Wednesday 20 March 2019 by Jonathan Sheridan General

Market pricing and new issue opportunity

One of the many benefits of being a client of FIIG is access to new primary bond issues, both originated by us in the unrated high yield space, and those in the wider market, where we allow access to the institutional market but in smaller parcels. Our ability to use our balance sheet to bid typically also improves allocated amounts for clients compared to unsupported bids, as bids are often scaled down as demand exceeds supply.

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In some instances, where FIIG knows the issuer well and/or sees value in distributing through FIIG and its strong client base for example, we may gain a guaranteed allocation, and scaling may be avoided altogether.

It is usual (although not compulsory) for new issues to come with a ‘concession’, or in other words an incentive for you to buy the new bond compared to an existing one already in the market. This can mean a better margin than other bonds currently trading, and may result in improved performance in the bond price post the issue, noting that general market conditions could otherwise negatively impact the trading of a new issue.

When participating in these offerings, it is important to know the market conventions, so you can be fully informed as to pricing and what you are actually paying for the bond.

Let’s deal with the different types of bonds and how they are typically priced in the primary market.

Fixed Rate bonds – investment grade

These usually have the coupon set in advance of the actual sale process, which is relatively close to the yield being offered, but usually a touch higher. The deal manager will then approach the market to seek bids from investors who will bid for the quantity they are interested in and the price they are willing to pay.

Once sufficient bids are received (which could be as short as a few hours after the deal is announced), the manager will determine the optimum balance between size and price. When the final pricing and volume is confirmed, the actual yield and price of the bond is set, and is usually around par, and often below.

A good recent example of this was the AT&T 4.60% 2028 bond. It priced at primary at 99.564 and clients were still able to enter under par. The bond has performed strongly since, with a current mid-market price of 105.4 for an annualised return of 16.9%.

Fixed Rate bonds – sub investment grade (or high yield):

The borrowers here are typically in a weaker position than an investment grade issuer, and as a result typically have less demand in the conservative Australian bond market. As such, they usually provide more certainty for the buyer of the bonds, by declaring the coupon early, and pricing at par (100). This can change depending on demand, as we saw recently in the new Virgin Airlines bond which had an initial coupon of 8.125% but with significant demand the coupon was set at 8.075%.

10 months ago Virgin actually broke new ground with their inaugural AUD bond, which is rare in the Australian market, as they have a B rating from S&P, which is sub investment grade (lower than BBB-). FIIG secured a $31.5m allocation in the $150m deal, and as a result was able to guarantee many of our clients a full fill of their bid.  The bond priced at par with a coupon of 8.25%, with clients accessing it around 100.50, and it is currently valued at a mid-market price of 103.1 for an annualised return of 11.8%.

For FIIG arranged unrated bonds, we set the coupon ahead of the deal being announced and sell at par, ensuring that our clients have full knowledge of the expected return if they were to invest.

PriceHistory

Floating rate bonds

As the name says, the return on these bonds is floating, so the price does not change the yield – that relates to the margin over the benchmark rate (BBSW) set during the bookbuild process. As such the price at primary is typically set at par.

The margins are easily comparable to existing margins that bonds currently in the market trade at, and so we find it relatively easy to be able to determine value. Recent issues that have looked cheap to us include the Suncorp BBSW+2.15% 2023c which priced at a margin of +209. It currently has a mid-market valuation of +1.92% or 100.993 for an annualised return of 5.52%. 

AMP issued a 5 year bond recently at BBSW +2.75%, which was approximately 0.50% better than comparable bonds in the market, to account for the ‘uncertainty premium’ of the Royal Commission. As bond investors we are comfortable with AMPs ability to pay us back, so we were happy to accept this extra return.

Liberty, the leading non-bank lender, last week issued a new 3 year senior bond at a margin of +3.25%. Due to our relationship with Liberty, we were able to obtain another guaranteed allocation of $15m in the oversubscribed $200m total deal. 

So it is clear that new issues represent an opportunity to pick up extra return over and above the basic income yield of the bond. Participating in them should be a foundation strategy of any bond investor.

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