Debt Market Update – Q1 2019

Debt Market Update

Q1 2019

AUSTRALIAN DOMESTIC BANK DEBT MARKET

There was a 6.7% increase in Australian syndicated loan Key themes volume for the first calendar quarter of 2019 from the previous period (on a 12 month rolling basis) to US$94.5 billion. This • Market conditions – Continued volatility with was driven by an increase in the average transaction size in mounting pressure for RBA action in 2019 Q1 2019 to the highest levels since Q2 2015.

• Australian bank debt market – refinances Figure 2: Australian syndicated loan volume (US$bn) comprise majority of volume with average transaction size the largest since Q2 2015 140 120 250 • Offshore bank debt funding – strong appetite 100 200 for Australian corporate debt from offshore 80 150 banks – in particular Asian-based banks 60 100 • Australian domestic bond market – quietest 40 50 Q1 period since 2016, partly attributable to the 20 influx of private debt capital allowing borrowers 0 0 to directly access capital long-term debt capital markets investors. LTM Volume (LHS) Quarterly Volume (LHS) No. of deals, LTM basis (RHS) • USPP – marginally higher recent volumes from Source: Loan Connector (data extracted May 2019) and KPMG Analysis Australia and NZ, however remains lower than prior 12 months Notable syndicated transactions for the quarter included:

• Amcor Ltd refinanced US$4.5 billion ahead of its proposed merger with the US-based Bemis Co. over tenors of 3, 4 and 5 years. MARKET CONDITIONS • Qantas Airways Ltd increased its three tranche The first quarter of 2019 saw heighted global market volatility refinancing to A$1.33 billion from the original A$1.18 in the midst of geopolitical developments, including the US- billion under a general syndication involving 36 banks. China trade war and the Brexit process. In response, market Pricing ranged from 105 to 115 basis points with the participants showed escalating caution relating to the outlook revolving debt facility basing margins on the company’s for debt markets. This was highlighted in early March with the Moody’s corporate credit rating of Baa2. US Federal Reserve abandoning its plans for further interest rate hikes after three years of tightening monetary policy, as • Metcash Trading Ltd went to market for a multi-tranche the US economy showed signs of weakening. facility comprising tenors of 3, 4 and 5 years with margins tied to their senior leverage grid. Initial margins for the Domestically, weaker Q1 inflation data continues to place facilities are 145, 160 and 175 basis points respectively. pressure on the RBA to reduce the cash rate further to assist in stabilising the housing sector and return inflation levels to • IX Infrastructure Pty Ltd, a special purpose vehicle of within the target range of 2–3%. Keppel Infrastructure Trust, has raised $607 million to assist with the acquisition of Ixom Group, which is a leading infrastructure group in Australia and New Zealand.

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• Canadian investment firm Brookfield Capital Partners’ is Whilst total loan volumes increased by a moderate level of seeking to raise A$2.15 billion as part of its planned $4.35 19.4% in Q1 2019 (on a LTM basis), the majority of key billion acquisition of Healthscope Limited via its SPV, VIG sectors were either flat or lower. Real Estate and Utilities fell Bidco Pty Ltd. Seven underwriting banks are seeking by 22.5% and 35.1% respectively over 1Q 2019, however commitments from banks after launching a senior issuance levels remain robust and these falls reflect a syndication in early March with initial talk on margins of reversion in line with historical levels. 400 bps. Figure 3: Australian syndicated loan volume, LTM by The domestic M&A market has produced a healthy flow of sector (US$bn) event-driven financings so far this year, as acquisition lending increased to US$3.69 billion from just US$818 million in 1Q 24 2018. Australian M&A lending is set to rise further in the 20 second quarter, particularly for leverage buyout financing. This 16 is evidenced with several large public to private buyouts currently in the pipeline, examples of which include 12

