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In this Q&A Mark Todd, director of Fixed Income at NAB, gives a rundown on the investment opportunities in the burgeoning corporate bonds market.
Newsletter
Opportunities in the corporate bond market: Part 2
15 September 2014
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16 minute read
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**This article has been prepared for education and information purposes and does not constitute financial product advice.**
How do returns on corporate bonds compare with other securities?
Well-known bonds such as Lend Lease and Coles can offer returns of 4-5%, while other ASX listed companies ranked lower in the ASX 300 might pay 6-8%. It’s a question of what funding avenues are available for the organisation issuing the bond. We have issued a bond called NEXTDC which had an 8% coupon and 1% increase in value per annum to the bond.
How does the issue of the bond affect the investor?
Large corporations such as NAB can issue into the global markets and are really well supported but as I move down the ASX 300 the capacity to access those international markets becomes harder. A lot of that’s to do with the size of the company, the issue it wants to do and the natural investor base on the company register. For instance, NEXTDC issued $60 million dollars in bonds. In international markets, this isn’t a big bond issue but that becomes attractive to some investors as it’s a smaller issue not crowded out by institutional money. Organisations, such as Telstra and other top 10 Australian corporates, can issue globally. Then you move down into different issuers meeting different investor bases. The less well-known a company is, the smaller the investor base and issuers want to expand their investor base through the use of the debt market.
How can investors assess risk in an issuer?
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This comes back to the capital structure. The first thing to consider is where you would sit in the capital structure in the event of a wind up. The investor should look at the underlying assets of the company because it all comes back to the likelihood of the investor being paid out. Try and ascertain the likely access to assets if the bond doesn’t get paid out.
Things for the investor to consider include:
• The covenants of the bond, i.e., what protections are embedded in the structure that the issuer has agreed to so that the investor has some protection.
• If I’m invested in the senior part of the company, what’s the negative pledge? How many senior bonds can the company issue? How many bonds rank above me? How indebted can the company get? Also, what will the company want to use the money for? Can they compensate themselves with an asset sale? Where do I rank in the payment structure?
• Investors should also look at where the company sits in its own sector. Is it a dominant player? Is it a small player? Where is it sitting at a corporate level? Understand more about the bond itself before deciding if those organisations can make money. Also ask, what are you lending money against before considering the corporate vision.
Why does NAB assist with the issuance of corporate bonds?
NAB, as a regulated ADI, is involved in the process of de-risking banking in Australia; the changes to Basel III are an example. NAB needs to assist in the funding of Australia’s corporates and one way this is evolving is by bringing our corporate banking sector to our natural investor base. We have extensive wealth channels and numerous clients who have funds. The banks will “arrange” the issuance of these securities by taking our corporate clients to our lenders and putting the two together. This has been driven by structural changes implemented through the transition into the Basel III banking environment.
What are some advantages of investing in corporate bonds over equities?
I think you should have a mix of equities and bonds because they play two different roles. The equities are your growth engines; they’re supposed to expand in capital value, increasing over time. Bonds are less volatile and play a different role, providing coupons and consistent earnings. So if in the investment cycle you are looking for a less volatile experience and more consistent earnings – and the data shows that as we age we are getting more conservative – bonds become assets that are attractive to the investor. When you think of the way in which the Australian equity market works, the big dividend payers such as the four banks, Telstra and Wesfarmers, are really well supported because they are consistently paying the same dividend. You could see them as ‘bond-like’ equities. There is a great demand for them in the Australian investor base and so the bond market provides that same consistent earnings, less volatility, pays bills and your equity provides the growth engine for your retirement.
What’s the difference between a wholesale issue and a retail issue of corporate bonds?
One aspect is the level of disclosure and documentation. The regulator and the respective issuers are looking to protect the investor. I regularly mention that the government wants to protect the investor from themselves, but it’s more nuanced than that. That’s not to say that retail investors are not intellectually up to it, it’s just that as these new markets evolve, the government is taking steps to make people aware of whether these are appropriate assets in their circumstances. As the market expands, it’s best to err on the side of caution. A sophisticated investor is a recognised term describing investors who meet specific requirements. The issuers objective is to make sure they are issuing bonds to people sophisticated enough to understand things like capital structure, covenants and who take the time to educate themselves on the offering.
How can investors access corporate bonds?
I think investors should develop trust relationships with their advisor, broker or accountant. Clients of the NAB can buy bonds directly from the NAB after opening up a custodial account. The NAB private wealth bankers will be able to facilitate opening an account.
For clients who utilise the services of brokers, advisors or accountants it is important to get as much information and education as possible before making the decision to invest.
What sorts of incidental costs are associated with bonds?
The start-up costs are borne by the bank, it’s just like opening up a bank account. You open a custodial account; begin a relationship with the bank finding what bonds are available. This is something provided as part of their normal course of business . Most clients who come to NAB are buying new issues and in those circumstances NAB charges an origination fee to issue bonds. The company issuing the bond pays that fee. In the secondary market, it’s a question of at what level we can buy and sell so we’ll try and get you the best price available in the market for our clients. We are compensated by clients when we provide superior pricing on a regular basis.
There will be a fee but that fee structure is starting to evolve; and as volumes increase costs will reduce
How is the secondary bond market evolving in Australia?
The secondary market will evolve over time enabling clients to buy and sell bonds in various markets. One of the things to think about is how that will unfold and how that is being driven in part by the government. The government has tabled the Simple Bond Legislation, which aims to make bonds available to the retail market via the Australian Stock Exchange and possibly other exchanges. The Simple Bond Legislation will give corporates the opportunity to come into the market and issue bonds in the way they would have previously done in the equity market, something that is groundbreaking. Once the legislation has passed everyone who is an adviser to clients will probably need to know something of what’s happening because the government and banks like NAB will be heavily marketing the change in legislation. I see this as a major event and expect it to roll out for the remainder of 2014 and into 2015. The legislation formalises the bond market to some extent and identifies the government’s goal. We really need this. It’s not just funding Australia’s corporates; it’s also providing opportunities for the Australian investor base to fund Australian corporates and getting the appropriate return.
Disclaimer
The information contained herein has been prepared by National Australia Bank Limited (ABN 12 004 044 937, AFSL 230686) (“NAB”). The information does not constitute, in any jurisdiction, a recommendation, invitation, offer, or solicitation or inducement to buy or sell any financial instrument or product, or to engage in or refrain from engaging in any transaction. It is not the intention of NAB to create legal relations on the basis of the information contained herein. No part of this document may be reproduced, copied or distributed without the prior permission of NAB. All material presented in this document, unless specifically indicated otherwise, is under copyright to NAB.
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