bird’s eye view
Warren Bird
f i x e d - i n t e r es t v e t e r an
Drilling into corporate development
The development of the Australian corporate bond market into a more broad-based and
diversified investment universe seems at last to have gained some momentum. Although net
issuance of fixed-rate securities in 2013 was slightly negative, at A$16 billion (US$13.9 billion)
of new deals against A$17 billion of maturities, the list of issuers is expanding and the structure
of the market is improving in terms of duration and credit quality.
T
o demonstrate this
momentum, a good
comparison is between the
current state of the market
and the end of 2006. Over
the decade to 2006 the credit market had
grown from very little to be 37 per cent
of the UBS Composite Bond Index. By
that time, a modest build up in lowerrated issues had commenced. With no
net new issuance by the Commonwealth
taking place during the latter years of the
Howard government, the future of the
overall Australian bond market seemed
to be in the hands of issuers in the
corporate sector.
Then, during 2007, the financial crisis
unfolded. The corporate bond market was
set back considerably as demand for credit
risk declined. This was a global trend,
but hit small, relatively illiquid markets
like Australia the hardest. Issuance
patterns turned on their heads and
Commonwealth and semi-government
bonds again became dominant. Credit fell
back to 15 per cent of the total market by
the end of 2013.
Nonetheless, within the universe of
corporate bonds, there has been a revival
during 2012 and 2013. How much further
developed is the market now than it was
before the crisis hit? Table 1 shows some
key comparison data over the past seven
years. A few pieces of information in
this table caught my eye, which I want to
unpack a bit further.
S h a r p ly lo we r tr i p le -A
issuan ce
The proportion of triple-A bonds in the
index is more than 7 per cent lower in
2013 than in 2006. In one way, this isn’t
surprising, as in the post-financial crisis
world there are fewer triple-A issuers
globally, let alone here in Australia. Some
of the issuers that were triple-A in 2006
are still in the market, but they have been
downgraded since then – for example, GE
Capital and Australia Post have slipped
into the double-A band.
Table 1: Corporate bond market data (As at Dec 31)
2013
2006
change by 2013
AAA (per cent)
20.8
27.9
-7.1
AA (per cent)
33.2
35.7
-2.5
A (per cent)
35.3
28.1
7.2
BBB (per cent)
10.4
7.9
2.5
Sub-IG (per cent)
0.2
0.4
-0.1
no. of issues
249
256
no. of issuers
129
124
no. of BBB issuers
49
25
+24
Market value
(A$bn)
104.8
76.4
+37%
Modified duration (years)
2.75
2.85
-0.1
Source: UBS Australia Credit Index february 2014
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f e b r u a r y
2 0 1 4
Another group of issuers no longer
sits in the triple-A band, but for good
reasons. Several names initially came to
market in the early 2000s with a triple-A
credit wrap. Today, many of these issue
with their own credit rating. It’s healthy
for the domestic corporate market that
companies like Sydney Airport no longer
need a third-party financial guarantee to be
able to sell bonds to local fund managers.
These trends have offset the addition
of Australian bank covered bonds to the
triple-A universe. There were a couple of
covered bond deals from offshore issuers
in 2006, which were classified at the time
along within the “other asset-backed”
sector. Now the credit index includes
almost A$15 billion of covered bonds,
which have their own sector classification.
Covered bonds make up 14 per cent of
the AUD credit market and the lion’s
share of the triple-A sector.
In cr e ase d tr i p le -B
i ssu an ce
At the other end of the investmentgrade ratings spectrum, the increase in
the proportion of triple-B rated issues is
welcome. This rating band now comprises
over 10 per cent of the market.
Most of the increase in triple-B from
the 2006 level took place in 2013, as the
local investment community became more
confident to go down the spectrum in
search of yield and some diversity. This is
the fruit of a focus by fund managers on
building their credit skills in recent years.
It also is due to the willingness of
new issuers to come to the capital market
for funding. The table shows that there
kanga
column
are now 49 issuers in the triple-B band
in UBS’s credit index, almost double the
number in 2006. When you realise that
some of the triple-B names in 2006 have
departed the bond market – such as
Fairfax, Coles Myer and Adelaide Bank –
the increase is even more impressive.