Healthscope, accounting and business software services 8 business MYOB Group Ltd and UK Forecourt operator EG Group. 4 - Whilst the domestic M&A market has seen a strong resurgence in 1Q 2019, syndicated lending in APAC (ex. Japan) fell to its lowest quarterly result in seven years with Mining, Oil & Gas Financial services total loans of US$76.4 billion in the first quarter. Utilities Real estate and construction Services & business services Transport Source: Loan Connector (May 2019)

Source: Loan Connector (data extracted May 2019) and KPMG Analysis Table 2: Notable syndicated loan transactions

Tranche The domestic lending market continues to show growing Tenor Margin Borrower Date amount (years) (bps) market share by foreign banks. Figure 4 below shows the (A$m) growth in total residential assets (i.e. those assets domiciled 150 3 145 in Australia) held by foreign banks by region since Q1 2014. Metcash Trading Mar-19 200 4 160 Ltd Asian banks continue to be the fastest growing institutions, 100 5 175 increasing levels of deployed capital into the Australian 500 4 105 market by 75.5% over the past 5 years and 6.7% in Q1 2019 Qantas Airways Mar-19 325 6 115 alone. Comparatively, domestic banks (inclusive of all Ltd registered ADIs / Mutuals) have grown Australian residential 500 5 115 assets by 23.9% and 0.9% over the corresponding periods. Lendlease 400 160 Mar-19 5 Group 100 165 Figure 4: Total Residential Assets held by Foreign Banks

25 5 225 500 IX Infrastructure Mar-19 50 5 225 450 Pty Ltd 400 532.4 5 225 350 750 USD 3 112.5 300 1500 USD 4 125 250 Amcor Ltd Mar-19 200 750 USD 3 125 150 A$ billions 1500 USD 5 125 100 50 360 5 400 - VIG Bidco Pty 100 5 425 Mar-19 Ltd 1440 5 425 Q12014 Q22014 Q32014 Q42014 Q12015 Q22015 Q32015 Q42015 Q12016 Q22016 Q32016 Q42016 Q12017 Q22017 Q32017 Q42017 Q12018 Q22018 Q32018 Q42018 Q12019

250 5 400 Asia USA & Canada Europe MYOB Group Mar-19 486 USD 7 400 Source: APRA (data extracted May 2019) and KPMG Analysis Ltd 116 7 162.5 Origin Energy ltd Feb-19 410 7 155 20 7 120

Source: Loan Connector & Debtwire (data extracted May 2019), KPMG Analysis

DOMESTIC BANK LANDSCAPE Transactions during 1Q 2019 featured both domestic and international issuers. Examples of notable transactions Australian major banks have experienced a continued decline included: in aggregate cash profits for 1H 2019. This has been driven largely by slowed lending growth and margin compression in • ConnectEast Finance (Baa2), the operator of Melbourne’s combination with increased levels of delinquencies in a softer EastLink printed a seven-year $250m domestic deal at a domestic economy. In addition, legal fees and remediation margin of 150 basis points with CBA and NAB acting as works relating to the Financial Services Royal Commission lead managers. has also materially impacted profitability. • Stockland Trust Management, one of Australia’s largest Major Banks have continued to allocate a greater proportion diversified property groups, tapped the domestic bond of their spending towards risk and compliance, comprising market with a five-year fixed A$200 million issuance almost 40 percent of investment expenditure for 1H 2019. priced at 158 basis points with a fixed coupon of 3.30%. Faced with growing competition from non-bank lenders and new entrants, the major banks will need to balance this • McDonald’s Corporation has launched is inaugural investment profile with digitalisation and innovation to Australian Dollar-denominated benchmark transaction maintain market share and deliver an enhanced customer with a jumbo multi-tranche offering totalling A$1.4 billion. experience. The offering included five-year fixed and floating rate notes at margins of 113 basis points and 7.5 and 10-year AUSTRALIAN DOMESTIC BOND MARKET notes at pricing of 140 and 158 basis points respectively. ANZ, Mizuho and Westpac acted as lead managers for The first quarter of 2019 was the quietest Q1 period since the transaction. 2016, with AUD corporate volumes totalling A$1.94 billion, marking a decrease of 11.7% and 35.9% on 2018 and 2017 Source: KangaNews (data extracted May 2019) and KPMG Analysis figures respectively. As a result of this, the 12 month rolling volume for Q1 2019 was the lowest recorded since Q4 2016. Notable corporate bond transactions and relevant terms are Despite this, the total corporate volume was marginally higher presented in Table 3. than Q4 2018. Table 3: Notable corporate bond transactions

