By the last day of May the month had seen

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Valentine McGee
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Kangaroo market participants ascribe the recent flurry of supranational, sovereign and agency (SSA) Kangaroo issuance to a global tightening of spreads and interest in rolling maturities.

B y S a m a n t h a H o d g e a n d L a u r e n c e D a v i s o n By the last day of May the month had seen 11 Kangaroo deals price for total volume of A$2.6 billion (US$2.

Although relatively small average deal sizes makes May a lower-volume month than January s traditional early-year SSA flurry, it is the most active month in terms of deal numbers since July last year

1 Kangaroo market participants ascribe the recent flurry of supranational, sovereign and agency (SSA) Kangaroo issuance to a global tightening of spreads and interest in rolling maturities. A tapering off of deal flow during the European summer is expected, but there are signs that fundamentals remain sound despite the Australian dollar s recent precipitous decline. B y S a m a n t h a H o d g e a n d L a u r e n c e D a v i s o n By the last day of May the month had seen 11 Kangaroo deals price for total volume of A$2.6 billion (US$2.5 billion) (see table on facing page). Although relatively small average deal sizes makes May a lower-volume month than January s traditional early-year SSA flurry, it is the most active month in terms of deal numbers since July last year (see chart on facing page). Demand weighting SSA Kangaroo borrowers say recent issuance has been met by a diverse investor base with increased demand from international investors continuing their search for yield. Jens Hellerup, director, and head of funding at Nordic Investment Bank (NIB) in Helsinki, tells KangaNews the supranational s A$100 million tap to its April 2022 line which priced on May 15 was dominated by asset managers and banks at a point in the curve where central banks were previously the most important investor base. Sometimes you pay a bit to issue in the Kangaroo market but at present it is at the same level as other options, especially in the fiveyear part of the curve. Jens Hellerup Nordic Investment Bank Hellerup says: Over 40 per cent of our demand is coming from Australia and around 40 per cent from Asia. The rest is split between Europe and South America. In our recent tap we saw demand from banks and central banks in Australia and Europe. KfW Bankengruppe (KfW) also noted a strong offshore bid for the A$300 million tap to its July 2018 line on May 16. Klaus- Peter Eitel, vice president of new issues at KfW in Frankfurt, confirms that the borrower s activity is biased towards the mid part of the curve, which remains appealing to offshore central banks but is also now attracting good interest from international balance sheet buyers. Despite recent reductions in the Reserve Bank of Australia cash rate, AUD remains an attractive yield play for international buyers. Indeed, a survey of global reserve managers published in May by the International Monetary Fund suggests the motivations for this key investor group to allocate to Australian dollar assets remain very much in place (see box on p40). Leopold Olma, head of funding at Rentenbank in Frankfurt, tells KangaNews absolute yield levels and spreads over swaps and government bonds are very attractive for investors compared with other currencies. Hellerup says this higher yield available compared with any other developed market has a positive influence on international demand. On a USD-Libor basis, it is competitive compared with issuing a USD benchmark. Sometimes you pay a bit to issue 38 kanganews june

