Sometimes it is feast or famine in the bond market for new issues. A few months ago we hadn’t seen one for a long time and we were wondering what corporate treasurers were doing with their days. In the last month however, and in particular this week, we have seen a slew of new issues hitting the market.
With a lot of choice, how do investors pick the wheat from the chaff, and decide which new issue to support with their capital?
We examine one deal from each of the investment grade, high yield and FIIG originated markets, and show how we assessed value against what was available in the secondary market, to persuade us to invest in the new issues in preference to what was already available.
Investment grade
Pacific National Finance Limited is the wholly owned subsidiary of Pacific National (formally known as Asciano Limited, collectively known as ‘PN’). Pacific National Finance acts as the borrower for the Group. PN is Australia’s largest national rail freight operator.
PN operates under two segments: (1) coal haulage; and (2) containerised freight. Around half of PN’s revenue comes from coal, 20% from thermal coal and 29% from met coal (FYE19). PN is the largest provider of containerised rail freight services in Australia, which generated about 32% of total revenue.
The appetite for genuine corporate issuers in the Australian institutional fund manager market is very strong given limited supply, and so we expected this new issue, which offered an attractive yield compared to similar bonds, to experience very strong demand both in the new issue and in the secondary market following the issue.
The new issue yield based on the existing PN bonds was expected to be around 3.4%.
Issued at a price just under par (100) for a yield of 3.75%, on the first day of trading post issue the yield fell 0.36% to 3.38%, which delivered a day 1 gain to investors of $2.70 or nearly 3%.
We anticipated that the new issue looked cheap by about 0.30% and it was gratifying to see this assessment validated.
Since then supply in the market has disappeared as bonds found their way into the portfolios of natural holders (as opposed to traders) and with supply now being scarce, the price has continued to rise, to a high of 105.75 earlier this month and 104.3 at the time of writing (given government rates have risen recently).
Rated high yield
Virgin Australia Holdings (‘Virgin’), last week issued $425m of a USD denominated high yield bond with a coupon of 8.125%.
The initial guidance was for a $400m deal size and a coupon in the range of 8-8.25%, which was well above our initial thoughts on pricing.
We looked at the existing bonds that Virgin had in the market at the time:
We then compared the spread (extra yield you receive for taking the particular credit risk of the issuer) of those bonds over the relevant government bonds of similar maturities, exchanged in to the USD equivalents to allow a like-for-like comparison, and extrapolated to the new proposed maturity date:
Source: Bloomberg
Assuming a new issue concession (the extra yield usually offered by a new issue to entice investors to buy the new bond over other bonds available in the secondary market) of around 0.3%, this gave us an implied yield to maturity on the new bond of around 7.75%.
So, when the pricing was announced in the range of over 8%, we concluded that the new bond looked very good value indeed.
Our good relationship with the issuer and the manager of the new issue, developed over our strong participation in their last 3 new deals, enabled us to obtain a protected allocation. This meant that clients were able to be assured of their allocation in the new deal, rather than having to bid into a bookbuild and accept the allocation given which, more often than not, is only a portion of what they were willing to purchase.
The issue closed last Friday and the price of the bonds is currently around 100.3, so a small pick up for investors.
FIIG originated AUD high yield
Sunland (ASX: SDG) is an ASX listed property development group. Headquartered in Brisbane, Queensland, Sunland has over 35 years’ industry experience with primary operations in Queensland, New South Wales and Victoria.
Sunland previously issued a 5 year note arranged by FIIG in November 2015, and they were looking to extend their maturity and take advantage of current lower rates to lock in another 5 years of funding.
As a previous issuer, Sunland were well known to FIIG clients, and so investors were comfortable with the credit risk.
The remaining hurdle was pricing, as the previous notes had a coupon of 7.55%. At the time, this represented a margin over the 5 year swap rate of approximately 5%.
Sunland had done everything they said they were going to do when they issued their first bond, largely meeting forecasts made at the time and performing well over the past 4 years. They continue to maintain a conservative balance sheet for a property group and have proven experience in the residential property markets in which they operate. However, Sunland is exposed to some geographic concentration risk to the SE Qld and Gold Coast housing markets and (along with many other property groups) is facing headwinds with uncertain economic and housing market conditions.
Consequently Sunland’s credit risk in our opinion was marginally higher than the first issue so deserved a wider margin (+0.25%) than at the previous issue. A margin of 5.25% over the current 5 year swap rate would imply a current coupon of approx. 6.20% which is where the bonds have priced.
The bond issues today and so over the next few weeks we will be able to see if the pricing was fair for the value presented.
Hopefully these three examples give you, the investor, an insight into the rigorous methods (which are simplified to fit into an article!) by which we determine value or not on newly issued bonds.
With new issues coming to market on a frequent basis, we encourage you to open an account so you can get the information you need to enable you to invest in new bond issues with confidence.
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