One of the main positives for
investors from this trend is that triple-B
issuers tend to be ‘true corporates’. The
dominance of banks and financials in the
Australian market is well known, but is
gradually being reduced.
Du rati on – b e gin n in g
to l e ng th e n on ce m o re
Another important statistic from table
1 is the modified duration of the index.
At 2.75 years it is for all intents and
purposes at the same level reached in
2006. What isn’t shown is the extent
to which domestic credit risk exposure
shortened after the financial crisis.
With investors reluctant to commit
funds beyond short tenor for a while, the
credit market’s modified duration dropped
to the 2.1-2.3 years region between 2008
and 2011. But not only are more issuers
now coming to market, they are able to
get deals done that are longer than the
3-5 year terms that have historically been
favoured. We’ve seen more issues of seven
years to maturity, with a few out to 10
years for higher-rated transactions. Thus,
the overall credit duration of the market
is lengthening again and has been restored
to where it was before the crisis.
Anecdotal evidence points to fund
manager willingness to extend duration
further. While the Australian market will
likely remain much shorter than global
indices, which are nearer to six-year
modified duration, it is encouraging to see
the maturity extension taking place.
Stro ng q u al i t y in
a po o r l y d i v e r s ifie d
ma r k e t
Table 1 also confirms that the Australian
market is still dominated by double-
and single-A issuers. Both in 2006 and
currently, around two-thirds of the
corporate bonds on issue are rated in
these bands, more or less evenly split
between the two. In global markets there is
also a high proportion of securities rated
single-A, but there is much less double-A
and more triple-B than we have locally.
Of course, given the lack of diversity
in the Australian market, the risk-return
position would be quite appalling if
we didn’t have such high average credit
quality. Global indices have thousands of
issuers – in Australia, there are 129. We
all hope that more companies are able to
issue Australian dollar bonds and generate
a more diversified investment universe.
But until this happens we also need to see
double- and single-A continue to hold the
dominant position in the market.
I n d us t r y se cto r s
n o t b eco mi n g mo r e
d iv er s ifi e d
While on the subject of diversification,
table 2 shows the industry sectors that
were represented in the market in 2006
and the position at present.
There is very little difference! The
media sector is no longer represented in
the index. In addition, there are no longer
commercial mortgage-backed securities
or commercial property issues. The only
‘new’ sector is autos, with Volkswagen
being the largest of a few issuers that have
come to market recently.
Arguably, therefore, the industry
representation in the Australian market has
narrowed a little; at best, there is no broader
diversification than seven years ago.
Mar ke t v alu e – th r o ugh
A$1 00 bi lli o n f o r th e
f i r st ti me
After 2006, the size of the market
dipped below A$70 billion. Despite
strong returns, total market value
languished just above that level in 2008
and 2009, before beginning to struggle
up to A$80 billion in 2010 and 2011.
Since then it has started to rise more
sharply, coming close to the century
mark in 2012 and finally reaching that
milestone in the year just gone.
I’ve stated publicly many times
my personal indifference to the
development of an ‘Australian corporate
bond market’ from an investor
point of view. I believe that a betterdiversified portfolio will always be
able to be put together in the global
markets. Diversification is the key risk
management strategy in credit investing.
However, regulatory changes are
undoubtedly increasing the cost of
hedging. What’s more, there are domestic
economic advantages to having a wellfunctioning and well-priced local bond
market. Also, many local investors –
retail and institutional – have a revealed
preference for owning ‘local’ bonds.
Given all this, it’s important to see the
domestic corporate bond market develop
in healthy ways.
Clearly there is still a long way to
go, but the setbacks experienced after
the credit Armageddon of 2008 seem
to have been put behind us and the
market is growing and broadening. These
developments are encouraging and
hopefully will continue. •
Table 2: Industry sectors change in UBS Credit Index
(as at Dec 31)
SECTOR
AUTOS & COMPONENTS
commercial mortgage-backed securities
COMMERCIAL PROPERTY
MEDIA
2006
2013
x
ü
ü
ü
ü
x
x
x
Source: UBS Australia Credit Index february 2014
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