Retailer bond batlle

Latest weekly column for Business Spectator...

Retailer bond battle - Business Spectator

Australia’s top retailers are not only squaring up to do battle on in the hardware front. Woolworths and Wesfarmers may be due for a face off in the corporate bond market.

The global financial crisis wiped some of the world's pre-eminent financial institutions off the planet and decimated the savings of millions. Some things however changed for the better, especially if you’re involved in buying, selling or arranging Aussie corporate bond deals (or writing about them for that matter).

Two years ago, bankers pitching the merits of the corporate bond market were politely ushered out of the offices of various corporate treasuries. Now, as this week has shown, even the highest and mightiest of our corporates are rolling out the red carpet.

“What has happened is that treasurers have said ‘We need an alternative source of funding. We can no longer just rely on the bank’. In the future, any company that is big enough to get a rating and has a borrowing requirement is going to have some sort of strategy that involves access to the capital markets,” says Gary Jenkins, head of fixed income research Evolution Securities in London.

“I’m not saying they all will access capital markets but they will have to at least consider it, and that’s very different to where we were even five years ago,” he adds.

While an appreciation of the corporate bond market was immediate for European and the US treasurers, Australian companies have dragged their heels to some extent.

With relatively strong balance sheets and attractive loan options being offered up by Asian banks, Australian corporates did not feel the same urgency as their offshore peers to issue bonds. There was some take up with a trickle of moderately sized deals from Tabcorp, CFS, Dexus and Leighton before Swiss cement maker Holcim’s $500 million bond issue showed the keenness of investors to support AUD corporate bond issues.

This week has seen a new phase in the local market’s growth spurt. For the first time in years, Australian bond investors are seeing the names that they desire, rather than the ones they merely tolerate, show an interest in the corporate bond market.

In the coming weeks, investment grade firms Wesfarmers and Woolworths plan to update debt investors. The meetings are not officially deal related but they are likely to be a signal of intention to issue notes at some stage in the future.

Wesfarmers recent experiences in the local bond market have been colourful. An unpopular decision not to redeem the Coles bonds in 2007 following the takeover got a number of large fund managers offside. The company however has since maintained a regular dialogue with investors and once the apologies were made, talk shifted to its diversified revenue sources, the progress of the Coles turnaround, and of course bond pricing.

Woolworths has always been at the top of bond fund managers’ shopping lists. A well managed, defensive and dominant household name, it meets all the criteria for a good fixed income investment. Unfortunately, a local bond issue hasn’t always been top of Woolworths’ priority list. Rumours are that the retailer was all set to go on a domestic bond issue earlier in the year but the terms of an Asian syndicated loan proved too attractive.

Flush with cash from the pockets of Australian consumers, in addition to its drawn funds from Asian lenders, Woolworths appeared uninterested in a bond deal, until now. The ‘A-‘ rated company, which has again reaffirmed a commitment to its credit rating, should see its bonds fly off the shelf should it choose to issue.

Other companies are also showing interest. With the stress of earnings season out the way, arranging banks are said to be inundated with requests from treasurers eager to either establish or consolidate their presence in the bond market. Mirvac and CFS have already held bondholder presentations while Stockland has explicitly stated its intentions to access the local bond market.

For all its potential however, the Australian corporate bond market does have its limitations.

Westfield is another name, whose paper local fundies would love to own. The property trust has always favoured offshore bond deals and this week’s dual tranche USD issue vindicated their faith in the depth of the US 144a market. Within 24 hours of releasing its annual earnings, it was able to launch and execute a $US2 billion bond offer of six and 10 year duration, inside of price guidance. Such a quick fire debt raising is unlikely to have been achievable in the local format.

The domestic corporate bond market might be some way off supporting Westfield’s high expectations, but the new found confidence in the local market, coupled with a desire from corporations to demonstrate access to alternative debt funding, bodes well for Australia’s corporate bond industry.

Bank to the future

This is article forms part of the cover feature for the July/August edition of Insto magazine. We examined the future of Australian banking from a variety of angles and created a cheesy move poster cover to get the point across that banking was going 'back to the future'.

http://www.insto.com.au/story/feature/001019/bank-future

Insto surveyed analysts and bankers on their views for the future. Their collective opinion is that a rear vision mirror will be more productive than a crystal ball, as Jonathan Shapiro explains.


