The purpose of this report is to review corporate and government debt market of Australia. The report illustrates effect of SGF to Australian corporate and government debt markets and how Australia managed debt market during that period. The main finding are that Australian economy was not effected in that extend as rest of the world.
Australian banks were concentrated in domestic market rather than investing offshore. Also government provided guaranty which supported debt market and saved it from default. Furthermore, it examines the shortage of supply in debt market. There are only a few offers of corporate debt available for retail investors through ASS. Analyze shows that the most of Australian debt issuers are rated as low risk investment companies which make issued securities high liquid and increases demand among investors who seeks for low risk and fixed income. It also analyses pricing, interest rate and guaranty that different bonds offer.
Government bond are the closest security to risk free investment and yields are the lowest compliance with sis. The report analyses different sources (such as ARAB, ASP S&P, ASS and other financial institutions), related to the debt market of Australia and provides overview of current situation with expectations. It also demonstrates the role of foreign investors in debt market of Australia with recent changes. Table of Contents Introduction 4 Corporate debt market 5 Government debt Market 8 Conclusions 13 Appendix 13 Australia Debt Market By Manville 1.
Introduction The Debt market plays crucial role in economy of every country as it is one of the main sources of finance for both Corporate and Government. Furthermore, an organization tries to maintain optimal debt level vs… Equity that would make an organization attractive for the investors dames & John, 1980). Also, to be able to control cash flow and pay current liabilities on time. On the other hand, issuing security is costly and there is a high requirement to issuer. For that reason mainly banks and other multimillion companies issue bond. Small companies prefer to take loan form financial institutions.
The role of debt market for the government is quite similar as for corporation: to be able to control cash rate as per monitory policy and jugulate budget cash flow. Australian government issues treasury bills (short term) and treasury bonds (mid-term and long term). Also different states can issue bond securities to finance Public Trading Enterprises that called semi government bonds. Demand for SMS and SUB from offshore investors has increased after SGF benefiting Australia debt market. Government and the financial institutions are the key players in Australian debt market.
The recent changes in legislation and requirements for securities, via implementation of Basel Ill are expected to have positive impact on the reporter and the government debt markets. 2. Analyze of Corporate debt market. There are a few different type of corporate bonds can be purchased in Australia debt market: Fixed rate bonds with fixed coupon; Floating rate notes with variable coupon; Inflation-indexed bonds with fixed coupon plus inflation rate; Hybrid bonds with option to turn it to equity and Kangaroo bonds that issued by non-residents (Phillips, 2012).
Australian corporate debt market is one of the most regulated debt markets in the world. The reason for that to secure debt buyers from loss of the investment as t did happen in US during SGF by selling high risk Cods with low yield rate of return. Because of this fact, ordinary people perception was that Cods have low risk. In the end Cods were not secured according to risk. In Australia, corporate bonds provide investors with regular interest payments that might be fixed or not fixed. Also payments are mostly secured by the issuing company’s cash flow, bank or the organization’s assets.
This way government can stop speculation with high risky debts and protect pension funds and retail investors. Lately, corporate debt market is short of supply. Investors, who are seeking for low risk and secured investment, do not have many options in terms of debt investment. Furthermore, debts are mostly sold through wholesale market rather than ASS. Retail investors have to invest to self- managed funds (trusts) in order to be able to invest to debt through wholesale. Table 1 clearly illustrates that only 0. 7% of the self-managed super fund allocated to debt securities.
Comparing to other fixed rate securities, corporate bonds vary rare as well. For example, there were only 5 issues with $400 million market capitalization, which s only 1 . 1% (see table 2) among ASS traded ones in November 2012 (O’Brien et al. , 2012). High risky bonds should provide higher return according with the risk related in case of insolvency of an organization debt holders paid first and only after shareholders. Table 3 clearly illustrates that yield return increases according to risk, where government bonds are equalized to free risk issues (Davis, 2012).
Corporate bonds yield coupon rate might fluctuate depending on rating of the company that reflects risk of the company. Investors also can gain or lose by selling bond in secondary market. In case if coupon rate prevailing current interest rate in the market, they sold at premium price and vice versa. In last rears (2009-2013) coupon rate has declined and according to S;P report, average rate of return was 8. 8% for corporate bonds (Graph 1) whereas standard deviation of return was only 3. 41%. ASS 200 (Graph 2) index was 0. 52% for the same period with 22. 7% standard deviation. It illustrates that investing to corporate debt is not only less risky but also might pay higher return. Graph 1 . S;P/ASS Corporate bond index Graph 2. 200 index The facility to issue covered securities has also assisted in the repurchasing of assured debt, as banks can offer nominees with AAA obligations an alternative asset to finance in. Covered bonds have created opportunities to banks to expand their investor base. They have delivered issuers with a comprehensive capital source less sensitive to risk affairs than usual unsecured funding.
Currently Australian covered securities value at a level close to much longer established covered bond programs (Debacle, 2013). According to NAB report (2012), the overall situation is expected to hanged due to regulatory changes. In recent years, retail investors (who are seeking for low risk investments) could deposit they money to bank and earn interest from around 2. 5% interest or act through Trusts and invest to different debt issues. Companies that are looking for investments usually finance it with bank loans as issuing bond is too complicated and costly.
