debt. Its main job is managing the curve of Commonwealth government securities, but in 2008 it stepped in to save the mortgage-backed market during the financial crisis — a programme it concluded in April. Chief executive Rob Nicholl spoke to EuroWeek in Canberra about shutting down that RMBS programme, as well as the likely challenges the AOFM will face in the future.

AOFM looks forward to life after RMBS programme

AOFM interview


unhedged, because it’s a portfo-lio allocation. We’ve given a lot of thought to this, because a large pro-portion of offshore ownership comes with risk. But any solution comes with risk. And we don’t see the cir-cumstances in which we would have a mass exit. We see plenty of turnover at the margin, but we expect that as a healthy characteristic.

EuroWeek: You’ve been moving to longer tenors. The latest was 2029.

Yes, 16-1/2 years when we issued it.

EuroWeek: How’s that gone?

We issued that again in April for the first time since syndication and it was a very pleasing result. The ten-der was over three times covered with pricing 0.25bp through mid-market. Our move to extend the yield curve to 15 years, 18 months ago, has been very successful, and we are in a peri-od of consolidating that.

EuroWeek: What role will CPF-linked [inflation-linked] paper take?

We have a broad mandate from the government to develop the inflation index part of our portfolio to 10%-15% of outstanding. We’re just below 10% now. We’ve gradually increased the issuance in that market and our out-look is to develop it in a steady way. We’ve got support to do that.

EuroWeek: [Opposition Treas-urer] Joe Hockey said if he was in power, he would ask you to launch 40 or 50 year bonds. We don’t have a 30 or even a 20. What’s your view about lengthening tenor?

Those are reasonable questions to ask and we should always be asking them. We are constantly asking our-selves this question, and we are asked a lot offshore. We’re open to the idea but we are naturally fairly conserva-tive in the way we will develop the portfolio. We would want to have a confident understanding that there was strong demand for us to be able to lengthen the curve. It would need to be by our normal process: syn-dication or tenders. Whether you go long and fill in, or incremental-ly move out, are open questions we think about all the time. I can’t give

you a timeframe: we are taking the opportunity to consolidate this 15 year extension but we have an eye to do other things as well should the opportunity present.

EuroWeek: Does longer tenor funding help infrastructure fund-ing in Australia?

Eventually it would. It is pretty hard to get past the proposition that a strong sovereign bond market is the foundation of the rest of your domes-tic market. In principle there is a good reason to argue that if you have a sovereign bond curve with longer dated paper, that helps price discov-ery of other products in the market, including corporate bonds. We are certainly aware of the policy reasons you would want to do that, and the reasons that it would facilitate infra-structure development.

EuroWeek: You’re from a state background with Tasmania. Can you spell out the relationship between Commonwealth and states in funding terms?

Australia is a federation, and that necessitates strong policy and fis-cal co-operation between federal and state governments. We see that. Most investors understand that the states collectively draw half of their budget revenues from a nationally collected tax. They are intrinsically linked to the Australian story. That’s a strong indication of where the semis sit rela-tive to the Commonwealth. There are lots of examples around where the

Commonwealth steps in and assists the states when they need fiscal sup-port. People like to highlight the dif-ferences between Commonwealth and states, which can be political, but if you step back you seem them work-ing together for a common good.

EuroWeek: You see no need for an explicit guarantee?

Not that I can see. The states borrow for different reasons, but their fiscal positions are monitored collective-ly including by the Commonwealth. There is very transparent reporting.

EuroWeek: Does the AOFM lengthening tenor have an impact on the states?

We’re certainly told that our efforts to build relationships with offshore investors helps to pave the way for the semis to participate, and we talk to investors who are interested in the semis because of the yield pick-up. A natural progression is for an inves-tor to be interested in our currency, then buy our paper at the short end, then across the curve as they become more familiar. The next steps from there are to SSAs and semis, and we have talked to investors who go on to buy corporate paper.

EuroWeek: There is a contradic-tion between the enormous scale of Australia’s superannuation funds, and the relatively small bond market. Do you have a view on what might improve that?

No, they’re policy issues. We would make similar observations about where the money sits and goes, but how you bring about the redirection of those flows is a policy question.

EuroWeek: Australia appears in great shape. Do you see any threat at all to its safe haven status and rating?

No. If you look at the fundamentals, the underlying picture is one of strength and opportunity. That’s part of the national debate at the moment: how does Australia even better position itself in the Asian region when this is our centre of global growth? It’s a good problem to have: which choices we make to develop the country. s

AOFM looks forward to life after RMBS programme

Nicholl: Developing Australia’s position in Asia is a good problem

Securitization/term Loan Bs


During the financial crisis — known, universally in Australia, as the gFC — the once-vibrant secu-ritization markets locked up to such a sharp extent that it seemed they might never revive. Five years on, though, they are moving once again. And in Australia, they got a big vote of confidence in April.

that came from the Australi-an Office of Financial Management (AOFM), which in September 2008 had set up a programme to pur-chase Australian residential mort-gage-backed securities under the direction of then-treasurer Wayne Swan. through the programme, the AOFM intervened as a buyer in deals that otherwise would not get off the ground — particularly those from smaller mortgage lenders.

the programme was in place, and at times very busy, for four and a half years. By April 2011 it had invested A$12.7bn in 45 rMBS issues to help 19 lenders raise A$29bn of funding, and financed mortgages over more than 150,000 residential properties across Australia. When it announced those statistics, the treasurer direct-ed AOFM to invest up to an addi-tional A$4bn, in addition to A$3.5bn of remaining capacity from earlier tranches of the programme, but grad-ually the need for it declined. And in

April 2013, the programme was ended. As AOFM chief executive rob

nicholl says in an interview elsewhere in this report: “[the programme] was critical in preserving the securitiza-tion infrastructure in a period when it looked like the market was basically in seizure…. the message is that the securitization part of the market has recovered.”

the consensus is that the market has, indeed, got better. “From Sep-tember 2012 to early 2013, the rMBS market had a great run,” says Will Farrant, head of debt capital markets for Credit Suisse in Australia. “Local real money and offshore investors showed a lot of support for deals and spreads tightened. Balance sheets and the AOFM were no longer the only buyers.”

Steve Lambert, executive gener-al manager, global capital markets at national Australia Bank, says the AOFM programme “was a great help to the market. But they hadn’t partici-pated since the middle of last year, so in formally ending the programme they were just announcing what as been a clear reality: that there’s no more need for them to participate.”

Several of the biggest Austral-ian dollar deals this year have been mortgage-backed, such as a A$2.535bn issue in the Medallion

trust series from the Commonwealth Bank of Australia in March and more than A$2bn from Westpac’s WSt trust series in February. important deals outside the big four banks have included a A$1.5bn transaction from Suncorp, A$850m from the Bank of Queensland and issues in the torrens series from Bendigo Bank.

rod everitt, head of global risk syn-dicate at Deutsche Bank, says a tor-rens deal that Deutsche and Mac-quarie led in February, which raised A$850m, provides a particularly good illustration.

“there is very good demand as long as the structure is right,” he says. “torrens for Bendigo Bank was a case in point: a great deal that reset the market to a new level for those sec-ond-tier banks. We went back almost to an old-school structure: big tranch-es, longer triple-A senior notes. Peo-ple are comfortable with it, they like the spread and the longer tenor, and they like the fundamental quality of the mortgage as well.”

Better still, everitt says: “Bids now come right through the structure. Where before it was always difficult to sell the lower tranches, it’s where the most bids are now and the hardest to allocate.”

Perhaps the strongest proof of an improvement, though, has been the presence of still smaller lend-ers. everitt highlights Liberty, a non-bank lender. John Chauvel, head of debt capital markets at Westpac, adds: “We’ve seen a relatively steady flow of issuance into the market — not crazy, a steady flow — from the whole spectrum: credit unions, build-ing societies, regional banks, non-banks. names like First Bank, Colom-bus Capital and resimac have been able to access the market quite com-fortably.”

Activity has been almost entire-ly confined to rMBS, though, with no sign of commercial mortgage-backed deals. there have, however, been some asset-backed deals away

The RMBS market in Australia is back in rude health, underscored by the AOFM’s decision to end its programme of market intervention after four and a half years. The market may never again look like it did in 2007, but issuers and investors are delighted to have it back.

A startling recovery

Monthly Australian RMBS issuance 2011-2013

Source: Dealogic

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

Sep

11

Oct

11

Nov

11

Dec

11

Jan

12

Feb

12

Mar

12

Ap

r 12

May

12

Jun

12

Jul 1

2

Au

g 1

2

Sep

12

Oct

12

Nov

12

Dec

12

Jan

13

Feb

13

Mar

13

Ap

r 13

May

13

Jun

13

Jul 1

3

Au

g 1

3

€

m e

qu

ival

ent

Monthly Aussie RMBS issuance in over two years

Securitization/term Loan Bs


from mortgages. One example was an A$400m deal for Case new holland to finance agricultural equipment; Bank of Queensland also completed an A$900m auto and equipment transac-tion in May.

Like other sectors of the market, volatility in May and June changed the picture and issuance fell away. But there is renewed optimism that this was simply a blip and that the markets are, broadly, back.

Australian rMBS issuance was A$11bn in the year up to early June, compared to A$4.4bn in the same period of 2012. And by August 14 rMBS issuance was up 35% year on year.

underpinning it all is the famed

strength of residential mortgages themselves: it is often said that the Australian individual relationship with land and the home is stronger than anywhere else, and that the resil-ience of mortgages is consequent-ly outstanding, with very low delin-quency rates.

“the Australian rMBS product is very robust, and that has been prov-en through the cycle several times over,” says grant Bush, head of capi-tal markets and treasury solutions at Deutsche Bank. “if anything, i’m surprised this market took so long to bounce back.