2 in the Kangaroo market but at present it is at the same level as other options, especially in the five-year part of the curve. Domestic bid While individual borrowers have seen demand patterns change lead managers say, overall, the buyer base seen on the SSA Kangaroo deals issued in May is largely unchanged from the beginning of the year. Similar investor names and geographies, predominantly from Asia, have continued to dominate the sector. Rod Everitt, Sydney-based head of Australian dollar syndicate at Deutsche Bank joint lead manager on the Nederlandse Waterschapsbank, Rentenbank and Asian Development Bank (ADB) deals tells KangaNews the recent run of SSA Kangaroo issuance has mainly been driven by reverse enquiry from investors targeting specific names, tenors or structures. While interest from Asia, supplemented by European demand, has been consistent the domestic bid appears to be coming through only in patches with different leads describing different levels of Australian-origin demand. Peter Dalton, Sydney-based head of syndicate at Westpac Institutional Bank joint lead manager on deals for Export Development Canada and KfW suggests domestic and real-money accounts and institutions, outside a couple of balance sheets, have not been active in the issuance seen in May this year. By contrast, Tom Irving, Singaporebased managing director and head of Asia syndicate at TD Securities, which led recent transactions for Inter- American Development Bank (IADB), Rentenbank and ADB, suggests levels of on- and offshore participation in deals number and volume of ssa kangaroo deals deal volume (A$M) Deal volume (LHS) 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1, Jan Mar are becoming more balanced. Irving comments: There are more domestic investors involved so the balance between domestic and international buying is moving to historic-type levels. Flurry drivers May Source: KangaNews May 30 Number of deals (RHS) Jul Sep Leads say the run of issuance on the back of demand from both on- and offshore investors seen over the course of May can be attributed to a global tightening We expect major Japanese life insurers and asset managers to increase their foreign bond holdings as the year progresses and low yields persist. Anthony Ruschpler African Development Bank Nov Jan Mar May number of deals SSA Kangaroo issuance, May Date Issuer Sector Maturity Coupon (% or bps) 9 May 13 Nederlandse Waterschapsbank 9 May 13 Inter-American Development Bank 14 May 13 Export Development Canada Margin (bps) Volume (A$m) Lead(s) Agency 11 Apr /ACGB 100 Deutsche, Nomura Supranational 22 May /ACGB 200 CommBank, TD Agency 22 May /ACGB 400 Citi, RBC, WIB 15 May 13 Nordic Investment Bank Supranational 19 Apr /ACGB 100 ANZ, HSBC 15 May 13 Rentenbank Agency 24 Jan /ACGB 275 Deutsche, TD 16 May 13 KfW Bankengruppe Agency 18 Jul /ACGB 300 RBC, WIB 17 May 13 Asian Development Bank Supranational 5 Jul /ACGB 300 CommBank, RBC, TD 22 May 13 African Development Supranational 31 May 18 25/BBSW 25/BBSW 100 Deutsche Bank 22 May 13 Inter-American Supranational 26 Sep /ACGB 175 JPM Development Bank 23 May 13 Kommunalbanken Norway Agency 30 May /ACGB 250 HSBC, JPM, Nomura 29 May 13 International Finance Corporation Source: KangaNews May 30 Supranational 6 Jun & 18/BBSW 64.5/ACGB & 18/BBSW 400 CommBank, Deutsche, RBC 39

3 Reserve reallocation continues In May, the International Monetary Fund (IMF) published the results of a survey of global reserve managers. The results make happy reading for Australian dollar borrowers, indicating that the currency remains close to the top of the list of reallocation targets as reserve managers continue to seek additional diversification. The IMF survey was sent to all 156 reserve-managing banks in IMF member countries. In total, 67 of these responded a group which the IMF says includes countries representing half of global GDP and a third of reserves or roughly US$4.4 trillion. The IMF also claims aggregate global reserves now amount to the equivalent of a third of the OECD bond markets, meaning the survey respondents alone are potentially managing funds covering more than 10 per cent of the developed world s total bond market. In total, 56 per cent of the survey s respondents holding roughly US$2.2 trillion in total told the IMF they are currently considering adjusting the currency composition of their assets. The response was relatively uniform across reserve-origin sectors: lowincome countries are the What type of assets are you investing in to enhance your rate of return (ex-gold)? Choice Longer-term government bonds 73.4 Credit-related securities (eg agency and corporate bonds) 60.9 Other 32.8 Asset-backed securities 18.8 Equities 14.1 REITs 3.2 Source: International Monetary Fund May least likely to be considering reallocation, with 53 per cent of this sector responding in the affirmative, while 59 per cent of advanced-country reserve managers say they are pondering diversification. The largest concentration of reserve managers currently considering reallocation say the types of currencies they are looking at includes those of advanced nations outside the traditional reserve stores. This Respondents (per cent, from 64 total) new currency basket comprises AUD, CAD, CHF, DKK, NOK, NZD and SEK, and 74 per cent of reserve managers considering diversification around 40 per cent of total respondents are looking at it. The news is even better for Australian dollar borrowers, as the IMF specifies high interest expressed in commodity currencies such as AUD and CAD. It adds: Most of our respondents are interested in the commodity currencies AUD and CAD. These commodity currencies may be attractive in their own right but can also function as a proxy for rapidlygrowing emerging market countries, which are less investable. The situation for Australian dollar assets could be more positive still given the acknowledged weighting of the survey results towards Europe. of spreads and a high level of redemptions: A$2.1 billion of SSA Kangaroos had May maturity dates. Laura Fan, head of funding at IADB in Washington, says the supranational received specific demand from investors looking to roll their holdings of its A$500 million maturing bond into a new IADB Kangaroo, for instance. However, market participants also say the largest individual Australian dollar maturity of all the May 15 Australian government bond maturity of nearly A$17 billion had no specific significance in terms of spurring Kangaroo demand and no noticeable effect on the SSA market. Dalton says besides the high level of redemptions in May, the flurry can also be attributed to issuers returning to the market following low supply throughout the early part of the year. He says: May is a massive month for redemptions across all sectors so there is very liquid cash which needs to be put somewhere. On the issuer side, the cross-currency basis swap has been both relatively stable throughout and attractive for offshore We would rather execute a smaller deal that is fully sold than to execute a larger deal in which the leads have significant longs. We believe that a fully-sold smaller deal should have stronger secondary market performance. Laura Fan Inter-American Development Bank 40 kanganews june