The companies that big enough as Westerners and BP to issue bonds without guaranty, prefer to sell it to institutional investors trough wholesale. BP issued $1 ban worth bonds in the December quarter in 2012. It was recorded as the largest deal non-credit wrapped transaction in local market (Debacle, 2013). Minimum investment was around a half million dollar. Legislation must simplify requirement for issuing security and standardize the forms. Changing the requirements and legislations might increase corporate bonds in the market and make it available to the public (retail investors).
Also small companies would be able to finance different projects with lower cost of finance as banks are not involved. On the other hand it would increase the risk for the investors as companies old not be backed up as they are currently. 3. Analyze of Government debt market. Australian government debt is not only most secured but also provides variety of different securities: Commonwealth Government bonds, treasury indexed bonds, treasury notes, semi government bonds that issued by states. In terms of maturity term bonds.
It is also financial instrument of ARAB to control inflation rate and cash flow. Australian is a low debt growth economy and government debts provide several benefits to investors (Dale, 2011): * Stable political system * Government debts has AAA rating by S$P and Moody’s Monetary policy aims to maintain inflation rate at targeted rate * The Banks are highly regulated by PAR * Long term low unemployment rate * High liquidity In recent years global debt market were facing several issues whereas Australian domestic markets have benefited from strong foreign demand for Australian dollar securities.
Debacle (2013) stated that local issuers remain to be viewed favorably by offshore investors. Yields can be reduced according to risk of the debt. With a stable growth of economy and financial stability Australian Commonwealth Government securities (CSS) were rated AAA by Moody’s and S;P. Yields on CSS along with semi-government bonds (SUB) have declined and moved in appliance with global government bond yields. Graph 3 clearly demonstrates declining trend of Australian Government Bond Yield over last 10 years. Graph 3.
The large amount of CSS purchased by offshore investors and demand remains strong (Graph 4). The percentage of overseas ownership has slightly declined from its peak in recent years. Due to ADD exchange rate decline, some international investors have sold CSS but net purchases have still sustained, Just not in appliance with the pace of supply (Debacle, 2013). The percentages of foreign investors in semis were relatively stable over the last six years. Graph 4. CSS and SUB outstanding have significantly amplified in recent years.
Only from beginning of 2005 till June 2011 , semi-government bond outstanding has increased from $Bonn to $Bonn (Graph 5). CSS outstanding has increased even higher. Almost $Bonn of outstanding semi-government bonds were issued to finance government-owned corporations that provides essential services to the public. Lancaster and Dowling (2011) stated that the demand for SUB is to be expected to upturn over coming years due to the implementation of Basel Ill reforms. It requires banks to hold higher levels of liquid assets at the Reserve Bank of Australia, which include CSS as well as SUB.
Graph 5 Growth of SUB mainly driven by two states (Queensland and NEWS) that represent two third of total SUB market (see Table 4). At least 85% of total SUB is long term debt at given time as the issuing state treasury corporation obligates to sustain a minimum amount of outstanding in the bond at any given time to stimulate and sustain the bond market. Treasury corporations also issue short term notes in order to manage rent cash flow. Gained capital is mostly allocated to support the electricity and water sectors.
NEWS Treasury Corporation and Queensland Treasury Corporation had total loans outstanding to the water and electricity sectors amounting around $25 billion and $22 billion, correspondingly, as at June 2010 (Lancaster ; Dowling, maintenance with private funds that would reduce issuing SUB as Victoria state did in 1990. Public Trading Enterprises (Pets) are long term that requires long term investment. For that reason treasury corporations prefer to supply debt market with Eng term bonds as possible and borrow capital for longer period.
But CSS delivers primary pricing for the domestic yield curve, and therefore it is problematic for SUB to be issued at longer maturities than CSS. The weighted average term to maturity of the CSS market (5. 0 years) is slightly shorter than that of the SUB market (5. 5 years) (see Graph 6). Graph 6 Backing by their corresponding state governments has intended investors that credit risk for state treasury corporations to be low. As a result Sibs has started trading at tight spreads to CSS (Graph 7). However, during SGF, SUB spreads commonly widen, as investors preferred to switch to the safest and most liquid securities which was CSS.
The Australian Government implemented a guarantee scheme for state and territory borrowings in March 2009. It helped Sibs to trade as the risk was reduced by government support during SGF. It allowed security issuer to guaranty any new or present ADD bond by paying certain fee to the government. Situation has improved since SGF with spreads retrieving most of the spreading that occurred during SGF. In last a few years NEWS and Queensland treasury corporations started reducing outstanding guarantied securities by payback as unguarded bond became less costly to issue than guaranteed bond (Lancaster ; Dowling, 2011).
Conclusion Australian debt market is highly regulated by the government in order to protect super funds and retail investors from losing whole investment which happened during SGF with many funds in US. Due to regulation and the fact that Australian financial institutions were focusing in financing of domestic market during SGF rather than investing to US Cods’, saved Australian economy from collapse and created high demand for ADD bonds among offshore investors. That also reduced yields of Government and semi-government securities as it is correlated to risk of the bonds (“Notes” if it is short term).
S&P and Moody have rated Australian government bonds with AAA rating. Australia government and corporate bonds mainly traded through wholesale market and retail investors do not have direct access to these securities. Moreover, super funds asset allocation illustrates that debt securities supply is in shortage even in wholesale market. Furthermore, main part of outstanding bonds belongs to offshore investors. ADD exchange rate decline has lowed down growth of foreign investor share in Australia debt market. States can also issue bond that called semi government bonds.