Of all rMBS markets in the world, it should always have been the one to bounce back first and fastest.” it

is something of a controlled market, though, with the four major banks controlling 90% of the A$262 billion mortgages written last year, according to reuters data.

As elsewhere in the market, foreign participation is playing a role in the rMBS sector’s revival. “Mortgage-backed securities have had a very good year, with a lot of interest from offshore,” says Lambert. “the last six or seven deals we’ve done have had a foreign currency element to them, mainly uS dollars but also sterling. Securitisation last year had a better year than 2011, and 2011 was better than 2010; we’re not going back to the days of 2007 but it’s in much better shape.” s

AuSTRAliA has no high yield market, nor one for unrated issuers. Australian corporates who have a sub-investment grade rating, or none at all, still have three choices available to them when they need funds, but they are all offshore.

issuers who are unrated but strong can access the uS private placement market, discussed elsewhere in this report. For others, there are the uS high yield and term loan B markets.

Australia’s wealth of dollar-driven re-source players makes the country a nat-ural breeding ground for potential issu-ers in these markets, since they can’t get what they need at home.

“When you see high yield paper from Australian corporates it’s usually in the resources space,” says Edwin Waters, ex-ecutive director, debt capital markets at ANZ. “Fortescue [Metals] has done $9bn in the last few years, but it has uS dollar needs. There’s a very deep market for that, and that is the uS. We’ve not even seen the first hint of a domestic high yield bond market.”

Another example of a mining company (or mining services) tapping the uS high yield market was Barminco, which raised uS$485m in May, in five year funds with a coupon of 9%. Another was Ausdrill, which raised uS$300m late last year, pay-ing a 6.875% coupon.

“issuer interest in high yield and term loan Bs has increased, indicative of cor-porates wanting to term out and address covenants,” says Sean Henderson, head of debt capital markets for Australia at HSBC. “Corporates have been pro-active-

ly managing their upcoming financing needs as the economic environment has become more challenging, particu-larly in the mining sector.”

But how to choose which option? “i think of the term loan B market as be-ing similar to the uS PP markets, but for sub-investment grade borrowers,” says Henderson. “Effectively, it’s loan-style documentation but targeting institu-tional investors, and the use of security and covenants will depend on the un-derlying credit.”

Generally, the high yield bond market has less restrictive covenants, but increas-ingly term loan B markets are offering looser (or absent altogether) covenant arrangements for stronger names. un-like uS private placements, both the high yield and term loan B markets do require public ratings.

A good example of a term loan B bor-rower from Australia was Melbourne’s Pact Group industries, which raised uS$885m paying 275bp over libor in May. “Pact was a very good name for this market, a solid BB rated credit with global presence, and achieved a fantastic out-come in term loan B,” says Henderson.

An alternative is obviously bank lend-ing at home, and the more pressure there is on the cross-currency swap for issu-ers who need their funding back in Aus-sie dollars, the more attractive that op-tion may be. But Paul Donnelly, global head of equity capital markets and debt capital markets for Macquarie Capital, be-lieves the term loan B market makes a lot of sense.

“For the first time for a long time, when you line up the pros and cons of an issue in the term loan B market versus the Aus-tralian bank market, the offshore deals look pretty good now,” he says. “it al-ways used to be the case that borrowers would hit the domestic market because it was not worth the premium to go to the uS market. That gap is so close now that, when you put the qualitative advantages in, i reckon it makes sense to go.”

These dynamics can change quickly with the markets, but whatever the out-come, Donnelly believes Australian bor-rowers are benefiting from the availability of the market.

“There is now a lot more confidence in going to the term loan B market as an al-ternative to the Aussie bank market,” he says. “This is introducing competition to the Australian bank market and sponsors are benefiting. The term loan B market is not as strong for Australian borrowers as in the first quarter but financial sponsors now understand they can get to the mar-ket very quickly if the window is there.” s

Term loan Bs — a handy option

“We’ve not even seen the first hint

of a domestic high yield bond market”

Edwin Waters,ANZ

Domestic capital markets


australia’s markets are deeper and offer greater tenor than ever before, but still bankers ask: why can’t it do more?

“the australian dollar market has taken a lot of people by surprise,” says luke Gersbach, director, debt securi-ties at Westpac. “We have started to see further demand for longer-dated tenor, something the a$ market hasn’t seen for a while. the aussie market has become more robust in the last couple of years and is prepared to look at issues it wasn’t in the past.”

all this is true. the australian market will now take an issue from a compa-ny rated BBB- by Fitch and unrated by the other agencies (Downer EDi), will re-open after a volatile patch not with a three-year bank floater but with seven-year corporate issues (Port of Brisbane and Perth airport), will take 10 year funding for the right name — and will absorb a billion dollars of issuance in one hit (BHP Billiton).

this is all promising. “Borrowers and investors’ willingness to extend dura-tion is definitely growing, despite recent volatility in long end rates,” says tim Galt, executive director in fixed income syndicate at uBs. “the lead is coming from the sovereign and semi-govern-ment borrowers, and more recently cor-porate borrowers. the australian Office of Financial Management has printed 2029 and 2025 maturities in the last 12 months.”

semi-governments, notably Victo-ria, have gone even further out: it is now commonplace to see seven year corpo-rate deals and the occasional 10s.

some fret that this is not enough. Even at the sovereign end, a 16 year deal is not so impressive. the lack of long deals is unsurprising: australia, lacking the debt load of other developed world countries, does not really need the money. But this hardly helps the devel-opment of a longer curve — and that is a problem for infrastructure financing in the country, for example.

“there is no 30 year government bond in this country because of the size and preferred financing structure

of the government’s debt,” says steve Black, working in debt capital markets at Credit suisse. “this lack of a bench-mark makes it more difficult for issuers to raise very long dated financing.”

at the other end of the credit spec-trum, although lower-rated issuers like Downer EDi are getting a reception now, there is still no high yield market, and issuers have to go to the us to do deals.

so what to do about the domestic market? “this question has been heav-ily debated and most participants have a view,” says Will Farrant, head of debt capital markets at Credit suisse. “the macro conditions of the last few years are as good as they’ve ever been to break the current cycle, and the market has indeed improved in depth and tenor, a trend we hope continues.”

By the current cycle, he means the

fact that long-dated and sub-invest-ment grade deals do not exist because people will not invest in them — but they might also not be investing in them because they are not there to be invested in, a circular situation that is especially irksome in a country with a vast a$1.5tr retirement savings industry looking for investments.

“Offshore demand for australian dollar paper, particularly private bank demand for higher yielding corporate paper, has been a big factor in spur-ring that growth, but the general rates environment has definitely assisted in pushing demand into longer tenors to pick up yield,” says Farrant. “if these

conditions persist for long enough to establish more diversity in the market, the vicious circle can perhaps be turned into a virtuous one.”

The Asian bidFarrant’s point about the offshore bid is echoed throughout this report, from sovereign to corporate paper. “a key development in the australian dollar market has been the incremental bid out of asia,” says Westpac’s Gersbach. “Where it was incremental, it is now becoming more of a cornerstone.”

australian issuers will now take their roadshows not only to sydney and Mel-bourne but to Hong Kong and singa-pore — Mirvac was a recent example. and this is for genuinely local names, rather than those that are australia domiciled but foreign-linked.

“We often see issuers like Coca-Cola amatil issuing in australian dollars off an international EMtN programme,” says Gersbach. “But with all three fac-tors — australian credit, australian dollars, off australian law a$ MtN doc-umentation — you would have histori-cally seen the liquidity out of asia vis-ibly diminished.”

Not anymore: Melbourne airport, for example, saw one third of its order book come from offshore on recent deals.

One question on the mind of market participants is whether the long-predict-ed rotation of investors from debt into equities will hurt the development of the domestic debt capital markets.

“rather than characterise this liquid-ity in terms of a great rotation from fixed interest to equities a better context might be that central banks are printing liquidity which is ending up with fund managers,” says Paul Donnelly, global head of equity capital markets and debt capital markets for Macquarie Capital. “rather than a rotation out of bonds into equities, we are seeing a deploy-ment of cash into equities.”

if that is true, there should be no short-age of capital for australia’s debt mar-kets — if it can only be coaxed into areas where issuers cannot find it yet. s

Tenor, depth and diversity of credit are all improving in Australia’s domestic capital markets. But local bankers and issuers would like the country to be able to do more, starting with longer-term benchmarks and the hint of a high yield market.

Longer, please

Australia can handle A$1bn deals from the likes of BHP Billiton

kangaroo bonds


The Kangaroo bond market is experiencing a disjointed year: a rocketing start, a lull during a period of global volatility — and a plum-meting australian currency — and most recently a revival at the long end of the curve. Where it goes next will depend on factors both local and global.

It started out looking like a record year. SSa issuers in the first two weeks of January included renten-bank, KfW, european Investment Bank, nordic Investment Bank, and International Bank for reconstruc-tion and Development.

Between them, they raised a$3bn in those weeks — a$4bn by the end of the month. and they did so cheap-ly: eIB’s a$400m of 10 year funding was priced at 77bp over swaps, com-pared with 112bp a year earlier.

With risk premiums falling glob-ally, investor demand strong, and the australian dollar apparently invincible — and with plenty of fair-ly low-priced capacity in the cross-currency swap market — the market was experiencing an ideal issuing environment.

“From a spread product point of view, it was perfect for the austral-ian market,” says rod everitt, head of global risk syndicate at Deutsche Bank. “at the start of the year the SSa borrowers wanted to take advan-tage of the basis swap at elevated lev-els. The australian market provided them with attractive levels compared to their offshore curves, and gave them an opportunity to kick off their year.”

at the same time, he says, domes-tic and regional investors had cash build-ups, as they often do at the end of the year, and there was a risk-on tone globally.

and beneath the good market con-ditions was a broader shift in the way foreign issuers and investors were viewing the currency.