The banks that go back to basics will prosper in the 2010s.

"I know not with what weapons World War III will be fought, but World War IV will be fought with sticks and stones," Albert Einstein once said. We’ll probably never know if he was right, but the prediction has rung true for global banking. The annihilation inflicted by highly complex structured products to once mighty institutions has left the industry unable to dabble in anything other than centuries old vanilla banking.

So, after the first decade of the 21st century, is the sector in retreat? And what does the future hold for Australian banks, which for the large part withstood the credit crunch? Insto’s special survey on the future of banking explores the outlook for the region’s banks from a number of angles.

A strong focus on old fashioned banking, or customer loans, was a key reason for the limited impact of credit crisis in the region. This focus looks set to continue. The way our banks do business, and the customers they seek will not change. What will be different is how they attract money. Conservative funding will prevail for years to come, restraining returns for shareholders as leverage is reduced.

But opportunities are there for Asian and Australian banks. They will develop new ways, independent of existing European and US models, to develop technologies, seek growth opportunities and service their customers.

The local regulators attained national hero status for their proactive approach to overseeing the banking system, but they can’t afford to rest on their laurels. In a globally connected world they will have to ensure that our policies still hold up after a wave of regulatory change has washed through the developed world. Regulators will also have to find the delicate balance between ensuring our four pillars stand firm and giving the next tier of local institutions a fair go.

Who will banks hire to take them into the brave new world? Banks will still attract the best and brightest but they will be enticed by the promise of stability rather than the prospect of bonuses and stock options. And it will be a person with a specific focus rather than Mr Multipurpose that banks will desire. This is the bank of the future.

Traditional is the new chic

By luck or design, a focus on age-old business products helped Australia’s banks avoid many of the massive losses their global peers suffered. What the crisis has changed, possibly forever, is the way banks fund themselves.

“For many years going into the crisis, the liquidity levels of the banking industry were not a great area of focus. That’s going to be a lasting legacy, particularly because Australian banks have a reasonably high reliance on deposit funding,” says James Ellis, Credit Suisse’s banking analyst.

“Banks have increased their focus on deposit gathering and looked to reduce their reliance on short-term funding. At the same time, capital levels have been increased significantly. While this is to some extent a function of the times, I think that even once markets settle down leverage levels will remain comfortably above pre-crisis levels,” adds Tim Roche, an associate director at Fitch Ratings.

This reduction in leverage through increased capital, and the need to hold lower yielding but more liquid assets will hurt profitability.

“All things would point to return on equity coming under some pressure. The question is: what’s the sustainable ROE using cross-cycle assumptions? Going forward, cross cycle assumptions might mean that bad debts will be higher, system credit growth won’t be as strong and liquidity might be permanently more expensive,” says Ellis.

Shareholders could eventually force banks to shed their risk aversion.

“How long this continues will depend on shareholders. They are likely to be tolerant to ultra conservative behaviour for short periods of time but as competing banks take on more risk and chase yield others may be obliged to follow suit,” says Sharad Jain, a credit analyst for Standard and Poor’s.

Guaranteed to reach its use-by date

The government’s guarantee scheme was a hastily introduced at the height of the crisis, to prevent a flight of capital away from the banks. The wholesale debt component is likely to be phased out.

‘The government guarantee for deposits and wholesale funding in its current form is unlikely to be a permanent feature of the banking system, although it will probably take a while for it to be unwound,’ says Roche.

Sharad of S&P agrees. “It is most likely to be a coordinated winding down in consultation with the governments of other G-20 countries, and after the global financial markets have sufficiently stabilized,” he says.

The guarantee scheme on deposits will stay, bringing it in line with other developed nations’ deposit insurance schemes.

“Australia was fairly unique in that it’s had no deposit insurance mechanism in place amongst the developed world. The one thing I can see potentially being changed is the current cap of $1 million, which is relatively high in a global context. A global benchmark is more like $50,000 to $100,000,” says Ellis.

Lending for more than interest

Corporate lending has been a source of pain for Australia’s banks. They’ll be demanding more than additional yield from their big ticket clients.

“Banks don’t want to do just straight lending; particularly as risk-adjusted returns are not very attractive there. I think there are more banks trying to get a greater share of wallet from institutional customers, which they are providing loan facilities to,” says Ellis.

“Because the banks have got liquidity in capital from which to provide lending they’ve used that to get additional collateral business to make a more profitable customer relationship,” he says.

