Rebounding kangaroos will drive investor demand

One task to begin with this week is to correct some misconceptions and highly misleading reporting on the bond market over the course of last week in one national newspaper, the Australian Financial Review.

Early in the week, reporting comments made by corporate treasurers and CFOs -who participated in a round table discussion held as long ago as mid-December - the AFR reported that corporate bond markets were said to be closed. The newspaper also reported there were $27 billion of bonds maturing this year, and concluded that equity markets would need to be tapped, and with deeply discounted share issues, to meet the funding gap.  

These comments would have angered all other corporate bond market participants and shareholders alike. But leaving this aside for the moment, the AFR went on to report later in the week that corporate bonds were "poised for a comeback".

Three themes featured in that second stab at reviewing the domestic credit market: that fund managers are looking for new bonds to replace maturing ones; that the four major banks are pushing larger companies to issue bonds to repay loans and take some pressure off of the banks' balance sheets and their own funding requirements; and the cost of debt for the average triple B rated corporate issuer is little changed from what it was before the GFC.

These all sound like very good reasons why the domestic corporate bond market should not be closed and could well be poised for a recovery.

But in advancing a wider analysis of the issues in the debt market, let's consider some other factors that might impact on the recovery of the market and how a recovery might even occur.

Firstly, are corporate bond markets closed? Well, in December 2008 it was probably fair to say that they were. While some issuance in international markets was taking place it was very thin and any Australian borrower, outside of a government guaranteed bank, probably would have found it very hard to raise funds.
 
However, since then, and as reported each Monday in The Sheet, there has been a surge in investment grade bond issuance in both Europe and the US, and these bonds are attracting finer pricing than higher rated bank bond issues.

And last week we noted the re-emergence of the junk bond market in the US, with issuance volumes by mid-January already 75 per cent ahead of where they were for all of January 2008.

This, of course, does not suggest that the domestic corporate bond market has reopened for anything other than bank issuance, but let's look at the $27 billion of corporate bond maturities that have to be dealt with.

Just where this figure comes from, other than to say it was sourced from Bloomberg, is less than clear. The suggestion was that it is the amount that Australian companies have maturing.

From our records, Australian companies including utilities and property trusts (or REITS, in the market jargon) but excluding the Australian banks, have just $4.9 billion of bonds maturing in the domestic market this year. There is further $5.6 billion maturing in international bond markets.

To this can possibly be added some $2.1 billion of CMBS with a 2009 final maturity, but given that these securities had a scheduled maturity 18 months earlier, it is likely that most, if not all, have already rolled over or been repaid. The latter is more likely, as CMBS issuance in recent years has been minimal, which also suggests scheduled maturities for 2009 would be a much smaller amount.

The total value of bonds maturing in the Australian market in 2009 is $42.4 billion, according to our figures. If bonds issued by the Australian banks are excluded from this figure, the remainder is $27.1 billion. So this appears to be where the figure comes from, but, as we have already pointed out, only a small proportion of this is owed by Australian companies, so their refinancing burden is not as large as was being suggested.

So who owes the rest of this money? Leaving aside what the Australian banks and corporates owe, the balance - $22.2 billion - is owed by kangaroo issuers: the vast majority of whom are unlikely to return to this market.

This will, in fact, create a sizeable hole for fixed interest fund managers: they will be looking for new bonds to fill the gap. (And for those fund managers who have already moved their 2009 maturing bonds in to cash funds, the 2010 gap that will be left by kangaroo issuers is $25.4 billion.)

We have been unable to verify whether the big four banks have a list of 20 large Australian corporates that they want to bring to the market; but wouldn't that be wonderful, the market has never seen as many Australian companies issue in their own right in the past. It would be a shot in the arm for the market and bring some real and much needed diversity, for the first time ever.

However, the corporates will only do that if they can be persuaded of three things: that the banks really do want their money back; that the cost of debt in the corporate bond market won't be horrendous; and that there is real investor appetite. The latter has been addressed for the moment, given the composition of maturities that the market faces over the next two years.

As for the cost of debt, it needs to be borne in mind that the banks are re-pricing the debt that they are now willing to provide, so credit margins levied by the banks are going to be much wider than they were previously. With 90-day bank bill rates around 3.2 per cent and three and five year swap rates at 3.7 per cent and 4 per cent, if a triple B rated corporate can fund in the market with a 400-500 bps credit spread, it's not a bad deal - especially when compared with the cost of equity - which we will come back to.
The remaining uncertainty is how badly the banks really want to see their loans repaid.