“For SSa borrowers the australian dollar has become more of a planned

currency in the last two years than in the past, when it was more of an arbitrage currency,” says Mark god-dard, executive director and head of debt securities at Westpac. “If you look at International Finance Corp as an example, the australian dol-lar was their second largest funding currency in 2012.”

Swell Wellsand it wasn’t just the SSas. The period from late 2012 to early 2013 saw keen appetite for foreign banks and corporates in australian dollars.

JP Morgan, Bank of america Mer-rill Lynch, Citi and Wells Fargo were joined by a host of Korean issuers and, late in 2012, oil firm BP. at the same time, the domestic market was playing host to global names with strong australian presences, such as Toyota. global mining firm BhP Bil-liton, despite being locally incorpo-rated, is considered an international name but its a$1bn bond issued last october was a landmark whether it’s considered a Kangaroo or a domes-tic issue.

Two deals stood out in the finan-cial space. one was from Wells Fargo, which raised a$900m in a two tranche Kangaroo deal in January, its first issue since 2007.

“Back in the pre-crisis days, Wells Fargo was an extremely popular name down in australia for many years,” says Tom Irving, head of asia syndicate at TD Securities in Singa-pore, which handles many Kangaroo deals.

Wells Fargo offered something extra to the big australian banks, Irving says. “The coupon was priced at plus 100bp, which at the time was considered a very fair level, and accounts jumped on that.”

The deal was made up of a a$400m 4.25% January 2018 bond, and a a$500m January 2018 Frn, priced at 100bp over mid-swaps and the three month BBSW respectively.

The other standout financial was

a a$300m deal for national Bank of abu Dhabi in February. It was only the second ever Kangaroo issue from the Middle east and the first since 2006. It might have looked a tough sell, but it flew out of the door, attracting an order book of a$1.3bn from over 130 accounts.

Under the coshBut the good times didn’t last. a combination of global volatility and a decline of the australian currency stopped the market for new issuance in its tracks for all but the big SSas who were already working through long-planned programmes.

“The aussie has been one of those currencies under the cosh, and it has meant new issues have been ham-pered,” says Irving at TD Securities. “But it’s typical for issuance to be quieter in the [northern hemisphere] summer. generally we see a pickup in September through november. Whether it happens will be based on what is happening globally with rates.”

Still, there is a sense that the cur-rency has steadied now, and bankers argue that at least for SSas the move-ment is not going to make much difference to their funding plans in australia.

“I don’t expect the currency to have an impact on how SSas view sup-ply into this market,” says apoorva Tandon, director, syndicate at anZ. “It could have an impact on demand. But the australian dollar plays a

The Kangaroo bond market got off to a flying start to 2013 but it didn’t last, as global volatility combined with a falling currency kept issuers away. But recent deals suggest demand is still strong for the right names in Australia – and for surprisingly long-term funding.

Ready to bounce again

“For SSA borrowers the Australian

dollar has become more of a planned

currency”

Mark Goddard, Westpac

kangaroo bonds


material role for some borrowers like KfW, although it isn’t a huge compo-nent in terms of volume.”

he says the currency represents about 10% of KfW’s overall funding needs, for example.

and there is, perhaps, a positive view on the currency decline.

“The currency level tends to be more of an interest to investors than to borrowers,” says goddard. “For Kangaroo issuers, swapping out to US dollars is impacted by the level of the basis swap — which is largely determined by flow of issu-ance. From the currency side, many would argue the sell-off means investors are looking at the aussie market again because it’s cheaper on a relative basis and still offers decent yield.”

In any event, issuer bearishness hasn’t lasted. In recent weeks, issu-ers have found demand for 10 year Kangaroos. In early august Interna-tional Finance Corp issued a$200m of 4.25% 2023 paper through Deutsche Bank and TD Securities, at 36bp over swaps. IFC had previ-ously issued a$300m of 3.5% five year paper at 18bp over swaps, and a$100m of five year floating paper at 18bp over BBSW, in a dual tranche deal in May.)

and nederlandse Waterschaps-bank (nWB) tapped a 10 year bond for a$50m at 83bp over swaps dur-ing the same week, also through Deutsche Bank. The IFC deal was sold heavily into asia, particularly to Japanese accounts, which often

drive the long end of the curve.Beside the SSas, banks have con-

tinued to be active. at the end of July, goldman Sachs sold its first Kangaroo bond of the year, a a$450m five year 5% bond and a$300m five year floating rate tranche. The deal attracted over a$900m of orders across the two tranches, with pricing — 170bp over swaps on the fixed tranche, 170bp over BBSW on the floating — rough-ly in line with goldman’s cost of funding in dollars.

and royal Bank of Canada issued a three year deal in July, and Singa-pore’s oCBC priced a a$350m senior Frn in mid-august. “You could con-tinue to see more deals: the market is receptive,” says Duncan Beattie, managing director, debt capital mar-kets at JP Morgan, joint bookrunner on the oCBC deal. “There is room for US financials or high quality europeans, plus the Sydney branch-es of the asian and Japanese banks.”

Asia steps inall through the year, issues have been helped by a growing interna-tional bid for australian dollar paper.

“on many deals we do, we can see a large component of the bonds sold offshore,” says adam gaydon, direc-tor, syndicate at anZ. “We acted as joint lead manager on a deal for Bank of america in May, a a$850m five and a quarter year Kangaroo, and more than 50% was placed with offshore investors, particularly in asia, which made up 42%. europe

and the Middle east made up 15%, with the balance of 43% placed domestically.”

on the nBaD deal, upon which anZ was also a bookrunner along-side Bofa Merrill Lynch and nBaD itself, 46% went offshore including 41% to asia and 5% to europe.

This has benefits. “Both the Bofa and nBaD deals were very granular and had over 130 accounts partici-pate,” gaydon says. “The books were not skewed by one or two key inves-tors. a lot of that granularity comes from private bank orders in asia and the Swiss and Benelux region.”

everitt at Deutsche says: “Particu-larly with the SSa deals, we’ve seen a lot of Japanese and asian money coming into our market. Two years ago it was very much the domestic accounts driving the trades. now, domestic investors are still partici-pating, but the flow is more consist-ently out of asia.”

Steve Lambert, executive general manager, global capital markets at national australia Bank, says that Japanese banks have stepped up as european banks are pulling back. “But it’s not just the Japanese,” he says. “You see Chinese banks, par-ticularly on the loan side. There are banks from India, Singapore and Taiwan who are active. asia, on the bond and loan side, is always a key part of the bid on any transaction. That will continue.”

and in particular it will continue in support of fund raising by local branches of big asian banks that have balance sheets in australia that need to be funded, he says.

There are nuances to that position, particularly around the Japanese, who normally drive demand in long-er-dated trades. “Japan has a num-ber of issues to deal with and has become less active when it comes to the longer dates,” says Tandon at anZ. “The view here is there will be less supply in the longer end because of that reduced demand.”

But Tandon was speaking before the 10-year IFC and nWB deals. Per-haps the Japanese will remain more central to Kangaroo paper than has been feared. and even if they do not, it appears that asian and euro-pean demand will provide a will-ing market for Kangaroo borrowers who can brave the currency’s recent wobbles. s

Kangaroo bond issuance by month, 2013

Source: Dealogic

0

1

2

3

4

5

6

AugJulJunMayAprMarFebJan0

100

200

300

400

500

600

700

800

AugustJulyJuneMayAprilMarchFebruaryJanuary

A$bn A$mIssuance maturing in 2023 (right hand scale)

superannuation


AustrAliA’s pension fund indus-try, known locally as superannuation, shows the country punching vastly above its weight. Despite a population of just 22m, Australia’s superannuation pool stood at A$1.58tr at March 31, one of the largest in the world.

the figures are only going to get big-ger and the rate of growth itself can be expected to increase, too. the reason the sector has become so big is because of the superannuation Guarantee which the then-prime minister Paul Keating put in place in 1992, requiring employers to put a mandatory 9% of each employee’s salary into their super-annuation. that rate of contribution increased to 9.25% on July 1 and will continue to step up incrementally until it hits 12% in 2019.

this has led to some very large pre-dictions for the future scale of the industry: Deloitte has suggested A$3tr by 2018 and A$7tr by 2028, while the Australian treasury itself has predicted a more conservative A$6tr by 2037. the precise figure will depend on invest-ment returns, voluntary contributions to super beyond the mandatory figure, and in particular the degree to which funds are withdrawn from superannu-ation in retirement. But whatever the outcome, there is already and there will continue to be an enormous amount of capital to be deployed.

One frustration in the investment bank and fund management sector is that that deep pool of investable wealth has not been turned into a driver of the domestic debt capital markets. the rea-sons for this have been debated end-lessly in various Australian forums and conferences for years, chiefly ask-ing the question of whether Australian super funds do not buy a wider range of Australian debt because they do not want to or because it is not available to buy.

“the super fund wholesale inves-tor base does support the Australian market in most forms,” argues rod Everitt, head of global risk syndicate at Deutsche Bank. “it has always been

quite active. But it has been a chick-en and egg situation with it not always getting the supply it has wanted, so it has had to source other forms of fixed income.”

Generally, though, super funds — as with Australian investment general-ly — have tended to favour stocks over bonds. “super funds are still very equi-ty-biased,” says steve lambert, execu-tive general manager, global capital markets at National Australia Bank. “Of the OECD countries, we have among the lowest amount managed in fixed income.”

