When gaming and wagering heavyweight Tabcorp issued its Tabcorp Bonds in April, fixed-interest brokers feted the issue as the rebirth of the retail corporate bond market.
Listed on the Australian Securities Exchange (ASX), the investment-grade-rated (at BBB+) Tabcorp Bonds were priced at 4.25 per cent above the 90-day bank bill rate, implying an initial interest rate of 7.4 per cent a year. In the secondary market, the yield has improved to 8.87 per cent.
The Tabcorp Bonds were closely followed by AMP’s issue on the ASX of its AMP Notes, rated A-, which were priced at 4.75 per cent above the 90-day bank bill rate, implying an initial interest rate of 7.9 per cent a year. In the secondary market the AMP Notes are trading at 8.26 per cent.
The pair were considered the closest things to a genuine retail corporate bond that have been listed for a long time: true corporate ‘names’, investment-grade rated, but tradeable in retail volumes. The Tabcorp Bonds, in particular, was the first bond issue from a substantial non-financial company in many years, and brokers hoped it would stimulate a flurry of issues from companies that recognised the appetite retail investors had for high-yielding issues.
Wright says retail investors looking for yield have been huge supporters of ‘hybrid’ securities, so named because they are a mix of debt and equity. Issued by companies to raise capital, hybrid securities – usually issued in the form of a preference share – offer investors a predictable rate of return or dividend for a set period, usually until a maturity or conversion date: the return may be fixed or floating, determined by a margin over a market rate, usually the bank-bill rate.
“The retail sector was very quick to grasp the attraction of the preference share sector years ago, because they could use the franking credits as well. It’s been a win-win, the bank issuers find them very attractive to issue and investors like them,” he says.
This was the investor base that was considered ripe for the tapping by corporate bond issues. But the hoped-for second coming of corporate issuers has stalled, stymied by prospectus requirements and more recently, by the decision of credit ratings agency Standard & Poor’s to cease rating issues that are sold to retail investors, in response to ASIC’s requirement that rating agencies hold a financial services licence. (If a ratings agency holds a financial services licence, it could be sued if an issue it had rated performed poorly.)
“We certainly haven’t seen the issuance we expected to see following the Tabcorp and AMP issues,” says Steven Wright, head of fixed interest at RBS Morgans. “The ironic thing is that with Tabcorp Bonds trading at just under 9 per cent and AMP Notes at about 8.25 per cent, both have been pretty solid contributors on the yield front, and investors like them, they like the fact that they’re both investment-grade-rated companies. But the market is still very light-on for retail issues.”
Wright says the prospectus requirements need to be sorted out by the Australian Securities & Investments Commission (ASIC). “What Tabcorp had to do in terms of a prospectus for the Tabcorp Bonds was more than it would have had to do for an equity issue,” says Wright. “Treasury and ASIC are working to streamline that process into a ‘short-form’ prospectus, which will help, because I’m sure a few corporates looked at what Tabcorp had to do and thought ‘that’s too hard.’
Corporate bonds are simply bonds issued by companies. Investors lend money to the company by buying the bonds: they receive interest either twice a year, or quarterly, and get their money back when the bond matures.
The bonds are generally not as reliable as those issued by governments or semi-government authorities, but the credit ratings reflect that.
Brad Newcombe, senior research analyst at specialist fixed-income broker FIIG Securities, says the market is not actually light-on for corporate bond issues: it is just that most of them are wholesale-only issues requiring a minimum investment of $500,000.
“Some of the wholesale corporate bonds do allow, once they have been issued at a minimum parcel of $500,000, smaller parcels to be bought – say, $50,000 or $100,000 lots – so they can be broken down once they have been issued,” he says.
“But only a handful of corporate bonds have that capability, and we’re working on that. Quite a few participants in the market are trying to stgelop a retail bond market, because there’s not one at the moment and people should have access to them.”
Newcombe says the S&P decision – which has been echoed by Moody’s – is a blow to the nascent retail corporate bond market, but will not “kill it off.” He says existing credit ratings are not affected by S&P’s decision: but as things stand, it will not issue ratings for issues sold into the retail market after 1 January 2010.
“What we’ve seen in the retail bond market – and especially in the hybrid market – is that the credit rating isn’t the be-all-and-end-all. Sometimes, companies that would otherwise obtain an investment-grade credit rating don’t actually bother to do it, because they might not think it worth paying the ratings agency a fee to be rated. So just as a strong credit rating is not an explicit recommendation of quality, the fact that an issue is not rated doesn’t mean that it is necessarily a bad credit risk.”
