Asian connections

Asian demand for Australian dollar assets has lifted the issuance of Kangaroo bonds to a post-crisis peak and helped deepen Australia’s debt markets.

The Aussie dollar is down more than 20% from its recent peak, but hot demand from Asian investors is driving the Australian debt market to new heights.

Australia’s domestic bond market has undergone an unspectacular, but steady expansion since the global financial crisis with total Aussie dollar issuance climbing to a post-Lehman-collapse high of A$143bn in 2014, A$10bn above the total of 2013.

Last year’s overall increase was attributable to a sharp upturn in supply of Kangaroo bonds, with sovereign, supranational and agency sales climbing to A$26bn from A$19.5bn, while such issues from non-SSAs, mostly bank, surged to A$12.5bn from A$8.5bn.

Rising Kangaroo issuance raises hopes that the Australian bond market will become an increasingly important second-tier destination for overseas credits alongside the sterling, Swiss franc, Canadian and Singapore dollar markets.

As many local funds are reluctant to consider foreign banks with ratings of less than Single A, lower investment-grade-rated financials have, instead, accessed Aussie dollar funding through the Reg S Eurobond market.

The Australian market has a lot of things going for it, including the world’s fourth-largest pension pool with total assets of almost US$1.6trn in 2013, or 105% of the country’s GDP, according to the Towers Watson Global Pension Assets Study.

However, Towers Watson showed that, in 2013, only 13% of Australia’s pension pool was allocated to bonds – less than half the 29% global allocation average and well below Japan’s 51% allocation – as domestic retail investors maintained a clear, tax-break related, preference for equity funds and term deposits.

Consequently, it is the increased offshore bid, especially out of Asia, that has been largely responsible for the upturn in demand for Kangaroos.

Asian banks, central banks and official institutions are drawn to the relatively high yields on offer in Australia to underline their desire to diversify portfolios overseas away from local markets, where property, resource and bank credits tend to dominate.

There was a rush of five-year Triple A rated SSA Kangaroo trades this month and, while this partly reflects higher domestic demand for the belly of the curve, Asian investors bought almost half of the African Development Bank’s A$300m print.

Typically, Asia’s allocations are even higher for 10-year SSA Kangaroos since they tend to be the targets of Japanese life-insurance companies which have a strong appetite for 10-year or longer Aussie dollar Triple A liquid assets.

Indeed, such is the level of Asian demand for Kangaroos that many offshore corporations and banks require a minimum domestic participation rate for their offerings.

Only two non-New Zealand offshore corporations visited the Kangaroo market last year and, despite issuers’ local investor bias, Asian accounts picked up 17% of Glencore’s A$500m and 29% of Total’s A$350m inaugural five-year offerings.

Last year, three Middle East banks made their debuts in the Kangaroo market and among these was Abu Dhabi Commercial Bank, which sold a A$250m five-year bond in May, with 40% of the buyers being Asian investors. Usually, the participation of Asian investors is higher among regional financials.

As many local funds are reluctant to consider foreign banks with ratings of less than Single A, lower investment-grade-rated financials have, instead, accessed Aussie dollar funding through the Reg S Eurobond market. Among such names are ICICI Bank, VTB Bank, Export-Import Bank of India and Turkey’s Garanti Bank.

Even Single A banks can struggle as Aa3/A/A+ rated Banco Santander Chile found in February 2014. The second-largest bank in Chile and one of the best-regarded financials in Latin America raised an underwhelming A$125m from its three-year Kangaroo debut.

Australian asset managers often find it uneconomical to do all the research required to get comfortable with new issuers from fresh locations, especially if they are not expected to become regular visitors.

Elevated offshore demand is also partly responsible for the growth in Australian residential mortgage-backed securities, although, in this case, European rather than Asian investors are behind the buy-side expansion.

The annual supply of Australian RMBS remains well short of its pre-crisis levels of A$40bn plus, but the Australian securitisation market has revived impressively relative to its overseas counterparts, having reached a post-crisis high of A$30.8bn last year.

Other than a low point in 2012, when Australia’s four major lenders shifted their attention to recently established covered bond framework and total RMBS sales slumped to A$11.4bn, home-loan securitisations have been running well ahead of the once-booming US market.

Similarly, activity in the European securitisation market remains very subdued with annual issuance, relative to the size of the economy, declining for four years in a row.

This lack of offshore issuance has supported foreign, especially European, appetite for all Australian asset-backed securities, with RMBS as the dominant instrument.