However, there are five trends under-way in superannuation which should have an impact both on debt mar-kets and the intermediaries who serve them.

they are self-managed super funds (sMsFs), industry funds, the trend towards direct investment, Mysuper, and post-retirement annuities.

sMsFs are a growing community of individuals who have decided to go it alone and manage their super funds themselves. Despite the fact that, for several years, the compliance and reporting burdens upon them have become steadily more onerous — an attempt by the regulators to ensure that people know what they’re doing — there are more of these funds than ever, and collectively they have become an enormous force. According to the Australian Prudential and regula-tory Authority, by March 2013 there were 503,320 individual sMsFs with A$496.2bn in assets between them — 31.5% of the entire superannuation industry, the biggest single chunk.

the relevance of this group is that they have a tendency towards assets that provide safe and stable income. Many bankers report this group as being steady buyers of the hybrid secu-rities that are sold to retail: AsX-list-ed securities that pay a steady rate of income, such as tier one securities from banks (see separate chapter in this report).

their relevance to the debt markets

may grow as other, vanilla bonds are increasingly listed on the AsX as well. Commonwealth government securities have been available through the AsX since May, and it is expected that more and more financial institution and cor-porate bonds will be listed too.

the sMsF constituency may well be the group that makes or breaks this as a successful pocket of the market, and there is a lot to suggest they will be enthusiastic buyers: the ability to buy and sell like a share, combined with the certainty of income from a bond, is exactly what sMsF buyers tend to want.

until recently, they have largely ignored government bonds, because the yields are not attractive in compari-son to bank deposits. But as bank rates fall alongside reserve Bank interest rates, more and more money is likely to leave bank deposits and go into debt. And with half a trillion dollars between them, only a small percentage of assets needs to start looking at local bonds to have a pronounced impact.

“the search for yield and certain-ty of income, with less volatility and strong capital preservation, is a theme that is likely to continue,” says Allan O’sullivan, director, retail syndicate at Westpac, “particularly given the low interest rate environment and aggres-sive repricing of deposits.”

the second theme is the other seg-ment of the superannuation industry that is consistently growing: indus-try funds. until 2005, industry funds were largely confined to the particular industry they represented: so MtAA was for the automotive industry, for example, and unisuper for employ-ees of universities. they were non-for-profit funds that had grown out of the unions.

in 2005, a new choice of super regime was introduced in Australia, allowing individuals to choose what super fund they went into.

this opened many industry funds up to wider application for the first time — and, since they were low-fee, certainly

Australia’s A$1.58tr superannuation industry is one of the biggest pension systems in the world, but it doesn’t appear to be supporting the development of the local debt market. Several subtle changes at work may be about to change that.

Super-sized

superannuation


compared to the super funds offered by the country’s big commercial fund managers, they proved to be extremely popular.

today, industry funds repre-sent 19.8% of the industry and have A$311.4bn under management between 54 active funds (a number that is gradually shrinking as industry funds merge to achieve economies of scale. Australiansuper, for example, the big-gest industry fund in Australia, has absorbed AGEst super, iBM super and Queensland’s Aust(Q) super in the last two years. “We believe in growing the fund and using our increasing scale to achieve sustainable results for mem-bers,” says Australiansuper chief exec-utive ian silk.)

the main difference this makes to the debt markets is that industry funds have tended to invest in quite a dif-ferent way to the equity-heavy retail funds. Many industry funds — MtAA and Westscheme being prominent examples — have far higher allocations than is typical in alternative assets, although they have pulled back a little since the global financial crisis follow-ing concerns over liquidity. For exam-ple, Westscheme’s balanced option (the default option into which most inves-tors put their funds) features a 14% allocation to infrastructure; among other things, it holds stakes in Mel-bourne, Brisbane and Perth airports, Anglian Water, the Port of Brisbane and the Polish energy utility Dalkia Polska.

MtAA has 15% in infrastructure, and a separate 3% allocation to a class it calls “alternatives credit”, which includes “infrequently traded debt securities (such as corporate bonds and

loans) that exhibit greater credit risk and higher expected returns relative to sovereign government debt.” until recently, Westscheme had a separate allocation to subordinated debt.

so if industry funds continue to gain traction, it is reasonable to expect more and more assets being deployed into infrastructure, which ought in turn to help create a fixed income market that matches infrastructure by being longer tenor.

the third theme involves some funds — industry funds in particular — doing more and more investment in-house and directly than through third-party external managers.

“Consolidation in the superannua-tion industry is creating funds with critical mass,” says Will Farrant, head of debt capital markets for Australia at Credit suisse. “if you are dealing with one of the in-house teams, they have a much broader view of what they want to do and achieve. they can be more flexible and if they see a good opportu-nity that doesn’t quite fit the mandate they have given to a third party manag-er, it is easier for them to say: we should be doing this. that is positive.”

Perhaps that will be the prompt for the beginnings of a high yield market in Australia, as individual super funds can make a call on one-off deals that the managers they mandate would not be permitted to do. Or perhaps it means taking on longer-dated bonds — which would, after all, be a better fit for funds that are meant to invest for the long, long term. Again, this has possi-ble consequences for infrastructure.

the fourth theme is Mysuper, a new measure coming into effect in Australia

this year following a lengthy review of the entire indus-try. Bill short-en, speaking to EuroWeek shortly before leaving his portfolio as Min-ister for super-annuation and Financial services to go to another ministerial role, describes Mysuper as: “a new, simple and cost-effective default superan-nuation product. the creation of Mysuper is intend-

ed to put downward pressure on fees and charges, meaning Australians will retire with more.”

it is designed for those people who do not take an active interest in their superannuation, so that the set-and-forget option is cheap, simple and transparent.

this, too, could perhaps have an impact on the debt markets. to keep fees low, fund managers are going to have to put a lot of their assets into pas-sive products. local debt — which pays quite well compared to international fixed income — is a logical way to do so, although as lambert says: “it’s not obvious what Mysuper means for more fixed income. there will be more pas-sive investments, but one doesn’t nec-essarily lead to the other.”

Finally, there’s the fact that more Australians are retiring. the baby boomer generation is hitting its mid-60s and is starting to draw on that vast mass of superannuation. these retirees will mostly want income — and this is perhaps the biggest potential boon for local debt.

“As we see a demographic shift towards an ageing population, it’s only natural we are going to see a greater allocation to fixed income products,” says luke Gersbach, director, debt securities at Westpac. “there will be more liability asset matching require-ments, leading to demand for long-er tenors. that should create more demand in the 10 year part of the curve over time, without doubt.”

the mechanism through which this will be done may well be through a more vibrant annuities industry than the somewhat infant one that exists today. “there has been a lot of dis-cussion about how superannuation is regulated up until retirement, and that there is little regulation of investment upon retirement,” says steve Black, head of bank capital at Credit suisse. “One school of thought is that there should be a requirement to invest some part of retirement savings into income generating products, such as annuities.

He argues that a more developed annuities market would create greater demand for fixed income instruments, including corporate credit, as annuities providers sought to match cash flow and return requirements.

“the introduction of a requirement to invest in long-dated annuities would be a game changer for the domestic bond market,” he says. s

Assets (A$bn) Number of By fund type entitiesCorporate 60.3 114

Industry 311.4 54

Public sector 247.2 37

Retail 415.0 128

Sub total 1,034.0 333

Pooled superannuation trusts 96.9 66

Small APRA funds 1.7 3,251

Single-member ADFs 0.0 74

Self-managed super fundsa 496.2 503,320

Balance of life office statutory funds 44.1

Totalb 1,576.0 507,044

Retirement savings accounts 1.8 9a Estimated data on self-managed superannuation funds are provided by the Australian Taxation Office (ATO)b Total assets does not include pooled superannuation trusts

Superannuation industry quarterly estimates

Source: APRA

Profile: the future fund


AustrAliA’s Future Fund is one of the world’s newest sovereign wealth vehicles, established by the Future Fund Act in 2006. it is also one of the most distinctive.

First, there is the exceptional clar-ity of the mandate, unusual in sover-eign wealth funds. Funds like the Abu Dhabi investment Authority or Kuwait investment Authority have a broad mandate to diversify hydrocarbon wealth to provide stable income when the oil runs out. Asia Pacific funds like singapore’s temasek and GiC, or China investment Corp, have a still more neb-ulous rainy day mandate, with no lia-bilities, no target date, and no obvious directive beyond the national good.

the Future Fund, by contrast, was set up specifically to make provision for the unfunded Commonwealth pension liabilities of civil servants in Australian federal public service. the government was worried that an age-ing population would place pressure on Australian government finances, and so it set up the fund with A$18bn in seed capital in May 2006. in total, it received A$51.3bn in funding by June 2008.

the trustees and managers were given a provisional target date of 2020 and a target total to hit by that date of A$140bn. there has almost certainly never been such a tightly defined sov-ereign vehicle.

Investing for the long termit stands out for other reasons, too. First, like it or not, it received 2.1bn tel-stra shares worth A$8.9bn in February 2007, from the third and final stage of the national telecommunications com-pany’s privatisation.

this single holding was skewed its portfolio and took years to be digested by gradual sales into the market.

And second, it became clear very quickly from the Future Fund’s hiring decisions that it was not going to look much like other funds in terms of tar-get allocations, either.

After the various operational and strategic posts had been filled, the first

hires seemed to have little to do with debt and equity and more with alterna-tive investments.

Five years on, the fruits of these hires can be seen in the fund’s portfolio allo-cation. On March 31, private equity accounted for 6.8% of the A$85.2bn portfolio, property 6.4%, infrastructure and timberland 6.5%, and alternatives — a definition which in many funds would already include all of the above allocations, but the Future Fund means hedge funds and similar strategies — 15.3%. that is considerably more on its own than the 11.6% of the fund in Aus-tralian equities.

