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Wednesday 11 October 2023 by Jonathan Sheridan flower field Opinion

Knowledge Series – Benefits of being a Wholesale Client #2

In the last edition’s opening article in this series, we examined how credit ratings can assist wholesale clients in evaluating bond risks. You can view the article here.

This edition we will look at FIIG-arranged unrated primary deals, which are only available to wholesale clients.

The background to FIIG arranging primary unrated high-yielding credit came in response to client demand on both sides of the balance sheet, i.e. investor and borrower, way back in 2011, as we were emerging from the depths of the GFC.

Investing clients were concerned that with the decline in overnight interest rates by the RBA and the follow-on effect to term deposits that their income would be reduced significantly, and on the other side, mid-size corporates who were excluded from the capital markets by overly conservative market participants focusing solely on investment grade rated issuers or banks who effectively monopolised lending off their own balance sheets meant that these fine companies were constrained in their growth plans.

Globally, bond markets provide significant amounts of capital to lower- or un-rated entities, but this part of the market in Australia was and remains hugely under-represented.

FIIG had a mission to ignite this corner of the market and the ability to connect lenders and borrowers.

To date, FIIG has arranged 75 unrated bond issues and 1 investment grade issue, for a total of $2.91bn.

The first issue was for ASX-listed equipment lender SilverChef, which issued a 6-year senior unsecured bond at an 8.50% coupon and proceeded from there across sectors, different places in the capital structure, varying tenors, and even including a social impact bond.

The total return on the complete cohort of issuers, assuming a passive investment in every issue from inception to maturity, including all coupon income and losses, has been 6.79% p.a.

This includes all early redemptions (typically at a premium) and losses from defaults as well as a current mark to market on bonds outstanding, many of which are valued below par due to the last year of rising interest rates. This impact has been lower than that seen in equivalent tenor investment grade bonds given their higher income streams (which lower duration or interest rate risk) and continue to provide a strong reliable income stream that our clients can rely on.

There have been 6 instances in the portfolio where a default has occurred. In one of those instances, investors returned 100% of their capital. In four, less than 100% of capital was returned, with recovery ranging from 50-87.5%, and in one case, the outcome was valued as a 37.5% recovery which was the level at which investors received equity in the company.

Over the equivalent period, the ASX200 returned a compounded 5.48% p.a. in capital terms, plus dividends which averaged approx. 4.32%, for a total return of 9.80% p.a.

These figures assume that all income is spent and not reinvested.

Adjusted for volatility (which is the measure of risk used in the classic equity models such as the Efficient Market set) then the unrated bond returns would be superior, using a figure of 15% as assumed volatility for the index, as bond volatility is much much lower.

The latest issue was the new bond issued by APMF (Australia Pacific Mortgage Fund), a short-dated 9% fixed rate bond underpinned by a collection of single-asset property loans.

If you have interest in finding out more about these bonds from either the investor or issuer side, please do not hesitate to get in touch with us.

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