As published in The Australian on 13 September 2016
Two Australian companies issued bonds recently – container and logistics company Qube in the retail ASX market and real estate company Mirvac in the wholesale over the counter (OTC) market
The issues were both initially marketed at $200 million, but that’s not the only similarity. Comparing the two gives plenty of insight into the broader bond market.
A big plus for both bond issues were that they were oversubscribed, meaning there was more demand for the bonds than supply. This is an encouraging sign to other companies thinking about raising debt in either market. Qube upsized its issue to $300m while Mirvac kept to its $200m target.
ASX versus OTC
There have been few genuine corporate bonds issued on the ASX. Most issues have been bank hybrids with high yields but complex terms and conditions, including optional call dates and the potential to defer or forego paying interest. The Qube issue is a bond with a fixed maturity date and the company cannot forgo interest payments, so is more defensive than the hybrids and a better diversifier given Qube is not a bank.
Corporate issuance excluding banks is more frequent in the OTC market. Issuers don’t have the same requirements as listing on the ASX and can get deals away more quickly. Typically there are fewer purchasers of bonds, making interest payments easier to administer. It’s an efficient market in its own right. There is usually a constant stream of issuance with BMW, Dexus Finance, Mirvac and Nissan issuing Australian dollar denominated bonds in August alone.
Assessing value for risk
The small number of corporate deals on the ASX provides few clues to potential investors regarding what yield they should demand and the fact that Qube doesn’t have a credit rating also makes the bond difficult to compare to OTC issues. Mirvac does have a solid investment grade credit rating and has issued other bonds which means OTC investors can look to past pricing or compare to more recent bond issues with the same credit rating to gauge value for risk.
In late June 2016, Mirvac issued its fourth bond transaction in the US Private Placement market, where it raised an equivalent A$536 million in bonds that had extended terms of 11, 12 and 15 years with margins over the 10 year US Treasury bond ranging from 195 basis points (bps) to 222bps. The margins on the bonds for the long dated terms would have helped institutional investors assess the pricing on the new deal.
Structure, financial assessment and yield
Crucial to comparing the two bond issues are the bond structure, the companies’ financial position and finally, the yield.
Qube’s bonds are subordinated and sit behind bank debt and finance leases of $690 million. If Qube was wound up the bank debt and lease finance would be repaid before bond investors received any money back.
The Mirvac bonds have the advantage of sitting higher in the capital structure and are classified as senior debt. Without an in depth analysis of the companies it’s difficult to get an idea of risk, but this should be part of your standard assessment.
A quick, superficial comparison of net assets, operating profit and gearing will help us weigh the two. Mirvac is the larger company with net assets of $7.18 billion, operating profit of $452 million and gearing of 21.9 percent at financial year end 2016. Qube’s net asset position over the 2016 year is considerably smaller at $2.04 billion, operating profit of $93 million and gearing at 24 percent.
Most subordinated bonds are penalised by the credit ratings’ agencies as they sit lower on the list for repayment in a wind up situation. If Qube was rated, I’d expect it to be on the cusp of investment grade. The subordinated bond would likely be lower and probably sub investment grade. My best back of the envelope guess is that the Qube bond would be three to four notches lower than the Mirvac bond.
So we arrive at the all important yield.
Qube marketed its floating rate note issue at bank bill swap rate (BBSW) plus 390 to 410bps and confirmed pricing at 390bps to provide an indicative yield to call of 5.65 percent per annum.
The Mirvac bond looks less appealing, its equivalent margin confirmed at 182bps, down from the guided 185bps on the strength of demand for the issue, to provide a yield to maturity of 3.5 percent per annum. However, keeping in mind the USD issue and its margin, and that this bond is four years shorter in term until maturity, this looks about right.
If you could buy either bond, you’d need to decide if the 2.15 percent extra margin is enough to compensate for the additional risk. You would want to have a good look at both entities’ financial statements as well as reading the prospectuses.
From a pure diversification play Qube is more attractive given most investors have an allocation to property in their portfolios, but the Mirvac bond locks in returns against a low interest rate environment where many economists expect further cash rate cuts.