Recent evidence would seem to suggest that European sovereign, supranational and agency participation in the Australian dollar kangaroo bond market is alive and kicking, but appearances can be deceptive.
In the week ending May 13, German agency KfW issued a A$450m 10-year note, which was increased from A$300m. The same week, Rentenbank, another of the German contingent, tapped its Australian dollar bonds due to mature in 2016 with an additional A$200m, while Norwegian local government agency Kommunalbanken also increased its 2014 bonds by A$200m. Rentenbank’s Aussie dollar borrowing for 2011 already totals A$1.9bn compared with A$2.2bn in the whole of last year. While it is predicting another record-breaking year in the kangaroo market, KfW – one of the most prolific borrowers among the European SSAs in this sector – has built a complete curve of Australian dollar debt with maturities between 2011 and 2021. This all suggests everything in Australia’s bond garden is rosy, but this is not the case, at least not without rose-tinted spectacles. Issuance of Australian dollars by top-rated borrowers has, in fact, shrunk drastically. Since March 31, triple-A rated offerings have totalled only A$264m, which represents almost a 50% decline from the same period in 2010. While Rentenbank might be bullish, issuance by KfW and Kommunalbanken have raised just A$1.9bn so far this quarter. Moreover, almost half of Rentenbank’s A$1.9bn of issuance was accomplished in January – there has been much less since. Liquidity drain
It is not difficult to find the culprit for this diminution of liquidity in the kangaroo market. In February, the Australian Prudential Regulation Authority ruled that issuance in Australian dollars by overseas supranationals would no longer count as level-one assets that banks must hold under Basel banking supervision standards. Bank treasuries constituted one of the biggest buyers of Aussie dollar debt issued by European SSAs so, at a stroke, to take that bulwark off the market dealt it a body blow from which it has still to recover. The shift in investment patterns is clear from examination of the order books on recent Rentenbank trades. Of the A$800m issued in January, 72% was bought by Australian and New Zealand banks. But when it sold the A$200m tap on May 9, Asian investors accounted for an amazing 87% of the order book. Asian buyers also accounted for 52% of the KfW A$450m trade. Without the Asian bid, European SSAs would not be able to issue Aussie dollar debt, and the surge of borrowing occurred only after the Asian holiday period was over. Since the Apra judgement, only four issuers have been prepared to sell triple-A rated kangaroo bonds. The reduction of the investor base has forced yields offered by European SSAs higher. Before the Apra ruling, European investment bank 10-year debt yielded around 50 basis points more than New South Wales Treasury debt, but after the ruling the premium expanded to 75bp – although it has subsequently contracted to somewhere between the two levels. With such a drop in issuance, one might have expected the rise in yields to be compensated by higher prices in the Aussie dollar versus US dollar Libor basis-swap market. But that hasn’t happened. Basis prices are still about where they were two months ago. At close on May 13, the two-year swap was quoted as 10.25bp mid-market, the three-year was 14.5bp mid and the five-year 20.25bp mid. Although basis swaps were better bid in the immediate wake of the Apra ruling, they have scarcely budged since. Basis prices
And these levels are considerably softer than they were at the end of the last year. Before Christmas, the two-year was 14.75bp mid, the three-year was 20.5bp mid and the five-year 26.75bp mid. These prices offered a much better pick-up to European SSAs. A little over a year ago, as the dislocation on money markets occasioned by the crisis continued to pervert basis prices, the five-year swap was as high as 45bp to 50bp. Levels like that offered extraordinary savings to European borrowers, but the subsequent attenuation of prices has made the kangaroo market much less attractive to them. A treasurer at a formerly prolific borrower of kangaroo debt was reported saying last week that the decline of basis prices has had a “huge impact” and had made kangaroo debt less cost-effective. The softness of Aussie basis swaps is surprising, given the diminution of issuance by European SSAs. They generally need to pay US dollar Libor and receive Aussie bank bills in the basis market – while issuance in offshore currencies by the Australian banks – who generally need to pay Aussie bank bills and receive the US dollar Libor, remains robust. New issuance is the traditional driver of prices in the basis market, but since the crisis things have been different. Global liquidity pressures in money markets are now more important and, as in the euro/dollar basis market, a global shortage of dollar funding is leaning on prices. This, at the end of the day, overwhelms new issuance pressures. So, with a much-reduced investment base and diminished arbitrage opportunities, the kangaroo market might have seen the last of its halcyon days. In the weeks following the ruling by Apra, it was hoped that the market would regain its poise. So far, that has not happened.