Tuesday 17 May 2016 by FIIG Securities house Opinion

High yield bonds return 6 to 10% p.a.

Residential property developer Peet announced this week that it had successfully filled an ASX listed bond issue to refinance its 2011 bond

As published in The Australian on 17 May 2016

Residential property developer Peet announced this week that it had successfully filled a targeted $50 million to $75 million ASX listed bond issue to refinance its 2011 bond. The issue was reportedly oversubscribed and extended. “Following solid demand, Peet sanctioned an increase to A$100 million with an ability to raise more or less,” it said.

What’s most interesting about this deal is not just the great outcome but the very positive signal it offers for our broadly developing high yield bond market.

This is the second bond to have been launched on the ASX under the new simple bond rules. The first was a bond from diversified financial services group Australian Unity late last year that was also oversubscribed from the target $200 million, raising $250 million.

Investors in the new Peet bond would have been attracted to the 7.5 per cent per annum fixed interest rate payable half yearly, along with the fact that interest is mandatory and cannot be deferred.

From the company’s perspective, the bond improves the diversity of its funding sources and increases the average maturity date of Peet’s borrowings, providing longer term stability. The bond is unrated, which has made the bond market more accessible for issuers who don’t have a rating, which is typically the case for smaller companies and bond issues.

The bonds have been issued for five years and are due to mature in June 2021. They have a face value of $100, but once they begin trading on the ASX their price may move up and down depending on a range of factors including interest rates and the perceived credit risk of the company.

The number of high yield bonds issued via the ASX and domestic over the counter market is growing, with over 30 on issue, worth over $2 billion. This pales into insignificance when compared to the more developed US market, which last year issued $127 billion in high yield corporate bonds and this constituted 21.7 per cent of the total corporate bond market.

Yet the business is clearly there: it’s worth noting that many Australian companies have issued into the US high yield market, including Fortescue Metals Group, Newcastle Coal, DTZ and Leighton Services. We expect over time that the continued development of the Australian market will be able to fulfil the needs of Australian companies.

Mum and dad investors have a growing appreciation of the benefits of high yield bonds compared to dividend paying shares, preferring to have the higher assured income which must be paid as long as the company continues to operate. It is entirely reasonable to expect share investors can map techniques they have learnt in the equity market to the bond market: in other words, they become able to spread the risk of bond investments by owning a diversified mix of bonds, which is now possible given the large range of bonds accessible via the ASX and over the counter market.

Investors also like the bonds as:

  1. Most are fixed rate, locking in returns for a specified period, whereas practically all hybrids are floating rate and dividends on shares can be cut.
  2. They diversify portfolios away from banks and resource companies. Other sectors available include childcare, food production, technology, finance services, infrastructure and logistics.
  3. Bonds can be traded in small parcels, accessing liquidity and pricing via the ASX and the over the counter market.

While high yield bonds pay higher returns for increased risk, there are a number of lending protections that give investors added confidence. For example, covenants could include limits to the incurrence of additional debt, limits to dividend distributions, minimum interest cover and change of control provisions. The bonds can sometimes be repaid early but usually there is a penalty where the company must pay a premium to the $100 face value of the bond. For example they must pay $103 as compensation to the investor.  

Two comparisons to Peet of unrated bonds in the over the counter market are ASX listed property companies 360 Capital and Sunland. 

Property fund manager 360 Capital raised $75 million by issuing a fixed rate bond paying 6.9 per cent per annum in September 2014, with the issuance assisting the company to launch new funds. The bond matures in September 2019 and has a current yield to maturity of 6.46 per cent.

The Sunland bond was issued in November 2015 with at a higher interest fixed rate of 7.55 per cent per annum and also has a five year term. It is trading at just over its $100 face value at $100.30 with a yield to maturity of 7.47 per cent per annum.

At the time, Sunland Group managing director Sahba Abedian, said: “the proceeds from the offer, together with Sunland’s existing banking arrangements and capital management initiatives, will be used to fund future residential developments, property inventories and working capital of the Group”.

Australian companies have recognised that bond finance can complement bank funding, and provide much needed diversity and greater stability over the longer term. This is an exciting development for the Australian market, following the maturity of overseas markets and providing issuers and investors with greater choice.

High yield bond returns range from 6 to 10 per cent per annum depending on the company, the time until maturity, and the covenants on the bonds.