Wednesday 05 May 2021 by Jonathan Sheridan Primary_800 Trade opportunities

Benefits of being a Wholesale Client #2 - FIIG originated unrated primary issues

In last edition’s opening salvo 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.

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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 62 (and a 63rd is currently in the process) unrated bond issues and 1 investment grade issue, for a total of $2.7bn.

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 6.89% p.a.

This includes all early redemptions (typically at a premium) and losses from defaults. There have been 5 instances in the portfolio where a default has occurred. For two of these defaults, investors recovered their entire capital, included all accrued interest. In 2 of those instances, less than 100% of capital was returned in cash, with recovery ranging from 50% to 62% of issue amount (which doesn’t account for periodic amortisation that investors would have received). In that last case, investors are now equity holders in the company, so the outcome is still uncertain but we have valued this as a 37.5% recovery which was the conversion level.

Over the equivalent period, the ASX200 returned an annualised 5.59% in capital terms, plus dividends which average approximately 4.25%, for a total return of 9.84% 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.

As market interest rates and term deposit rates have continued their decline to their current record lows, high yield bonds continue to provide a strong reliable income stream that our clients can rely on.

The latest issue was a $30m increase in an exiting bond from WA Stockwell, which is the subject of our third article this edition. A 7.00% 2026 senior secured bond, it was issued at a slight discount to yield 7.25%.

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.