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Listed Issuance: Where to From Here?

In the benign economic climate, the technical environment (the forces of demand and supply) continue to dictate valuations in the ASX-listed Debt & Hybrid Market.  While trading margins have enjoyed an 18-month tightening cycle on the back of resilient demand, the momentum has undoubtedly slowed in recent months, with minimal net margin gains since January.

Figure 1. Average Additional Tier 1 Trading Margin Compression

Source: BondAdviser

While there has been some primary market activity with ANZ’s new capital notes (Prospective ASX Code: ANZPH), this is expected to ultimately result in a $340 million net reduction in supply ($1 billion total expected to remain outstanding across ANZPC and ANZPH).  In conjunction with Caltex and Goodman’s scheduled redemptions (ASX: CTXHA, GMMPA) this month together with Crown’s reinstated buy-back of its Subordinated notes (ASX: CWNHA), the technical environment is expected to remain supportive of current trading margin levels.

As we have previously noted, listed issuance will remain moderate in the near term with regulatory requirements largely met for financials and corporates opting to issue in wholesale markets.  Although this will limit the investment opportunity set for retail investors, the technical backdrop (strong demand) should remain intact and protect valuations from a sharp correction, all else (fundamentals) remaining equal.

Figure 2. 1-Year Trailing Listed Issuance / Maturity Profile

*Note: Assumes $1 billion left outstanding between ANZPC and ANZPH (yet to be finalised)

Source: BondAdviser

The Bendigo Convertible Preference Shares (ASX: BENPD) and Suncorp Convertible Preference Shares II (ASX Code: SUNPC) are next up on the maturity schedule, expected to be called on the 13th and 17th of December 2017.  While its expected these instruments will be met with by new AT1 hybrids, we note that Suncorp issued $375 million of Capital Notes in May 2017 (ASX: SUNPF).  For this reason, the group’s capital financing requirements around the SUNPC maturity ($560 million) could be limited, which would add to further supply-side pressure in the market.  However, Suncorp’s robust asset growth could see future capital instrument issuance upsized in anticipation of future expansion in coming years.

Figure 3. Suncorp Capital Position

Source: Company Reports

Looking to 2018, there are a number of securities that are due to reach their first optional call date.  However, 2017 has shown us financial institutions are reluctant to roll-over listed Tier 2 securities (with the exception on NABPE), preferring instead to satisfy solid demand in the domestic wholesale market. Similarly, the listed corporate market continues to shrink as the need for inherent equity credit to support underlying credit ratings has lessened in today’s low-growth global economy.  On this basis (without considering company-specific factors), it is likely the APA Subordinated Notes (ASX: AQHHA), Westpac Subordinated Notes 2 (ASX: WBCHA), Crown Subordinated Notes (ASX: CWNHA – currently being partially bought back), Suncorp Subordinated Notes (ASX: SUNPD) and AMP Subordinated Notes (ASX: AMPHA) will be redeemed at their respective first optional call dates without replacement.  In dollar terms, this equates to ~$2.9 billion.

Figure 4. The Year Ahead: 2018 Listed Maturity Profile

Source: BondAdviser

As a result, the market will be looking to upsized or new Additional Tier 1 (AT1) hybrid issuance to pick up the slack.  While we expect issuance growth for these types of securities to be broadly inline with bank loan growth, we acknowledge APRA’s ‘unquestionably strong’ capital standards exclusively targeted Common Equity Tier 1 (CET1) capital which leaves banks with less incentive to significantly increase Additional Tier 1 and Tier 2 issuance (like levels witnessed in 2014) in the near term.  This was highlighted by ANZ in the ANZPH launch in August.

Figure 5. Major Bank Domestic AT1 Hybrid Issuance

*Note: Calendar Year, 2017 Year-To-Date

Source: BondAdviser

Even assuming BENPD and SUNPC are met with new AT1 hybrids of equal size, the ASX-listed Debt & Hybrid market is on track for its first year of net redemptions since the Global Financial Crisis (GFC).  This aligns with the current margin tightening cycle being experienced by investors with increasing demand failing to keep pace with shrinking supply.  Given the trends we have witnessed in 2017, it is likely 2018 will see a similar supply outcome in the absence of a major structural shift in the regulatory environment.  While this is always possible, no announcements have been made yet by APRA and for this reason, we can assume AT1 financing requirements to remain moderate for Australian financial institutions.  We outlined the key scenarios we believe will result in the next potential wave of hybrid issuance in the August edition of our monthly review but assuming the status quo, yield-starved investors are likely remain unsatisfied in the near term.

Figure 6. ASX-Listed Debt & Hybrid Market Yearly Net Issuance

*Note: Calendar Year, 2017 Year-To-Date

Source: BondAdviser