4 Australian dollar borrowers have targeted and seen significant interest from Asian reserve managers, yet the region provided just 15 per cent of the IMF survey s respondents or 10 in total. By contrast, 42 per cent of the survey responses came from Europe, from 28 reserve managers. Most of our respondents are interested in the commodity currencies AUD and CAD. These commodity currencies may be attractive in their own right but can also function as a proxy for rapidly-growing emerging market countries, which are less investable. International Monetary Fund Drivers and preferences The survey appears to underline the longer-term nature of reserve manager allocation decisions: asked to list the main considerations on which currency composition is based all the main drivers named by managers related to fundamental factors rather than short-term market attractiveness. The number one factor depth and liquidity of the underlying asset markets was named by 50 per cent of respondents while the nominal interest rate trailed in ninth with just 21 per cent of respondents listing it. The initial reasons for currency reallocation clearly relate to the financial and sovereign crises. Of the respondents, 80 per cent name rating downgrades as a driver and 60 per cent other sources of awareness of increased credit risk. Reputational risk, worsening credit default swap spreads and increased volatility round out the top five motivators. As a result, a May 28 research note penned by Westpac Institutional Bank analysts, Damien McColough and Timothy Jung, covering the IMF survey, suggests: We find that many of the motivations that have favoured the AUD as a diversification target are still in place and hence there is little reason to fear a reversal of recent trends. It is undoubtedly important that Australia retain both its strong sovereign rating level and a deep and liquid sovereign bond market in order to remain favoured, though. Around 80 per cent of the IMF s respondents say credit ratings remain the key instrument for assessing credit risk, though the survey report also notes reserve managers apply more flexibility on the ratings issue in the area of sovereign bonds. This also means that sovereign rating downgrades are not automatically followed by forced selling by reserve managers, the IMF concludes. Government bonds are the preferred holding of reserve managers, although subsovereign and corporate bonds also feature strongly and many also hold asset-backed securities and equity (see table on facing page). CalPERS action It is not just the reserve manager sector which is showing ongoing signs of interest in Australian dollar product. In mid-april this year, CalPERS revealed a significant planned reallocation of its global fixed income international benchmark which takes in a substantial increase in allocation to both the dollar boc group which includes Australian dollars and to emerging markets, International fixed income represents a small portion of CalPERS assets under management 1.6 per cent of its total fund policy benchmark but this is out of a total of more than US$250 billion. The firm uses internal and external managers in the sector. At an individual country level, CalPERS plans to increase its allocation to Australia to 4.27 per cent from 1.37 per cent. New Zealand is a smaller beneficiary, with a proposed increase to 0.47 per cent from 0.31 per cent. The biggest individual loser is Japan, which could see its allocation from CalPERS fall to per cent from per cent. borrowers coming to the Australian dollar market. According to data provided by RBC Capital Markets, the five-year AUD/USD basis has been range bound at positive basis points for all of the current year; in the first five months of it traded in the range basis points. We benchmark against the six-month Euribor and in the Australian dollar market the cross-currency basis helps, confirms Rentenbank s Olma. While lead managers say the basis is conducive to deals rather than a specific driver, stability in the basis is clearly supportive of programmatic Kangaroo borrowers. For SSA issuers, renewed deal flow is a global phenomenon and more a product of a favourable change in spreads. Irving explains: Spreads across the globe have come in noticeably over the last few months so pricing is more competitive on a global basis. Although Kangaroo yields have some appeal to and garner demand from investors, pricing in Australian dollars is also competitive for borrowers. SSAs themselves tell KangaNews funding results in Australian dollars are currently comparable with the US dollar market and favourable against euro issuance. Fan, for instance, says while coupon rates are higher in the Australian dollar market because the interest rate cycle is different compared with other countries, the swapped-back cost of Kangaroo bonds remains in line with other options including US dollars. Deal downsizing Although SSA Kangaroo deal flow has been strong in terms of deal numbers, transaction volume has been smaller. Out of the deals seen in May, Export Development Canada and International Finance Corporation raised A$400 million but the remaining transactions were all of A$ million in size. By comparison, the 10 deals seen in January this year were mostly for A$ million apiece. Borrowers say a strong preference for fully-placed deals driven by banks reduced capacity to warehouse bonds on balance sheet drives transaction volume. According to African 41

There is some volatility in the FX market and investors are watching the move in currency with interest. The effect on demand depends on the tenor and the focus of the transaction.

financial year though this may change in the coming months.