But even that is just the beginning: according to its most recent annual report, its target allocation at June 30 this year is 17.5% to alternatives, 16.5% to tangibles (infrastructure, timber-land and property), and 8% to private equity. that’s 42% of the fund in assets which, in most allocation definitions, would be considered alternative.

it’s not how most sovereign wealth funds look. Government Pension Fund Global, the sovereign wealth fund of Norway, has 60% of its assets in equi-ties, 35%-40% in fixed income, and up to 5% in real estate, for example.

temasek in singapore is almost 100% equities. ADiA, considered visionary on alternatives, can never-theless go up to 67% in listed equities — double the Future Fund target — and as low as 13% on combined alter-

natives, real estate, private equity and infrastructure (though it could theoret-ically go up to 33% too).

the Future Fund approach may reflect a way that more and more sov-ereign and pension funds invest. Most of the asset classes in which it has built internal expertise, particularly infra-structure and timber, pay off over the very long term, and along the way pay predictable and stable income streams.

in this respect, the Fund has been joined by many of the country’s bigger superannuation funds (a theme dis-cussed in greater detail elsewhere in this report). in turn, this has created a large pool of capital for the funding of infra-structure development in Australia.

like many sovereign funds, the Future Fund appoints external invest-ment managers: 98 separate mandates were listed in the 2011-12 report. But it is perhaps its willingness to go direct into unlisted assets that gives a marker for the way it, and the broader pension industry in Australia, may develop.

“there is a an emerging trend amongst the industry super funds, and the Future Fund, in looking to be more directly involved in investment deci-sion making, including in relation to debt,” notes Paul Donnelly, global head of equity capital markets and debt capital markets for Macquarie Capital. “Where this may be of particular inter-est is in relation to debt for infrastruc-ture assets. long duration funds are natural investors in long duration debt, in contrast to the bank market where longer maturities are problematic.”

it’s also a model that has worked well in performance terms. the fund returned 10.6% in the nine months up to March 2013; over three and five year periods it is up an annualised 8.1% and 6.4% a year respectively.

Managing director Mark Burgess says at every results announcement that the fund is committed to a medium to long-term return model with an emphasis on diversification. With seven years to go to its originally mandated target date, the novel approach has every chance of meeting its goal. s

Australia’s Future Fund stands apart from other sovereign wealth funds for its devotion to alternative asset classes and for a mandate far more specifically expressed than by its peers.

Alternatives rule Future Fund roost

Asset class A$m % of fundAustralian equities 9,890 11.6

Global equities Developed markets 15,452 18.1

Emerging markets 4,810 5.6

Private equity 5,764 6.8

Property 5,473 6.4

Infrastructure & 5,547 6.5

TimberlandDebt securities 14,174 16.6

Alternative assets 13,060 15.3

Cash 10,996 12.9

Total 85,166 100

Asset allocation at the Future Fund

Source: Future Fund

AustrAliA in figures


Over the following pages EuroWeek provides a snapshot of Australia’s macro-economic, bond market and bank sector data, from a range of official sources, including the Reserve Bank of Australia, the Australian Prudential Regulation Authority, the Australian Bureau of Statistics, the World Bank and the rating agencies. For more detailed information, please refer to the websites of these institutions.

Australia in figures: an economic snapshot

Standard & Poor’s: AAA • Moody’s: Aaa • Fitch: AAA • Outlooks Stable

ReseRve Bank of austRaliathe tReasuRy

austRalian PRudential Regulation authoRity

glenn stevensGovernor

guy debelleAssistant Governor (Financial markets)

John lakerChairman

Philip loweDeputy Governor

Malcolm edeyAssistant Governor (Financial system)

ian laughlinDeputy Chairman

Martin ParkinsonSecretary to the Treasury

helen RowellMember, Executive Group

seleCted key offiCials

austRalian offiCe of finanCial ManageMent

Rob nichollChief Executive

ian Clunies-RossInvestor Relations

Strong Fundamentals Intact: Australia’s ‘AAA’ rating underlines its fundamental strengths, including a high-income developed economy, strong political and social institutions, and a credible policy framework.

Australia has built up the capacity to absorb shocks due to a combination of low public debt, a free-floating exchange rate, and liberal trade and labour markets, which allows the authorities to run strong countercyclical policies during downturns and the economy to adjust.

Robust Economic Performance: The country has remained one of the strongest performing economies in the ‘AAA’ universe since the 2008 global financial crisis, with real GDP rising 3.6% in 2012, up from 2.1% in 2011.

The combination of strong demand for natural resources, along with robust mining investment, should continue to provide valuable support to the economy.

Fitch forecasts real GDP to grow by 2.5% in 2013 and 2.8% in 2014.

Mining Boom Challenges: The continued strength of the Australian dollar as a result of the mining boom has led to strains in the non-mining sector. However, Australia’s unemployment rate remains low − 5.4% in February 2013. The key longer-term challenge facing Australia is how the economy will respond after mining sector investment peaks and begins to turn down. However, it is too early to ascertain how the economy will perform once this stage is reached.

Fiscal Consolidation Slows: The original goal to bring the Commonwealth/central government budget back to surplus in the financial year ending 30 June 2013 (FY13) will not be met, due to recent volatility in commodity prices and a strong Australian dollar. Nonetheless, Fitch believes that fiscal consolidation has only slowed and not reversed. Fitch forecasts a

Commonwealth budget deficit of about 1.5% of GDP for FY13 (versus 3.0% in FY12). Weak External Finances: The current account deficit widened to 3.7% of GDP in 2012, compared with 2.2% of GDP in 2011. It could widen further as commodity prices moderate and repatriation of profits by foreign investors increases. Australia’s net external debt, at 51.3% of GDP in 2012, will remain well above the ‘AAA’ rating group median of 25.1% of GDP for at least the next few years as a result.

Sound Banking Sector: Fitch regards Australia’s banks as among the strongest in the world on a standalone basis, despite the heavy reliance on wholesale funding markets. The banks have made strides, however, in reducing reliance on short-term foreign funding, increasing their customer deposit base and strengthening their liquidity positions. In addition, asset quality is healthy — the non-performing loan (NPL) ratio was below 2.0% at end-2012.

SELECTED KEY OFFICIALS

fitCh key Rating dRiveRs foR austRalia — aPRil 5, 2013



The unsolicited ratings on the Commonwealth of Australia benefit from the country’s significant fiscal and monetary policy flexibility, economic resilience, and public policy stability. We believe these factors provide Australia with a strong ability to absorb large economic and financial shocks, as was demonstrated during the global recession in 2009.

Moderating these strengths are Australia’s high external imbalances, dependence on commodity exports, and high household debt.

Australia is a wealthy economy, with GDP per capita of about US$66,000 in 2012. Australia’s economic resilience reflects decades of reforms, its diverse economic structure, and flexible labor and product markets. Growth of the Australian economy is expected to slow to 2.6% in year ended June 30, 2013, from 3.4% in fiscal 2012, as mining investment peaks and begins to be a drag on growth. But we forecast growth will improve to 3% in fiscal 2014, as other sectors gradually strengthen, supported by low interest rates. We also expect commodity exports to increase as mining projects are progressively completed and commence production.

Growth in national incomes is likely to remain under pressure in the near term, despite a solid outlook for real economic growth. Australia’s terms of trade are likely to continue to decline, as prices for the country’s key commodity exports continue to weaken — in large part due to rising Australian and global production.

Moreover, risks remain for Australia’s growth prospects, prosperity, and credit quality. These

stem largely from its growing dependence on trade with China. If demand for Australia’s resources were to weaken sharply, this could lead to a range of disorderly dislocations in its economy, including in its labor and property markets. However, while robust demand for its commodities continues — from emerging Asia, and particularly China — we believe Australia’s economic prospects over the forecast period will remain favorable.

Australia’s public finances have worsened as a result of the global recession, but the deterioration has been more contained than for many ‘AAA’ rated peers, which have had steeper deficit increases. The federal government has pushed out its planned timeline for fiscal consolidation, due to revenue downgrades. Taking state and local government budget performance into account, we expect the general government sector’s budget balance to post relatively small and declining deficits as a share of GDP, and to be broadly in balance by 2016. Under this base-case scenario, general government net debt is expected to peak at 20% of GDP in 2014 before gradually declining.

Although Australia’s public-sector finances are not strained, its private-sector balance sheets — particularly in the banking system — carry high external liabilities. Overall, Australia’s external liabilities, net of liquid assets, were 240% of current account receipts (CARs) in fiscal 2012. Historically, Australia’s banks have been a principal channel to fund the country’s current account deficits, which has helped fund

lending for domestic residential housing and businesses.

More recently, the current account deficit has been mainly funded by foreign direct investment (FDI) into the resources sector, and government debt. Ongoing high levels of resources investment will likely mean that FDI continues to play a major role.

In our opinion, the risks associated with Australia’s high private-sector external debt are manageable because of the strength of its financial system, the high degree of foreign currency debt hedging, and an actively traded currency that historically has allowed external imbalances to adjust.

outlook

The stable outlook is based on our assumption that Australia’s historically conservative budgetary policies will remain in place, such that fiscal deficits continue to narrow and that the general government debt burden will remain low.

We could lower the ratings if external imbalances were to grow significantly more than we currently expect, either because the terms of trade deteriorates quickly and markedly, or the banking sector’s cost of external funding increases sharply.

Such an external shock could lead to a protracted deterioration in the fiscal balance and the public debt burden. It could also lead us to reassess Australia’s contingent fiscal risks from its financial sector.


Australia’s Aaa rating is based on the country’s very high economic resiliency, very high government financial strength, and very low susceptibility to event risk. Economic resiliency is demonstrated by the country’s large size, economic diversity, and track record of solid economic growth. As one of the world’s most advanced economies, the country has not only a significant natural resource sector — including minerals, hydrocarbons, and agriculture — but also well developed manufacturing and service sectors.