Figure 4: A$ corporate bond market (A$bn) Tenor Amoun Margin Borrower / Rating Date (Years t ($m) (bps) Qtly Vol LTM Vol ) 20 15-Mar- ConnectEast - Baa2 A$250 7 150 16 19

12 Mercedes-Benz - 14-Mar- A$150 3 88 A/A2/A- 19 8 Stockland Trust 14-Mar- A$200 5 158 4 Management - A-/A3 19

Incitec Pivot - 08-Mar- A$450 7 240 0 BBB/Baa2 19 McDonald's - 26-Feb- A$300 5 113 BBB+/Baa1 19 Source: Bloomberg (data extracted May 2019) and KPMG Analysis Note: Excludes Financials and Government Source: KangaNews (data extracted May 2019) and KPMG Analysis

The reduced borrower appetite for longer dated issuances is There was a slight decrease in implied margins for 1Q 2019, likely a function of the borrowers achieving their target with the margin on ‘A’ and ‘BBB’-rated corporate issuances weighted average maturity profile. The higher volumes in for 5-year tenors falling from 95 to 85 basis points and 128 to 2018 and 2019 were reflective of a switch from shorter dated 121 basis points respectively. With margins still relatively bank facilities to longer dated funding. compressed, credit conditions and liquidity levels remain An additional factor is that relative pricing in the USPP market favourable for borrowers. continues to be more attractive than the Australian bond market. In addition, the traditional bond market is being increasingly disrupted by the strong appetite from non-bank alternative lenders driving a direct private placement market.

Figure 5: Australian corporate bond 5yr spread to US PRIVATE PLACEMENT MARKET A$ swap (bps) Australian and New Zealand (Aus & NZ) issuers in the USPP market recorded a marginal increase in Q1 2019, with AA A BBB 350 US$1.97 billion of issuances for Q1 2019 which represented an increase of 15.4% from Q4 2018 levels. On a 12 month 300 rolling basis, Aus & NZ issuances fell by 14.1% for Q1 2019 250 relative to Q1 2018. A total of five Aus & NZ borrowers utilised 200 this alternative pool of capital across tenors of 10 – 20 years, 150 demonstrating the substantial appetite of USPP investors for 100 Australian credit. 50 For the USPP Market as a whole, issuances totalled US$12.7 0 billion for 1Q 2019, with Aus & NZ comprising 15.6% of this Dec… Dec… Dec… Dec… Dec… Dec… Dec… Dec… Dec… volume. On a rolling 12 month basis, issuance volumes for Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 Jun-18 the Global USPP market has continued to grow year-on-year Source: Bloomberg (data extracted May 2019), KPMG Analysis at an average 12.1%. Whilst the investment grade corporate bond market Figure 6: USPP Q1 2019 volume percent by country continues to demonstrate liquidity, the non-investment grade corporate bond market has recently featured two transactions 4.4% where a loss of capital is anticipated for investors. Both 6.4% USA Mackay Sugar and ASX-listed Axsesstoday are currently facing restructures or administration filings, reigniting Australia & concerns within the trustee industry about litigation risks from 19.5% NZ providing services to issuers of notes, bonds and debentures. UK 54.2% Source: Australian Financial Review, 2019 Canada 15.6% AUSTRALIAN DOMESTIC PRIVATE PLACEMENTS Other