The credit crunch exposed the shortcomings of some of the major banks’ wholesale operations. ANZ spent 2008 dealing with damaging fallout from their “hobby businesses” such as private equity and margin lending. Westpac and CBA had mixed success with intentions to build or improve on their equities distribution businesses and NAB took heavy hits on assets in its structured credit conduits.

“Basically they were going down the path of the ‘originate, warehouse and distribute’ models so it will be interesting to see whether they revisit that model again, because there’s been a substantial pull-back from it,” says Ellis.

It’s AA all the way

Australian banks might be cleaner and leaner but they still face challenges. While S&P has enough confidence to reaffirm the coveted AA stamp on the major banks, they see three potential risks that would lead them to downgrade the banks’ credit ratings:

the banks’ losses could be underestimated;

another disruption to wholesale funding markets could leave the banks once again struggling for funding; and the banks may shed their risk aversion through acquisitions or other strategies.

It’s been a close-run race at times, but our banks pulled through, and what didn’t kill them has made them stronger.

Covenant Chaos - Private Equity and the Aussie Corporate Bond market

This article was awarded the 2007 Citigroup Business Journalism Award for Financial Markets. 

My trusted editor, Phil suggested I submit an article for consideration and we were both invited to attend the function at Citigroup's offices in Sydney. On the night neither of us were in the mood after a busy day, but I thought at least one of us should represent Insto. The night, as it turned out , was a treat, good food,good wine, good company, and entertaining speeches. When the category awards were being announced, I was horrified to hear that the winner of the Financial Markets category covered the exact same subject matter as I did.. until I heard my name! My stunned reaction even prompted the MC to ask if he had made a mistake. 

The article was hardly riveting but the judges' comments were that I livened up the dull subject matter of bond covenants, which are nothing more than 'terms and conditions'.  

It was a extremely proud and satisfying moment , but I did feel humbled in the company of other winners - brilliant and seasoned business journalists Barry Dunstan, Gilles Parkinson and Stuart Washington (Stuart was not actually there on the night). It was a confidence boost for me but I knew that I still had a very long way to go before I could consider myself to be in their league. 