It also demonstrates strong governance indicators. In particular, the framework for fiscal policy is transparent and has consistently kept government debt at low levels.

The government’s financial position is very strong in comparison to most other advanced countries. General government debt is the lowest of all Aaa-rated sovereigns with the exception of Luxembourg.

The Commonwealth government has recorded small deficits for a few years, but is likely to return to a balanced fiscal position by 2016.

The diversity of the economy and the strength of the financial system lead to a very low level of event risk. However, the banks are dependent on foreign funding. The large size of the negative net international investment position can be a vulnerability in times of global financial market stress.

Australia’s economic strength is assessed as very high by Moody’s based on the country’s high per capita income, its relative economic

diversity, the performance of the economy during the past two decades, and favorable long-term growth prospects.

While Australia’s income per capita falls slightly below the median for Aaa-rated sovereigns, its rate of economic expansion has outpaced all its peers with the exception of Singapore, although Australia’s growth has been much less volatile.

Over the past six years, Australia did not experience a recession — although it did post a quarterly contraction in 2008 and 2011, respectively — unlike most advanced economies. A factor contributing to this positive performance during the global financial crisis was the government’s ample fiscal room to implement a stimulus program, which included tax cuts and infrastructure spending.n Additionally, the country’s strong banking system insulated Australia from the contagion that affected other advanced economies.

Over the last 10 years, Australia’s economy has undergone a significant transformation as investment poured into the country’s resource sector, benefiting both economic performance and fiscal revenues. Since 2003, new capital expenditure into the mining sector has increased almost ten-fold coinciding with the global commodities boom and increasing Australia’s primary resource output significantly.

The investment boom in mining and LNG has peaked, and investment in the next few years should be considerably lower, though remaining relatively strong over the coming quarters.

Authorities currently expect a gradual change in the structure of the economy to take place, with growth being less influenced by investment into the resource sector and moving towards exports, non- mining investment and household consumption. According to the RBA, some early signs that this shift is taking place are now visible. First, as mentioned, new investment into the mining sector appears to have peaked. The housing market will also help dictate future trends, as dwelling prices continue to rise, low interest rates increase households’ appetite to borrow and the rental market remains tight, supporting a recovery in investment in this sector. On the labor market front, employment has begun to move away from mining and business services and into construction and goods distribution.

Although still high, lower commodities prices should continue to bring down Australia’s terms of trade and the dollar, which in turn should help non-mining and import-competing sectors recover. Finally, because of increased capacity in the resource sector, the volume of exports from this sector should also grow fairly strongly, returning the current account deficit to below its average level of the past couple of decades. Meanwhile, as the government continues to consolidate its accounts moving towards its goal of achieving a balance budget by 2015-16, public consumption will likely weigh on growth. As such, although there is still a high degree of uncertainty, especially on the external front, we expect the economy to grow within the 2.5-3.5% range over the next few years.


standaRd & PooR’s Rating Rationale foR austRalia — august 1, 2013

Moody’s Rating Rationale foR austRalia — June 28, 2013



Base Metals, Rural and Oil PricesWeekly

l l l l l l l I70

100

130

160

190

220

l l l l l l l I 25

50

75

100

125

150

*RBA Index of Commodity Prices sub-indices; SDR terms;2005 average = 100

Sources: Bloomberg; RBA

Index $/b

Base metals*

Brent oil

2009

Rural*

2013 2009 20132005

Base Metals, RuRal and oil PRiCes

Sources: Reserve Bank of Australia (RBA)

1993 1997 2001 2005 2009 20130

100

200

300

400

Bonds on Issue in Australia$b

Australian Government*

Non-government**

State governments

* Excludes bonds purchased by the Australian Government** Excludes ADIs’ self-securitisations, includes government-guaranteed bonds

Sources: ABS; RBA

outstanding Bonds

Sources: Australian Bureau of Statistics (ABS), RBA

Aaa Peer Comparison

Source: World Bank, Moody’s, National Sources

USA

Australia

Luxembourg

New Zealand

Switzerland

Denmark

GermanyCanada

Austria

Singapore

Netherlands

Norway

Sweden

Finland

30,000

40,000

50,000

60,000

70,000

80,000

90,000

-1 0 1 2 3 4 5 6

GD

P p

er c

apita

(PP

P b

asis

, 20

11 U

S$)

Real GDP Growth (% y/y, 2007-12)

Size of the bubble = Nominal GDP (US$ Bil, 2012)

aaa PeeR CoMPaRison

Source: World Bank, Moody’s, National Sources

Capital Ratios *

0

5

10

15

%

Building societies

Other Authorised Deposit Taking Institutions (ADI)

Locally incorporated banks

Tier One

Tier Two

Total

Credit unions

1992* Percent of risk-weighted assets; break in March 2008 due to the introduction of Basel II for most ADIs; break in March 2013 due to the introduction of Basel III for all ADIs

Source: APR A

201320061999

Consolidated global operations

201320061999

CaPital Ratios*

Sources: APRA

6

12

Bank Profit s

0.0

0.5

$bn

2014-1.6

0.0

1.6

2010201420102006

n Actualn Analysts’ forecasts

n Actualn Analysts’ forecasts

Major banks* Major banks*

Regional banks** Regional banks**

Foreign-owned banks*** Foreign-owned banks***

Profits after tax Bad and doubtful debt charge

Sources: APRA; Credit Suisse; Deutsche Bank; Nomura Equity Research ;RBA; UBS Securities Australia; banks’ annua l and interim reports

* ANZ, NAB and Westpac report half yearly to March and September, while CBA reports to June and December** Suncorp Bank, and Bendigo and Adelaide Bank report half yearly to June and December, while Bank of Queensland reports to February and August

*** All results are half year to June and December

nana

Bank PRofits

Sources: APRA, Credit Suisse, Deutsche Bank, Nomura Equity Research, RBA UBS Securities Australia, banks’ annual and interim reports

2012

gdP (us$bn) 1,540.7

gdP per head (us$ 000) 67.1

Population (m) 22.9

international reserves (us$bn) 49.2

net external debt (% gdP) 51.3

Central government domestically issued debt (a$bn) 234.0

Source: Fitch Ratings

finanCial oveRview



0

2

4

6

8

FY9

1-9

2

FY9

3-9

4

FY9

5-9

6

FY9

7-9

8

FY9

9-0

0

FY0

1-0

2

FY0

3-0

4

FY0

5-0

6

FY0

7-0

8

FY0

9-1

0

FY11

-12

Mining Investment

(% of GDP)

Source: RBA, Fitch

0 1 2 3 4

Netherlands (AAA)

OECD

US(AAA)

Canada (AAA)

New Zealand (AA)

Sweden (AAA)

Norway (AAA)

Australia (AAA)

Potential Real GDP Growth

(2012-17)

Source: OECD Economic Outlook, Volume 2012/1

(% annual average)

0

2

4

6

8

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

0

2

4

6

8

RBA: Cash Rate (LHS)

CPI (RHS)

Policy Rate vs. CPI Inflation

(%)

Source: CEIC, Fitch

(% yoy)

50

75

100

125

150

175

200

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

Average of capital cities

Sydney

Melbourne

Brisbane

Housing Prices

(2003-04 = 100)

Source: CEIC, Fitch

130

140

150

160

170

180

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

Banks' Loan-to-Deposit Ratio

(%)

0 20 40 60 80 100

Australia (AAA)

Norway (AAA)

‘AA’ median

Sweden (AAA)

‘AAA’ median

Netherlands

Canada (AAA)

US (AAA)

General Government Debt (2012)

Source: Fitch estimates

(% of GDP)

0

2

4

6

8

10

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

RBA: Cash target rate

Banks' housing loans: Variable rate

Interest Rates

(%)

Source: CEIC, Fitch estimates

0

5

10

15

20

25

30

35

FY9

6-9

7

FY9

7-9

8

FY9

8-9

9

FY9

9-0

0

FY0

0-0

1

FY0

1-0

2

FY0

2-0

3

FY0

3-0

4

FY0

4-0

5

FY0

5-0

6

FY0

6-0

7

FY0

7-0

8

FY0

8-0

9

FY0

9-1

0

FY10

-11

FY11

-12

FY12

-13f

States/local governments

Commonwealth government

General Government Debt

(%)

Source: CEIC, Fitch

geneRal goveRnMent deBt in 2012

Sources: Fitch estimates

0

1

2

3

4

5

6

US

%

Germany

Japan

2013

10-year Government Bond Yields

Source: Thomson Reuters

2010200720042001

10 yeaR goveRnMent Bond yields

Sources: RBA

0

2

4

6

8

FY9

1-9

2

FY9

3-9

4

FY9

5-9

6

FY9

7-9

8

FY9

9-0

0

FY0

1-0

2

FY0

3-0

4

FY0

5-0

6

FY0

7-0

8

FY0

9-1

0

FY11

-12

Mining Investment

(% of GDP)

Source: RBA, Fitch

0 1 2 3 4

Netherlands (AAA)

OECD

US(AAA)

Canada (AAA)

New Zealand (AA)

Sweden (AAA)

Norway (AAA)

Australia (AAA)


(2012-17)


(% annual average)

0

2

4

6

8

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

0

2

4

6

8


CPI (RHS)


(%)

Source: CEIC, Fitch

(% yoy)

50

75

100

125

150

175

200

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012


Sydney

Melbourne

Brisbane

Housing Prices

(2003-04 = 100)

Source: CEIC, Fitch

130

140

150

160

170

180

200

5

200

6

200

7

200

8

200

9

2010

2011

2012


(%)

0 20 40 60 80 100

Australia (AAA)

Norway (AAA)

‘AA’ median

Sweden (AAA)

‘AAA’ median

Netherlands

Canada (AAA)

US (AAA)



(% of GDP)

0

2

4

6

8

10

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012



Interest Rates

(%)


0

5

10

15

20

25

30

35

FY9

6-9

7

FY9

7-9

8

FY9

8-9

9

FY9

9-0

0

FY0

0-0

1

FY0

1-0

2

FY0

2-0

3

FY0

3-0

4

FY0

4-0

5

FY0

5-0

6

FY0

6-0

7

FY0

7-0

8

FY0

8-0

9

FY0

9-1

0

FY10

-11

FY11

-12

FY12

-13f




(%)

Source: CEIC, Fitch

PoliCy Rate vs CPi inflation

Sources: CEIC, Fitch

Source: RBA

2

3

4

5

6

7

%

20102001

10-year Australian Government Bond Yield

20072004 2013

10 yeaR austRalian goveRnMent Bond yield

Sources: RBA

l l l l l l l l l l l l l l l2

4

6

8

Australian Bond Yields*

%BBB corporates

*Australian Government yields and swap rates are for 3 year maturity. Corporate bond yields are a weighted average of senior bonds with remaining maturities of 1 to 5 years; they include financial and non-financial corporates.

