Australia's embryonic high-yield bond business is growing fast thanks to burgeoning demand from yield-starved wealthy individuals - a trend that may be loosening up the nation's conservative debt market.
Two factors are driving the surge in high-yield issuance: Higher capital costs which mean banks are now less willing to lend to riskier unrated companies, and low interest rates globally pushing investors to take on more risk to get decent returns.
In the past 18 months, seven firms sold a combined A$1.5 billion ($1.39 billion) in local high-yield debt, up from zero just two years ago, ThomsonReuters data shows.
Besides Qantas (QAN.AX), which lost its investment-grade rating earlier this year, most borrowers are small unrated businesses and are new to the bond market.
Including offshore issuance, outstanding Australian high-yield debt has leapt 10 times to a record $20 billion, according to estimates by Moody's Investor Services, from just $2 billion in 2010.
"This is the biggest development in the Australian fixed-income market and should broaden funding alternatives to borrowers," said Augusto Medeiros, a credit analyst at Deutsche Bank.
While Australia's sub-investment grade market is tiny compared to the United States' $1.5 trillion and Europe's 400 billion euros ($528.04 billion), more supply is on the horizon.
"We have a pipeline of around A$1 billion," said Mark Paton, chief executive officer of fixed-income brokerage firm FIIG Securities.
FIIG recently started originating bonds, having completed nine unrated transactions since 2012 with yields from 6.5 percent to 9.5 percent.
Paton said the firm has nine more issues in the pipeline, including a A$60 million payment-in-kind (PIK) securities issue with an all-up return of 18 percent.
PIK notes are a high-risk instrument that allows the borrower to repay lenders with more debt rather than cash in times of crisis.
PIK notes are rare in Australia but were popular in the United States and Europe before the global financial crisis and are slowly re-emerging as investors seek higher returns in a low-yield environment.
National Australia Bank (NAB.AX), the nation's largest lender, will also bring on more transactions this year. It made its high yield-debut in June with a A$60 million unrated bond issue for data center company NextDC (NXT.AX).
"(Domestic demand) has picked up this year and my expectation is that next year we'll see larger deal sizes with a higher frequency," said Steve Lambert, executive general manager of debt markets at NAB.
CHANGING TIMES
High-yield bonds have been rare in Australia partly because of a lack of investors, namely big hedge funds, and because banks had traditionally been fairly willing to extend cheap loans.
More stringent bank regulations in the wake of the global financial crisis has made it more expensive for banks to lend to small unrated companies, so banks are now less willing to do so.
A new investor group of high net-worth individuals, who have available net assets of more than A$2.5 million, are taking up where the banks left off.
Frustrated with yields below 2 percent thanks to ultra-loose monetary policies in the developed world, these investors are taking on more risk to boost their returns.
High net-worth individuals are common investors in Asia's high-yield bond issues, but are a new feature in the Australian high-yield market.
Traditional fund managers are also investing in riskier debt, which suggests the emergence of high-yield debt issuance could be a lasting phenomenon.
Perpetual Ltd, for example, which manages about A$5 billion in fixed-income assets, earlier this year hired a high-yield credit specialist - a rarity in Australia.
Michael Korber, Perpetual's head of credit and fixed income, expects the firm's sub-investment grade fund to reach A$500 million in a few years, from A$150 million currently.
So far, 80 percent of the assets, which include loans, unrated bonds and subordinated tranches of mortgage-backed debt, are sourced from Australia.
(1 US dollar = 1.0758 Australian dollar)
(1 US dollar = 0.7575 euro)
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