Published link

Citigroup Awards link

Private equity’s raid on Coles Myer has served as a wake up call to Australian corporates, and is set to have a lasting effect on Australia’s debt markets. LATE ON AUGUST 17 Coles Myer confirmed rumours that a private equity consortium had made an offer of A$17.3 billon for the company. The following day Coles Myer shareholders saw their fortunes climb. In the credit world, however, panic set in. Cash spreads on Coles 2012 notes blew out. Credit default spreads on Coles also spiralled from 30 points to 100 points. A private equity takeover, the market assumed, would place a heavy debt burden on the company and severely devalue existing debt. But by afternoon the 2012 cash spreads were back where they had started. Investors had spent the day mulling over their documents and reconfirmed that the notes did benefit from extensive covenant protection, including a change of control clause and a financial leverage test. A takeover would have limited impact on the value of the Coles 2012 notes. The covenants had worked. Bondholders could breathe easier, but the market was clearly spooked. That investors could witness one of Australia’s iconic corporations being gobbled up by PE raiders – and their bonds buried under a pile of junk – was not only possible but a probable scenario. Promises, promises A covenant, put simply, is a promise; a commitment to do or not do something and a legal undertaking to comply. “In the case of issued securities, covenants are provided to investors by issuers to ensure they maintain an adequate financial position to meet debt service obligations,” says Craig Saalman, credit strategist at ABN AMRO. This can be achieved in a number ways. Covenant protection ranges in terms of content financial ratios that need to be maintained to behavioural undertakings that ensure bondholders are treated in a certain way. Other operating covenants can be provided to protect investors and banks from a material deterioration in the operating profile of the business or issuer. Covenant protection is a standard feature in the bank loan market with bank creditors demanding financial and operating covenants. They are less common in the corporate bond market, but in an environment where all of corporate Australia is a takeover target, and the risks of noteholders falling down the pecking order are greater, this looks set to change. Takeover protection Covenants protect investors from adverse occurrences that result in the reduction of their ability to service their debt. There are a number of ways corporate credit can be affected, but the most likely trigger is when the company is a target of a takeover. Takeovers, of course, can be good or bad for bondholders. For instance, the AA rated retail giant Walmart has been linked to an offer for Coles, rated BBB. Such a takeover would significantly increase Coles’ ability to service its existing debt. If Coles did fall victim to a leveraged buyout, the opposite would occur. An LBO typically results in a highly leveraged final entity. As there is a high likelihood of a deterioration of credit risk, the value of the outstanding notes would fall. “For Coles, depending on who the final purchaser is, you have an extreme set of outcomes for the credit profile of the company,” says Sarah Percy Dove, head of credit research markets at ANZ Investment Bank. The value of the Coles 2012 notes, however, have stood firm following early jitters but other corporate credits remain dangerously exposed. Australia uncovered In a market where companies have been able to raise cheap money in easy conditions, Australian corporate bond issuance has flourished. As a result additional concessions have taken a back seat; Australian bonds have typically not had strong covenants. “It fell out of favour as liquidity and demand increased,” says Steve Adamek, credit analyst at AllianceBernstein. The irrelevance of covenant protection has been compounded by a market of highly rated issuers. “Because it’s an investment grade market, they are less of a facet,” says Percy-Dove. And the security of covenant protection has served little purpose as investors boldly hunt for yield in a benign credit environment. “On the one hand investors may be well aware that covenants are poor and don’t provide good protection but on the other hand they still want to be in the chase to get hold of decent assets,” said Robin Miller, investment manager at Member’s Equity. “It’s been hard for people to step out of the market and take the highly principled position of not buying because of poor covenants. There has not been a coordinated response from bond market investors,” he explained. “You could put it down to group complacency and unwillingness to give up yield,” adds Percy-Dove. “Investors may have to built a cross for their own back which they will have to wear.” For investors, it has been a time for reflection. As Andrew McLachlan, credit analyst, Perennial Investment Partners, points out, benign credit markets have led investors to be more relaxed on covenants when they should have been paying more attention. “Ironically these are times of higher risk in some ways for investors as the risk of M&A activity, and the possibility of lower ratings attendant with this, is heightened. " Barbarians at the Barbie In offshore markets, where LBO activity is in full swing, investors have been demanding covenants for some time. “Compared with Europe and the US, Australian bond holders are typically less protected by financial and operating covenants,” says Craig Saalman of ABN AMRO. Many Australian issuers that have accessed other markets are well aware of this. Telstra’s outstanding Eurobonds for instance, carry a 25 basis point step up for each ratings downgrade. “We have been relatively insulated from the other trends that have been detrimental to bondholders. The risks have become quite distant on a lot of these things over time,” says Percy-Dove. But private equity and LBOs have arrived in Australia. The barbarians are at the barbie; and the same risks that scalded European and US investors are now becoming prevalent in Australia’s credit market. “Now they seem a little closer to home and a little more real,“ adds Percy-Dove. But investors may be forgiven for being caught off guard. An LBO for a company the size of Coles Myer has not been done in this market. A successful bid would make it the seventh largest private equity deal in history. The threat, however, has well and truly captured the market’s attention now with corporate credit spreads reacting to takeover talk. “The arrival of large private equity bids to these shores is one of the landmark developments we have seen in these credit markets