Monster $9.3bn bond issue attracts little interest from overseas

The Australian 12:00am January 23, 2017

David Rogers

Offshore investors were noticeably absent during last week’s record $9.3 billion syndicated five-year bond issue, contrasting with previous large issues where offshore investors have dominated demand.

Even so there was strong demand from trading desks of local banks for the bumper issue, which will eventually see a large chunk of the bonds head offshore in the secondary market.

Domestic fund managers and banks took up 70.6 per cent of the monster bond issue, leaving offshore investors with just 29.4 per cent of the December 2021 notes, according to the Australian Office of Financial Management figures.

Foreign demand for federal government debt has softened in recent years alongside a decline in the Australian dollar. From a peak holding of 75 per cent in 2012, the proportion of Australian commonwealth government securities owned by non-foreign residents had fallen to just over 57 per cent by the end of last year, the lowest since mid-2009.

In the same period, the Australian dollar fell from around $US1.05 to US75c amid weaker commodity prices and official interest rate cuts.

The bond issue comes on the back of rising borrowings for Canberra and follows the $7.6 billion debut 30-year bond issued in October. While the financing remains near record low interest rates, the cost of new issues could rise if Australia loses its top “AAA” credit rating. Ratings agency Standard & Poor’s last year warned it could cut Australia’s rating, based on rising net debt levels.

Nearly $80bn in new bonds are forecast to be issued this financial year, up from $52bn last year, according to Treasury figures. The borrowings are aimed at covering budget deficit as well as refinancing maturing debt. At current rates the total bonds on issue are forecast to reach 25 per cent of GDP.

Despite the lacklustre offshore response to the latest syndicated issue, AOFM chief executive Robert Nicholl said demand from high-quality investors like central banks was encouraging.

“The large component onshore was a reflection of the fact that we allocated quite a bit to the bank’s trading books,” Mr Nicholl explained. “They are classed as domestic, whether they are the big four banks or the international investment banks.”

Indeed, banks took 40.4 per cent for trading purposes and 13.8 per cent for their balance sheets. Long funds bought 27.6 per cent and hedge funds took 12.4 per cent. Central banks bought 3.8 per cent. A record $15.3bn of bids were made at the clearing price — equivalent to a yield of 2.24 per cent — but the full amount wasn’t allocated because the additional demand was mainly from trading desks and hedge funds rather than more stable holders such as fund managers or central banks, Mr Nicoll said.

“It was a pretty big order book — that probably was surprising, but you would also expect that there were a lot of bids from trading books and hedge funds,” AOFM’s Mr Nicoll said. “People may wonder why we don’t necessarily issue the total amount of bids received, but the more bonds you have sloshing around out there after a deal, the more price-sensitive they become.”

He noted that the stronger offshore demand for the 30-year issue in October was reflective of the longer maturity of that bond, together with the fact that the AOFM is more inclined to sell bonds to asset managers and direct investors than trading books and hedge funds.

“We would see the nature of this deal as quite different to the 30-year bond,” he added. “The market dynamics are quite different in that part of the curve, and we feel comfortable printing a larger number of five-year bonds and knowing that the trading books are getting more, because we are not going to reissue to this line for a couple of months, and in that time some further underlying demand for those bonds will emerge.”

While foreigners took 65.2 per cent of the government’s debut 30-year bond issue in October, analysts said the longer maturity and higher yield of that issue made it more attractive to life insurers.