Strong investor demand not attracting willing corporate bond issuers

13/11/17

 

13 November 2017

Investors around the world continue to seek out anything with a yield return. The demand appears to be continually growing as many fund managers start to allocate funds away from potentially over-hyped equities asset class towards fixed interest securities/bonds. The pursuit of yield in some areas is getting into dangerous territory with European corporate junk bonds (non-rated) trading at yields below US 10-year Government Treasury bonds (2.30% pa).

Here in New Zealand we have witnessed insatiable investor demand (retail and wholesale) chasing the small number of new corporate bonds issued in the debt capital markets. Companies like Summerset and Wellington International Airport have commanded very attractive pricing from a borrower’s perspective this year. It is a little surprising that a larger number NZ corporate borrowers have not advantaged from these conducive market conditions to lock into longer-term debt at lower issuance margins. My advice to borrowers who can access the debt capital markets under their own name is to issue corporate bonds when the market window of opportunity is open (i.e. strong investor demand). That timing may not necessarily coincide with the borrower’s own maturity profile/issuance plan, however bank facilities are normally flexible enough to cancel without penalty and thus engineer the debt issuance requirement when the market window is open.

Corporate bond issuance volumes in New Zealand have dropped off in 2017 compared to previous years, so it makes you wonder why more borrowers have not come to the market given the investor demand and lower issuance margins. One explanation for the lower than expected activity levels is the fact that overall bank lending to corporates is not exactly increasing a lot, therefore the banks are very keen to hang on to their direct lending books and not be repaid from a corporate bond issue. One of the main reasons a borrower goes to the corporate bond market is to secure longer term debt of seven years plus that is generally not available from bank sources. Unfortunately, retail investors here have historically had an aversion to investing beyond five years in such bonds. Education of investors to accept seven and 10 year tenors is required, however often the carrot in the form of an increased interest coupon is required to entice these investors to go longer. That may not fit with the borrower’s own pricing aspirations.

As an advisor to corporate borrowers, my general rule of thumb is that diversification of core debt sources away from solely banks starts about the $300 million to $400 million mark. The materiality of funding risk becomes more meaningful at and above these levels. Surprisingly, there are many local borrowers who would be strong enough from a credit rating perspective to utilise the debt capital markets in their own name, who have bank debt only for much higher debt amounts.

 

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