The recovery signs to look for
Further to our discussion last week on the prospects for a recovery in the domestic corporate bond market, we note that the view of ANZ's economists on the outlook for short-term interest rates has already been supported by the Reserve Bank of New Zealand, with its 50 basis point cut in the official cash rate last week to 2.5 per cent and its comment that it expects the OCR will be kept at or below the current level until late 2010.
This is certainly not helpful to the argument that rising interest rates will allow investor yield expectations to be met and consequent credit spread compression will encourage bond issuance.
Nevertheless, with National Australia Bank now being the second major bank to issue bonds in large volume without a government guarantee and with perhaps a nascent revival in the kangaroo market, there are positive signs emerging that conditions are improving.
To say that the market is indeed recovering though, we would need to see non-government guaranteed issuance by the four major banks become the norm again. The non-guaranteed issuance that has occurred to date is encouraging but it totals only $3.1 billion, with guaranteed issuance by the four major banks amounting to $16.6 billion, this year.
It is also encouraging to see that more non-government guaranteed bank bond issuance is occurring overseas. Last week Goldman Sachs issued US$2 billion of non-guaranteed bonds with a five year term to maturity and Credit Suisse New York branch issued US$2.25 billion of five-year non-guaranteed bonds. However, Citigroup issued US$7.0 billion of two- and three-year bonds with a government guarantee although this may have more to do with the speculation that the US bank stress test results will require Citigroup to raise more capital.
We should also expect to see further credit spread contraction as confidence returns and further non-guaranteed bank bond issuance should act as a catalyst. As we noted above, credit spreads seem to have stabilised over the last three months and at the moment there is no indication of any further compression occurring.
If credit spreads contract and there is more non-guaranteed bank bond issuance, the regional banks should be able to return to the market. Suncorp-Metway has been the only regional bank to issue in the market so far this year and on its $500 million, three-year, public bond issue in March, it had to pay a credit spread of 90 basis points plus 100 bps for the guarantee fee. AMP Bank issued $300 million of four- and five-year bonds in February, with credit spreads of up to 107 bps and a 100 bps guarantee fee. It is these prohibitive costs that have kept the smaller banks out of the market to date.
Another sign of a real recovery in the domestic market would be less issuance from the big four banks. Typically, the big four have not relied on the domestic market for the bulk of their wholesale funding: they have relied on international markets.
Using total domestic bank issuance as a proxy, prior to the GFC, say in 2007, domestic market issuance totalled only $10.8 billion, while international issuance amounted to the equivalent of $46.8 billion, at prevailing exchange rates.
In 2006 the difference was even more marked with domestic issuance of $11.2 billion and international issuance equivalent to $56.7 billion. In 2008 domestic issuance by Australian banks totalled $34.9 billion and so far this year it already amounts to $23.1 billion.
A departure of the banks from the domestic market would be a sure sign that conditions are in fact normalising. It would also free up capacity for others to return to the market. As it stands though, it is likely to be the states that will step in to fill the breach. The absence of the banks would make issuance easier than expected for the states and may mean that the states will not have to avail themselves of a Federal government guarantee but, on the other hand, they may find themselves competing with SSA issuers, if this sector is also recovering.
It is great to see early signs of improvement in the domestic corporate bond market and let's hope this continues. But it is worth remembering that this time last year conditions in financial markets appeared to be rapidly improving, post the demise of Bear Stearns, but by mid-May were deteriorating again.