Tuesday 01 October 2019 by Ben Taylor Opinion

From the trading desk - Ben Taylor

Looking back over the last three months, we have seen a great deal of activity across the trading desk. Around 30% of trades have been in USD, which is down on past experience and stems in part from the fall in the Australian dollar we’ve witnessed recently - as I write this, it sits around 67.50. The high yield market has accounted for about 60% of all trades for the last quarter, with investment grade taking up the remaining 40%.

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A shift in sentiment has seen clients taking more investment grade bonds in their portfolio; an inclination that has intensified as global risks increase. Investors are also becoming more wary of riskier credits, and those companies operating in cyclical or environmentally-challenged sectors.  It seems it’s time to seek more certainty and less risk. 

Pleasingly, clients have heeded our warnings and added allocations away from some of the more speculative high yield offers. Where clients do take high yield, we still encourage diversification, viewing it as a balanced option to improve a portfolio’s risk profile. 

One of the major challenges facing clients at the moment is the lack of supply. Across all sectors and fixed income assets, sourcing bonds at good levels requires diligence and patience. With respect to FIIG originations, although we meet with many potential borrowers, only a handful ultimately present a risk profile that FIIG believe is adequate for its clients’ portfolios. 

We believe that credit quality remains very important, especially now as risks across the globe increase. With the current and expected economic headwinds, lending to the right companies continues to be key – sentiments that have precipitated a wave of cancellations and re-pricings in high yield issuance. 

Peabody pulled its high yield bond deal at the last minute, and steel manufacturer Stelco scrapped a US$300 million offer. Some deals that were completed also had to pay up; Howden, a spinoff from Colfax, hiked the yield on a junk bond to 11.75%, and Australian steel and recycling company InfraBuild had to pay 12% on a five-year bond (and that was after owner Sanjeev Gupta pledged a further US$150m in equity).

In terms of investment grade issuance, the weight of money has been impressive, coming in like a tsunami. With such large volumes of cash chasing the highest quality bonds, many new issues have seen allocations below 50%. Given the huge demand and limited issue sizes, it’s perhaps surprising it’s not even lower.

Interest in Residential Mortgage Backed Securities (RMBS) has waned over the quarter as a result of tighter credit spreads and further falls in outright yields. Clients who set themselves up with higher quality RMBS with 3% margins over BBSW would now be very happy with their purchases given the quality of the returns being generated.

Given the supply-constrained environment, my suggestion would be to take advantage of new issues wherever possible. We typically see capital appreciation more often than not offset any new issue premium in a short space of time.

In the last quarter, we saw the issue of two bonds from FIIG. The first was a $30m issue from WorkPac Trust, Australia’s largest privately-owned provider of temporary, short-term and increasingly permanent staff, primarily to the mining, mining services, civil construction, infrastructure, utilities, and healthcare sectors. Workpac Trust issued a floating rate note offering a margin of 5.20% over the bank bill swap rate. 

The second was a $50m issue from WA Stockwell, a Queensland based property investor and developer, who was looking to refinance its existing notes and finance its investment in a new asset in Noosa. WA Stockwell issued a 7year fixed rate note with a 7.00% coupon. Both these deals were met with high demand and  the bonds have recently been trading over 1% richer, which is a great outcome for those who got involved.

We also saw over the quarter a number of banks come to the market as part of their Tier 2 capital raising requirements. Westpac, ANZ and CBA all issued, in both USD and AUD denominations. Primary support was strong, especially for the Westpac 29’s and 39’s which are now trading at large premia to their issue prices.

The other new issue drawing attention was the new fixed rate bond from Pacific National, which issued a 10year fixed rate note with a 3.70% coupon. While a larger margin was partly warranted due to the company’s exposure to coal, private ownership and low investment grade, the extent of the pick-up in yield saw the bonds open higher in the secondary market and continue to appreciate. Many of our clients used proceeds from lower-yielding investment grade bonds to fund into the offering and have continued to pursue similar switches in the secondary market. 

My top picks at the moment are the Pacific National 29 bonds, which I believe will continue to improve in price as interest rates cuts come through over the next 6 months. In the US dollar space, I very much like the new Fortescue Resources bonds. We remain comfortable with this credit, especially as the company is focussed on generating free cash flow and maintaining a low leverage.

Ben Taylor is in the Sydney office and can be contacted on (02) 9697 8731 or click here to view his profile

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