5 There is some volatility in the FX market and investors are watching the move in currency with interest. The effect on demand depends on the tenor and the focus of the transaction. Peter Dalton Westpac Institutional Bank Development Bank (AfDB), the trend for smaller-sized deals can also be partly attributed to the slow return to markets of key Japanese accounts in their new financial year though this may change in the coming months. Anthony Ruschpler, senior treasury officer at AfDB in Tunis, explains: We expect major Japanese life insurers and asset managers to increase their foreign bond holdings as the year progresses and low yields persist. We maintain a flexible funding strategy that allows us to consider smaller new-issue and tap sizes to accommodate actual investor demand. The Kangaroo market appears to have adjusted well to the potential for deal sizes to be smaller. Eitel explains transaction size will be a trade-off between safeguarding performance on a bond line and having offer-side liquidity available. Although balancing these two aspects will be tricky, he adds, it is not expected to have a negative overall effect on the market. Rentenbank s Olma says the agency is not seeking larger deals as its funding needs in are limited at 10 billion (US$12.9 billion). But he also confirms deal sizes have reduced because A$500 million-plus transactions are more difficult to execute with dealers less inclined to keep large inventory. He says: We have raised A$1.8 billion in six different Kangaroo transactions so far this year with an average deal size of A$300 million. This was above our expectations, bearing in mind the deals were fully placed. But Olma also adds: We expect to see larger deals again when offshore demand returns to the market, because the Australian dollar offers relative value versus government bonds. In addition, the Australian dollar remains an excellent opportunity to diversify their investment portfolios. Fan says the feature of small deal sizes is no concern to the IADB, which prefers to size transactions to demand. She comments: We would rather execute a smaller deal that is fully sold than execute a larger deal in which the leads have significant longs. We believe a fully-sold smaller deal should have stronger secondary market performance than a larger transaction in which Spreads across the globe have come in noticeably over the last few months so pricing is more competitive on a global basis. Tom Irving TD Securities there may be loose bonds floating around in the market. Slowdown in sight? There is a suggestion in the market that the flurry of deals may slow in the near term, but the consensus from leads seems to be that the run would likely continue, or even ramp up, into June before tapering off entering the northern hemisphere s summer holiday months and picking up again in September. Irving and Dalton agree that issuance may not have such an extreme frequency going forward but it will certainly continue. Dalton also points out that the number of triple-a SSA Kangaroo issuers is reasonably concentrated, and that a number of names with smaller funding programmes may only have capacity to issue two or three times per year. With relatively positive deal flow at the start of the year and now in May as well, some subsequent periods of inactivity can be expected. Dalton explains: We have seen a good range of names come to the market and there are still some transactions in the pipeline into early June. Then the European and North American summer will start, which will reduce some of the issuer activity particularly from European names. Everitt agrees that activity from borrowers in the northern hemisphere will likely slow down from June until September but says he expects the flurry of activity to be maintained up to that point. The market is not back to where we would like it to be but deals are getting done, he concludes. There has been some speculation about the impact of a falling Australian dollar on SSA Kangaroo demand. However, despite a fall of nearly 10 per cent versus the US dollar in the middle part of Q2, it may be too early to tell what consequences a lower AUD will have. Dalton says there is not necessarily a clear, linear relationship between the recent decline in the Australian dollar and offshore demand for SSA Kangaroos. He says: There is some volatility in the FX market and investors are watching the move in currency with interest. The effect on demand depends on the tenor and the focus of the transaction in terms of its distribution. A declining Australian dollar could have one of two impacts on demand from the sub-set of international investors who buy based on an FX view. If investors expect a rebound they would likely up their interest, but if they foresee an ongoing declining trend they would be more likely to withdraw funds. To some extent the market is currently in wait-and-see mode on this issue. If we see the currency stabilise we will be able to make some calls in terms of what it may or may not do to demand, Dalton suggests. 42 kanganews june

International Finance Corporation

Kanga Trends IFC prices debut Roo asking for accelerated deal timetable International Finance Corporation (IFC) (AAA/Aaa) priced its debut Kangaroo deal on February 20 a A$500 million (US$464.46 million)