Australian corporate funding has long been dominated by bank funding; a key structural difference to the European and US markets which typically source a large portion of debt Source: Private Placement Monitor (data extracted May 2019), KPMG analysis capital from other sources (i.e. public markets and private debt providers). Some notable recent transactions completed by Aus & NZ issuers in 1H19 include: Recently however, the growth in appetite and flexibility from the non-bank financiers has seen a number of Australian • Origin Energy Ltd (NAIC-2) tapped the USPP market corporates reviewing their funding platforms to create a more securing US$275m, across 10-year bullets at 225 basis diversified lending group and maturity profile. This is leading points. Origin Energy is an energy retailer in Australia to greater optionality for borrowers to tap private debt across electricity, gas and LPG. The transaction marked providers for AUD denominated from superannuation funds, Origin’s latest activity since tapping the USPP market in US Pension funds and private credit funds. This shift is being late in 2018 for a total of US$250m. driven by relatively low and flat yield curves, falling margins • Mirvac Group (NAIC-1) raised at total of US$600m across on longer-dated tenors and greater flexibility in documenting tenors ranging from 11 to 15 years at margins of 145 longer dated facilities. This is consistent with KPMG’s basis points to 166 basis points. Mirvac is an integrated, experience, having assisted a number of borrowers with diversified Australian property group comprising an executing alternative financing strategies over the past 18 investment portfolio and a development business. months. With the prospect of rate decreases in the cash rate of up to 50 basis points 2019 we expect fixed interest and • Australia Pacific LNG Co (APLNG) conducted a placement credit investors continue to chase yield from in corporate via JP Morgan. Rated NAIC-2, APLNG operates a coal credit market. seam gas to LNG project in Queensland. This represented the company’s second USPP deal, having previously issued in August 2018. The new issuance was sized at US$600m with an average tenor of 9.7 years and priced at a margin of 220 basis points.

Figure 7: USPP volumes and NAIC-2 pricing (bps (RHS) Following the release of the Royal Commission findings, and and US$bn equivalent (LHS)) in the face of potentially softening economy and property market, we expect Australian banks to maintain their tighter 25 270 credit standards for some time.

20 240 Despite the market sentiment, the domestic bank continues

15 210 to market remains competitive, with strong appetite for quality credits from alternative lenders and offshore banks 10 180 providing ongoing competition to the Big 4 banks. US$ bn 5 150

- 120

Volume (All ex-Aust.) Volume (Aust. & NZ)

7 year 10 year

15 year

Source: Private Placement Monitor (data extracted May 2019), KPMG analysis

OUTLOOK

In the face of heighted economic volatility largely driven by factors such as US / China tariffs, Brexit and political changes in Europe, market participants are becoming increasingly concerned about the outlook for the global economy. Credit spreads for companies in the US and Europe have begun to increase which signals a market shift in response to more challenging credit conditions.

According to Moody’s, global corporate credit spreads have widened over the past 12 months to March with spreads across all tenors increasing. Highlighted below are the median credit spreads over US Treasuries for ‘Baa’ rated borrowers. However, with base rates continuing to be at record lows in the Australian market, debt remains incredibly cheap money for borrowers.

Mar-18 Mar-19 Duration Baa Baa Change >=1 and < 3 92 101 9 >=3 and < 5 103 138 35 >=5 and < 7 122 184 62 >=7 171 210 39

Source: Moody’s Investor Services Inc. (data extracted May 2019)

Central bank policy is at the forefront of market scrutiny as investors closely monitor decisions influencing the cash rate. The RBA have continued to hold the cash rate at 1.5% at the May meeting, despite a steadily widening spread becoming evident with market-based pricing levels. The RBA’s hand may be forced in the short-term however, in order to address weakening macroeconomic indicators. With inflation lower than expected in 1H 2019, the likelihood of one or more rate cuts in 2019 has only increased, with ANZ recently joining Westpac and NAB in forecasting two rate cuts this calendar year.

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Scott Mesley David Heathcote Partner Partner Head of Debt Advisory, Australia Global Head of Debt Advisory Melbourne Sydney P: +61 3 9288 6748 P: +61 2 9335 7193

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