Newcombe says Seven Network, which has a preference share in the market under the ASX code SEVPC, is the stand-out example of this. “SEVPC is an unrated security, but Seven Network has $2 billion of cash and listed investments, and no debt. You can’t really see it going broke in the near term: obviously they could make acquisitions, and that could change your assessment. SEVPC does not have a credit rating, so it does not follow that an unrated issue is necessarily high-risk.”
The lack of a rating from the likes of S&P would hardly deter the likes of BHP or Telstra from issuing a retail bond, he says. “Retail investors tend to associate with brand names rather than credit ratings and if any of Australia’s top listed companies decided to issue a retail bond and it were priced correctly, we suspect they would be barreled over in the rush regardless of the lack of rating.”
Where this issue could become problematic, however, is for large Australian companies, say Top 200, which don’t have a strong brand name. “This is where the lack of a credit rating, which is used to compare like products, could hurt.
“Again however, there is a potential solution. There are several other financial services companies that rate financial products and while not as well known as the major agencies, it is likely they will fill the void and take on the opportunity presented to them,” he says.
Newcombe says the retail fixed-interest market has also been “spooked” by the recent decision by Moody’s effectively to downgrade the ratings on bank hybrids. Major bank hybrid issues, which have usually been Aa3 by Moodys will now be A3 – a three-notch downgrade.
“We think this is a massive over-reaction to the woes being faced by overseas banks. Over the past few weeks, since the S&P and Moody’s decisions were made, the prices of most bank hybrids have plummeted. The fall in price of the bank securities initially appears completely unfounded. The credit risk of banks and the likelihood that they will have to suspend distributions on their hybrids remains completely unchanged.”
Newcombe says there is a risk that certain institutions, which require their investments to carry a certain rating, will sell down bank hybrids in anticipation of the forthcoming changes. “The funny thing about selling is that it can breed more selling. Some investors who believe that the bank hybrids will fall even further may sell their securities now in anticipation of picking them up cheaper later.”
Investors should not get involved in such speculation though, he says. “The sell-down of the bank hybrids has again seen many of them trading at bargain prices. We believe now is the perfect opportunity to be purchasing bank hybrids while they represent good value rather than gambling on the short-term direction in prices.”
Wright says yields on hybrids have come in from the “extreme levels” they reached at the height of the GFC, but there are “still good opportunities” in the sector.
“If you look at the bank hybrids, securities like CBA’s PERLS IV, which is trading on a yield of about 9 per cent to maturity, if you compare that to fixed-interest – with ten-year bonds giving you 5.3 per cent – that’s pretty attractive.
“At the other end of the spectrum, if you look at Australand step-up preference shares, they’re trading at about $85, which gives a yield to maturity of about 21 per cent, including a decent running yield (cash yield on the current price) of more than 9 per cent, and some capital upside.”
Even further out on that spectrum, he says, is the Multiplex SITES step-up preference share, which has recovered from a price below $18 in March to be back above $75. “The SITES offer a cash running yield of nearly 7 per cent, but people are starting to price that as a step-up, so the yield to maturity that it represents has blown out dramatically, to close to 100 per cent,” says Wright.
Choosing from the six ASX-listed retail corporate bonds and the hybrid securities sector, Newcombe has put together three sample portfolios, one low-risk, one medium-risk and one high-risk, as shown in the table below. He says yields in the 5-9 per cent range are achievable in the low-risk category, with 9-12.5 per cent on offer with medium risk levels – and if an investor wants to use some of the price dislocations in the hybrids market to chase higher yields, there are some hybrid situations that “look worse than what they will probably turn out to be” – and they have yields that reflect that.
Another means of access to the kinds of corporate bonds not usually available to retail investors is through a bond fund, which will hold part of its portfolio in corporate bonds, or more specifically a fund created solely to give retail investors access to senior corporate bonds (bonds secured against the assets of the company). An example of this kind of fund is the Australian Masters Corporate Bond Fund No. 5, launched by Dixon Advisory. This fund offers access to a conservative portfolio of senior corporate bonds, both current and new issues, with a yield to maturity of about 8 per cent a year or higher, that mature no later than 31 December 2015. The third tranche of the Australian Masters Corporate Bond Fund No. 5 is open for investment until Thursday 17 December.
Top yielding bonds for Low, Medium and High Risk Investors, supplied by FIIG
Other articles in this week’s newsletter