An individual in Europe can walk into a local bank and buy a corporate bond for the equivalent of only $1000. In some countries, investing in bonds issued by major companies is as natural and as simple as investing in a term deposit.

In Australia that’s not so much the case. The domestic corporate bond market is, in many respects, quite underdeveloped. That is slowly changing, however, as a combination of factors come together to spur its development.

Download the full In Focus feature – The name is bond…corporate bond – here.

Steve Lambert (pictured), executive general manager of debt markets for National Australia Bank (NAB), says it’s valid to say the domestic corporate bond market, as distinct from the overall Australian bond market, has some way to go to match its global counterparts in both depth and breadth.

“The Australian bond market is actually fairly deep, and fairly developed,” Lambert says.

“It has its own challenges – the broader bond market has challenges – mainly related to asset allocation, because Australians generally like equity and property more.

“So that’s the bond market in a generic sense. But there’s three classes of issuers: governments, both domestically and offshore; there’s financial institutions, which means the big [Australian] banks but also means foreign banks; and then you’ve got corporates.

“Relative to other markets offshore, the percentage issued by corporates is smaller than these other two segments. It still exists, but it’s just not big relative to the others.”

Lambert says that when corporations think about raising debt, historically the bank market has been “very, very effective”.

“For most corporates, historically they would just borrow money from banks,” he says.

“Many corporates are not rated in Australia, and it’s only in relatively recent years that options exist for non-rated companies, and one of those big options for non-rated companies is an offshore market called the US private placement market. There are some alternatives, but the main alternative has historically been overseas, not necessarily in Australia.”

At the end of the day, when a company seeks to raise capital, it only has two fundamental choices: equity, or debt.

David Carruthers, head of core and redit, global fixed income, for AMP Capital, says a company will carefully assess its “overall weighted average cost of capital”.

“Depending on the type of corporate, you’re paying in the teens for cost of equity, and in the corporate bond market you get an after-tax cost-of-debt benefit,” Carruthers says.

“That’s why it’s quite attractive to have a mix of both.

“As a shareholder you would prefer the company not to continue to raise equity, because you’re diluting your existing shareholder base. They’ll tend to look at the mix of the two. A corporate treasurer, when they’re looking at the balance sheet if they’re rated AA, A or BBB, they’ve got to make sure they stay within certain financial covenants, because if they raise too much debt they will start to put too much pressure on their rating, which will mean their average cost of debt will go up over time. So there’s this constant balancing act between equity holders and debt holders.”

How the market will grow

Australia needs a more robust corporate bond market for the benefit of both investors and the issuers of bonds, and there’s also a national interest aspect to that need, says Professor Deborah Ralston, executive director of the Australian Centre for Financial Studies (ACFS), and Professor of Finance at Monash University.

“If you look at the Australian debt markets, they are very skewed towards bank credit, and the danger of that is one reason we need to offer more diversified sources of debt finance for companies,” Ralston says.

“Secondly, on the other side of the ledger, it provides a more diverse range of investments for investors.”

But the market is not as robust as it could be, or needs to be.

“It tends to be fairly thinly traded, and I think almost everyone would acknowledge that it’s a fledgling bond market,” Ralston says.

“One of the things in a paper we’ve published is from a PhD study looking at firms and whether they raise debt through loan syndication or through the bond market, and it shows that corporates in Australia are very much more inclined to raise debt through their banks, through syndicated loans, than they are through the bond market.

“Therefore it’s not a particularly liquid market at the present time. And if corporates can’t achieve the debt funding that they might wish to achieve, that’s an impediment to economic growth and the national interest.”

Ralston says sophisticated financial markets offer a range of sources of funding for the different needs of business. Australia has lacked that range of sources, and after the global financial crisis, companies found it difficult to borrow from banks.

Ralston says there will be a natural growth in the corporate bond market.

“The research we’ve seen indicates that one of the biggest impediments to more firms achieving funding through the bond market is that they tend not to have a credit rating,” she says.

“Organisations that want to make sure they have diversified sources of funding would need to have a credit rating – that would greatly increase the number of people going to the market for debt funding through the bond market.

“The other impediment would be just [getting companies to recognise] that diverse funding sources reduce the financial risk of an organisation. There’s a good reason to look at more diverse sources.”

Download the full In Focus feature – The name is bond…corporate bond – here.





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