Sources: Bloomberg; RBA; UBS AG, Australia Branch

AustralianGovernment

Swap

AA corporates

2001 2005 2009 2013

austRalian Bond yields*

Sources: RBA, UBS AG

Bank Funding*

%

0

10

20

30

40

50

2011

Short-term debt**

Equity

Securitisation

20092005* Adjusted for movements in foreign exchange rates

** Includes deposits and intragroup funding from non-residents

Sources: APRA; RBA; Standard & Poor’s

Long-term debt

Share of total, all banks

Domestic deposits

20132007

Bank funding*

Sources: APRA, RBA, Standard & Poor’s



-2

0

2

4

2013

%

Quarterly

GDP Growth

2009

Source: ABS

1997 200520011993

gdP gRowth

Sources: ABS

1993 1997 2001 2005 2009 20130

50

100

150

Non-government Bonds on Issue in Australia

*Excludes ADIs’ self-securitisations

Sources: ABS; RBA

Financials

Asset-backed securities*

Non-residents

A$bn

Non-financial corporates

outstanding non-goveRnMent Bonds

Sources: ABS, RBA

-4

-2

0

2

4

6

GDP Growth – World

Major trading partners*

World**

* Weighted using Australian export shares** PPP-weighted; accounts for 87% of world GDPSources: ABS; CEIC; IMF; RBA; Thomson Reuters

2013200720042001 2010

%

gdP gRowth — woRld

Sources: ABS, CEIC, IMF, RBA

0

5

10

%

2013

GDP Growth – China and India

India

China

2010200720042001

Sources: CEIC; RBA

gdP gRowth — China and india

Sources: CEIC, RBA

2

4

6

8

10

12

14

11/12

Industry Share of Output*Manufacturing

Retail and wholesale trade

Construction

Mining

Other business services**

07/0803/0499/0095/96* Nominal gross value added

** Includes: information media and telecommunications; rental, hiring and real estate services; professional scientific and technical services; administrative and support services

Source: ABS

%

91/92

Agriculture

Financial and insuranceservices

industRy shaRe of outPut*

Sources: ABS

Gross issuanceNon-government Bond Issuance

* Excludes ADIs’ self-securitisations** O�shore non-resident issuance includes Australian dollar-denominated

bonds onlySource: RBA

$bn Australia

20

40

O�shore

2001 2004 2007 2010 20130

20

40

60

n Domestic issuers*n Non-resident issuers* *

non-goveRnMent Bond issuanCe — gRoss issuanCe

Sources: RBA



Net External Debt

Australia Medians

% of CXR

0

50

100

150

200

250

300

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

2013

e

2014

f

Current Account Balance

% of GDP

-8

-6

-4

-2

0

2

4

6

8

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

2013

e

2014

f

% of GDP

0

10

20

30

40

50

60

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

2013

e

2014

f

General Government Balance

% of GDP

-6

-5

-4

-3

-2

-1

0

1

2

3

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

2013

e

2014

f

Australia Medians

Australia Medians Australia Medians

geneRal goveRnMent deBt as a % of gdP

Sources: Fitch Ratings

Net External Debt

Australia Medians

% of CXR

0

50

100

150

200

250

300

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

2013

e

2014

f


% of GDP

-8

-6

-4

-2

0

2

4

6

8

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

2013

e

2014

f

% of GDP

0

10

20

30

40

50

60

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

2013

e

2014

f


% of GDP

-6

-5

-4

-3

-2

-1

0

1

2

3

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

2013

e

2014

f

Australia Medians


net exteRnal deBt


Net External Debt

Australia Medians

% of CXR

0

50

100

150

200

250

300

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

2013

e

2014

f


% of GDP

-8

-6

-4

-2

0

2

4

6

8

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

2013

e

2014

f

% of GDP

0

10

20

30

40

50

60

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

2013

e

2014

f


% of GDP

-6

-5

-4

-3

-2

-1

0

1

2

3

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

2013

e

2014

f

Australia Medians


CuRRent aCCount BalanCe


Net External Debt

Australia Medians

% of CXR

0

50

100

150

200

250

300

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

2013

e

2014

f


% of GDP

-8

-6

-4

-2

0

2

4

6

8

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

2013

e

2014

f

% of GDP

0

10

20

30

40

50

60

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

2013

e

2014

f


% of GDP

-6

-5

-4

-3

-2

-1

0

1

2

3

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

2013

e

2014

f

Australia Medians


geneRal goveRnMent BalanCe


Figure 2

0

2

4

6

8

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

2013

f

2014

f

Australia 'AAA' median

Unemployment Rate

(%)


Figure 3

50

60

70

80

90

100

110

120

1993 1998 2003 2008 2013

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

REERª (LHS)

Exchange rate (RHS)

Exchange Rates

(2010 = 100)

ª Real e�ective exchange rate

Source: BIS, CEIC, Fitch

($/A$)

uneMPloyMent Rate

Sources: CEIC, Fitch estimates

Figure 2

0

2

4

6

8

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

2013

f

2014

f

Australia 'AAA' median

Unemployment Rate

(%)


Figure 3

50

60

70

80

90

100

110

120

1993 1998 2003 2008 2013

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

REERª (LHS)

Exchange rate (RHS)

Exchange Rates

(2010 = 100)

ª Real e�ective exchange rate

Source: BIS, CEIC, Fitch

($/A$)

exChange Rates

Sources: BIS, CEIC, Fitch



0

2

4

6

8

FY9

1-9

2

FY9

3-9

4

FY9

5-9

6

FY9

7-9

8

FY9

9-0

0

FY0

1-0

2

FY0

3-0

4

FY0

5-0

6

FY0

7-0

8

FY0

9-1

0

FY11

-12

Mining Investment

(% of GDP)

Source: RBA, Fitch

0 1 2 3 4

Netherlands (AAA)

OECD

US(AAA)

Canada (AAA)

New Zealand (AA)

Sweden (AAA)

Norway (AAA)

Australia (AAA)


(2012-17)


(% annual average)

0

2

4

6

8

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

0

2

4

6

8


CPI (RHS)


(%)

Source: CEIC, Fitch

(% yoy)

50

75

100

125

150

175

200

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012


Sydney

Melbourne

Brisbane

Housing Prices

(2003-04 = 100)

Source: CEIC, Fitch

130

140

150

160

170

180

200

5

200

6

200

7

200

8

200

9

2010

2011

2012


(%)

0 20 40 60 80 100

Australia (AAA)

Norway (AAA)

‘AA’ median

Sweden (AAA)

‘AAA’ median

Netherlands

Canada (AAA)

US (AAA)



(% of GDP)

0

2

4

6

8

10

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012



Interest Rates

(%)


0

5

10

15

20

25

30

35

FY9

6-9

7

FY9

7-9

8

FY9

8-9

9

FY9

9-0

0

FY0

0-0

1

FY0

1-0

2

FY0

2-0

3

FY0

3-0

4

FY0

4-0

5

FY0

5-0

6

FY0

6-0

7

FY0

7-0

8

FY0

8-0

9

FY0

9-1

0

FY10

-11

FY11

-12

FY12

-13f




(%)

Source: CEIC, Fitch

geneRal goveRnMent deBt


0

2

4

6

8

FY9

1-9

2

FY9

3-9

4

FY9

5-9

6

FY9

7-9

8

FY9

9-0

0

FY0

1-0

2

FY0

3-0

4

FY0

5-0

6

FY0

7-0

8

FY0

9-1

0

FY11

-12

Mining Investment

(% of GDP)

Source: RBA, Fitch

0 1 2 3 4

Netherlands (AAA)

OECD

US(AAA)

Canada (AAA)

New Zealand (AA)

Sweden (AAA)

Norway (AAA)

Australia (AAA)


(2012-17)


(% annual average)

0

2

4

6

8

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

0

2

4

6

8


CPI (RHS)


(%)

Source: CEIC, Fitch

(% yoy)

50

75

100

125

150

175

200

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012


Sydney

Melbourne

Brisbane

Housing Prices

(2003-04 = 100)

Source: CEIC, Fitch

130

140

150

160

170

180

200

5

200

6

200

7

200

8

200

9

2010

2011

2012


(%)

0 20 40 60 80 100

Australia (AAA)

Norway (AAA)

‘AA’ median

Sweden (AAA)

‘AAA’ median

Netherlands

Canada (AAA)

US (AAA)



(% of GDP)

0

2

4

6

8

10

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012



Interest Rates

(%)


0

5

10

15

20

25

30

35

FY9

6-9

7

FY9

7-9

8

FY9

8-9

9

FY9

9-0

0

FY0

0-0

1

FY0

1-0

2

FY0

2-0

3

FY0

3-0

4

FY0

4-0

5

FY0

5-0

6

FY0

6-0

7

FY0

7-0

8

FY0

8-0

9

FY0

9-1

0

FY10

-11

FY11

-12

FY12

-13f




(%)

Source: CEIC, Fitch

housing PRiCes

Sources: CEIC Fitch

0

2

4

6

8

FY9

1-9

2

FY9

3-9

4

FY9

5-9

6

FY9

7-9

8

FY9

9-0

0

FY0

1-0

2

FY0

3-0

4

FY0

5-0

6

FY0

7-0

8

FY0

9-1

0

FY11

-12

Mining Investment

(% of GDP)

Source: RBA, Fitch

0 1 2 3 4

Netherlands (AAA)

OECD

US(AAA)

Canada (AAA)

New Zealand (AA)

Sweden (AAA)

Norway (AAA)

Australia (AAA)


(2012-17)


(% annual average)

0

2

4

6

8

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

0

2

4

6

8


CPI (RHS)


(%)

Source: CEIC, Fitch

(% yoy)

50

75

100

125

150

175

200

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012


Sydney

Melbourne

Brisbane

Housing Prices

(2003-04 = 100)

Source: CEIC, Fitch

130

140

150

160

170

180

200

5

200

6

200

7

200

8

200

9

2010

2011

2012


(%)

0 20 40 60 80 100

Australia (AAA)

Norway (AAA)

‘AA’ median

Sweden (AAA)

‘AAA’ median

Netherlands

Canada (AAA)

US (AAA)



(% of GDP)

0

2

4

6

8

10

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012



Interest Rates

(%)


0

5

10

15

20

25

30

35

FY9

6-9

7

FY9

7-9

8

FY9

8-9

9

FY9

9-0

0

FY0

0-0

1

FY0

1-0

2

FY0

2-0

3

FY0

3-0

4

FY0

4-0

5

FY0

5-0

6

FY0

6-0

7

FY0

7-0

8

FY0

8-0

9

FY0

9-1

0

FY10

-11

FY11

-12

FY12

-13f




(%)

Source: CEIC, Fitch

Potential Real gdP gRowth (2012-17)

Sources: OECD Economic Outlook

0

2

4

6

8

FY9

1-9

2

FY9

3-9

4

FY9

5-9

6

FY9

7-9

8

FY9

9-0

0

FY0

1-0

2

FY0

3-0

4

FY0

5-0

6

FY0

7-0

8

FY0

9-1

0

FY11

-12

Mining Investment

(% of GDP)

Source: RBA, Fitch

0 1 2 3 4

Netherlands (AAA)

OECD

US(AAA)

Canada (AAA)

New Zealand (AA)

Sweden (AAA)

Norway (AAA)

Australia (AAA)


(2012-17)


(% annual average)

0

2

4

6

8

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

0

2

4

6

8


CPI (RHS)


(%)

Source: CEIC, Fitch

(% yoy)

50

75

100

125

150

175

200

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012


Sydney

Melbourne

Brisbane

Housing Prices

(2003-04 = 100)

Source: CEIC, Fitch

130

140

150

160

170

180

200

5

200

6

200

7

200

8

200

9

2010

2011

2012


(%)

0 20 40 60 80 100

Australia (AAA)

Norway (AAA)

‘AA’ median

Sweden (AAA)

‘AAA’ median

Netherlands

Canada (AAA)

US (AAA)



(% of GDP)

0

2

4

6

8

10

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012



Interest Rates

(%)


0

5

10

15

20

25

30

35

FY9

6-9

7

FY9

7-9

8

FY9

8-9

9

FY9

9-0

0

FY0

0-0

1

FY0

1-0

2

FY0

2-0

3

FY0

3-0

4

FY0

4-0

5

FY0

5-0

6

FY0

6-0

7

FY0

7-0

8

FY0

8-0

9

FY0

9-1

0

FY10

-11

FY11

-12

FY12

-13f




(%)

Source: CEIC, Fitch

Mining investMent

Sources: RBA Fitch

0

2

4

6

8

FY9

1-9

2

FY9

3-9

4

FY9

5-9

6

FY9

7-9

8

FY9

9-0

0

FY0

1-0

2

FY0

3-0

4

FY0

5-0

6

FY0

7-0

8

FY0

9-1

0

FY11

-12

Mining Investment

(% of GDP)

Source: RBA, Fitch

0 1 2 3 4

Netherlands (AAA)

OECD

US(AAA)

Canada (AAA)

New Zealand (AA)

Sweden (AAA)

Norway (AAA)

Australia (AAA)


(2012-17)


(% annual average)

0

2

4

6

8

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

0

2

4

6

8


CPI (RHS)


(%)

Source: CEIC, Fitch

(% yoy)

50

75

100

125

150

175

200

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012


Sydney

Melbourne

Brisbane

Housing Prices

(2003-04 = 100)

Source: CEIC, Fitch

130

140

150

160

170

180

200

5

200

6

200

7

200

8

200

9

2010

2011

2012


(%)

0 20 40 60 80 100

Australia (AAA)

Norway (AAA)

‘AA’ median

Sweden (AAA)

‘AAA’ median

Netherlands

Canada (AAA)

US (AAA)



(% of GDP)

0

2

4

6

8

10

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012



Interest Rates

(%)


0

5

10

15

20

25

30

35

FY9

6-9

7

FY9

7-9

8

FY9

8-9

9

FY9

9-0

0

FY0

0-0

1

FY0

1-0

2

FY0

2-0

3

FY0

3-0

4

FY0

4-0

5

FY0

5-0

6

FY0

6-0

7

FY0

7-0

8

FY0

8-0

9

FY0

9-1

0

FY10

-11

FY11

-12

FY12

-13f




(%)

Source: CEIC, Fitch

inteRest Rates

Sources: CEIC, Fitch estimates

0

2

4

6

8

FY9

1-9

2

FY9

3-9

4

FY9

5-9

6

FY9

7-9

8

FY9

9-0

0

FY0

1-0

2

FY0

3-0

4

FY0

5-0

6

FY0

7-0

8

FY0

9-1

0

FY11

-12

Mining Investment

(% of GDP)

Source: RBA, Fitch

0 1 2 3 4

Netherlands (AAA)

OECD

US(AAA)

Canada (AAA)

New Zealand (AA)

Sweden (AAA)

Norway (AAA)

Australia (AAA)


(2012-17)


(% annual average)

0

2

4

6

8

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

0

2

4

6

8


CPI (RHS)


(%)

Source: CEIC, Fitch

(% yoy)

50

75

100

125

150

175

200

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012


Sydney

Melbourne

Brisbane

Housing Prices

(2003-04 = 100)

Source: CEIC, Fitch

130

140

150

160

170

180

200

5

200

6

200

7

200

8

200

9

2010

2011

2012


(%)

0 20 40 60 80 100

Australia (AAA)

Norway (AAA)

‘AA’ median

Sweden (AAA)

‘AAA’ median

Netherlands

Canada (AAA)

US (AAA)



(% of GDP)

0

2

4

6

8

1020

01

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012



Interest Rates

(%)


0

5

10

15

20

25

30

35

FY9

6-9

7

FY9

7-9

8

FY9

8-9

9

FY9

9-0

0

FY0

0-0

1

FY0

1-0

2

FY0

2-0

3

FY0

3-0

4

FY0

4-0

5

FY0

5-0

6

FY0

6-0

7

FY0

7-0

8

FY0

8-0

9

FY0

9-1

0

FY10

-11

FY11

-12

FY12

-13f




(%)

Source: CEIC, Fitch

Banks’ loan-to-dePosit Ratio




Sources: ABS, RBA

0

100

200

300

Non-government Bonds on Issue O�shore

All currency denominations

* Australian dollar-denominated bonds only

Sources: ABS; RBA

Financials

$bn

Non-financialcorporates

Non-residents*

201320092001 20051997

Asset-backed securities

1993

Sources: ABS, RBA

20

40

60

80

100

20

40

60

80

100

RBA Index of Commodity Prices

SDR, 2011/12 average = 100Index

20132008200319981993

Source: RBA

1988

RBa index of CoMModity PRiCes

Sources: RBA

Policy Interest Rates – G3

US

Euro area

-1

0

1

2

3

4

5

%

Japan*

2005 2007 2009 20132011*Since April 2013, the Bank of Japan’s main operating target has been the money base

Source: central banksSources: Central Banks

0

5

10

15

20

25

30

35

State Share of Output *

* NominalSource: ABS

11/12

New South Wales

Victoria

Queensland

Western Australia

South Australia

Tasmania

03/04 07/0899/0095/9691/92

%

state shaRe of outPut*

Sources: ABS

Underlying Inflation*

0

1

2

3

4

5

2013

Weighted median

Trimmed mean

* Excluding interest charges prior to the September quarter 1998 and adjusted for the tax changes of 1999–2000

Sources: ABS; RBA

CPI excl volatile items

%

20092005200119971993

undeRlying inflation*

PoliCy inteRest Rates — g3outstanding offshoRe non-goveRnMent Bonds

l l I 50

150

250

350

l l I50

90

130

170

Bulk Commodity PricesFree on board basis

*Iron ore fines, Newcastle thermal coal and premium hard coking coal

Sources: ABS; Bloomberg; Citigroup; Energy Publishing; globalCOAL; Macquarie Bank; RBA

201 3

Spot price*

Iron ore(LHS)

Thermal coal(LHS)

Coking coa l(RHS)

Average Australianexport price

201 32013 201 120112011

$/t$/t

l l I

Bulk CoMModity PRiCes

Sources: ABS, Citigroup, Energy Publishing, globalCOAL, Macquarie Bank, RBA

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