in recent times,” says Chris Viol, head of fixed income credit analysis, Australia & NZ at Citigroup. “The fear has gripped other names including Fosters, Suncorp Metway, Amcor and Telecom New Zealand, with the market failing to differentiate between trade and financial buyers and the likelihood of an eventual bid succeeding,” says Saalman. Viol believes ‘the local leverage clock’ may now tick faster as more corporates examine their capital structures, and that there will be more covenant-related questions asked in corporate roadshows primarily regarding corporate protection. The effects are already being seen. Mirvac, a recent issuer into the market, incorporated a change of control clause because of investor concerns. The covenant protects investors from an event that results in over 50 per cent of the company changing hands and the notes falling to below investment grade. Transurban, the first major corporate to visit the market since the Coles announcement, has also ensured that investor’s demands were met by adding extensive covenants to its five year issue. “In some respects, issuers need the covenant to maintain market price and to maintain where they expected to issue. They have had to give it away,” says Percy- Dove. Origin Energy, the integrated utilities company, is another recent issuer that faced questions from investors on covenant protection. The notes did benefit from financial covenant protection in the form of gearing and interest cover ratios that need to be maintained. Broken promises Investors are not only asking for covenants but questioning the effectiveness of covenants themselves. Are these promises worth the paper they are drafted on? AllianceBernstein’s Adamek is sceptical. “Generally they are either so far from actuals as to be meaningless, for ratio controls, or poorly thought through leaving obvious gaps in structure and definitions,” he says. Saalman agrees: “Material Adverse Change (MAC) clauses are most often vaguely defined which leaves bond investors in a quandary with issuers.” For Adamek the issue is not with the poorly construed covenants themselves, but in the market’s ability to come to terms with pricing and valuing covenant protection. “An investment grade bond can overnight become a sub-investment grade credit on the consummation of an LBO. This type of risk is difficult to quantify and price at time of issuance,“ says Saalman. But if issuers do give up spread to investors in place of protection, does this adequately compensate investors? “Some pressure over the last month is seeing spreads in general moving out. But to date, issuers have not seen any pricing benefit for giving covenants,” adds Adamek. “Investors are not being compensated for the underlying credit risk let alone event driven risk,” says Percy-Dove. Covenant crazy LBO Mania has arrived but it might not be appropriate for Australia to go covenant crazy. Viol agrees and many of the LBOs being touted will not eventuate. “We don’t think investors should get too carried away. We would be amazed if there were more than two major completed LBOs in our local CDS/bond universe by the middle of next year,” he said. There will be speculation and scares though which creates trading opportunities in the CDS and bond markets. Also as Saalman points out, many credits in the market are unlikely to ever fall within the private equity radar. “Because of their market caps and business profiles, some issuers, for example trading banks, kangaroos and corporate names like BHP will be spared these demands (for greater covenant offerings),” he said. Lazy balance sheets While issuers and investors come to terms with covenants, there is a larger issue at hand. The arrival of private equity looks set to shake up corporate Australia and change the profile of its debt capital markets. “We see PE interest in Coles as a precedent event in local credit markets, and it’s our view that as a knock-on effect, the local leverage clock could well start to tick faster,” says Viol. One of the appeals of many of Australia’s corporates is their ‘lazy balance sheets’. Companies that have not fully utilised their capacity to take on debt financing have become attractive targets because of the amount of leverage they can withstand. This creates another puzzle for investors: the better the credit quality of the company, the more vulnerable it may be to a takeover. Credit risk and event risk can be on opposite sides of the coin. Covenant protection may be more relevant where it appears not be. “Ironically, there are times when you can accept the risk of weak covenants in a highly leverage business more so than for a high quality name with a lazy balance sheet. It has probably been easier to advance the need for good covenants to the treasurer of a marginal investment grade borrower than to an apparently stronger business. Sometimes people may have been looking for strong covenant standards in the wrong places,” said Miller. “There will be other boards and corporates revisiting their capital structures,” says Viol. “As our equity guys point out, if local corporates don’t gear their capital structures efficiently, private equity will be quite happy to do it for them. “ Australia Gas Light (AGL) has acted with this in mind. “They have effectively LBO’d themselves when they have moved from A to BBB flat because if they didn’t do it there was a high likelihood that someone else would,” says Percy-Dove. Aussie Corporate Bond Covenant Checklist A list of 23 Australian corporate credits, their takeover and acquisition potential and the covenants they have in place. Many of the notes benefit from ‘negative pledges’ which prevent subordination of the notes. Information provided by Westpac Institutional Bank’s capital markets research team. (Michael Phillip, head of capital markets research and David Goodman, analyst) Company Takeover Potential* Acquisition Potential* Change of Control Covenants Notes AGL/Alinta (BBB/Baa2) Medium High No No Amcor (BBB/Baa1) High Low Yes No Hybrid notes have change of control provision which allows notes to be converted to shares if 50 per cent of shares are acquired. AMP (A/A3) Medium Low No No Negative pledge CCA (A-/A3) Low Medium No No CFS Retail Property Trust (A) Low Medium No Yes Financial covenants – total liabilities/total tangible assets (tta), interest cover, priority debt/ tta ratios Coles (BBB/Baa2) High Medium Yes Yes Change of control review event -two thirds majority can demand repayment in the event of inability to agree to new terms with the issuer. Financial covenants- secured lending/ tta, limiting secured lending and fixed charge cover ratios. CSR (BBB+/Baa1) Low Medium No No Negative pledge DBRREEF (BBB+) Low High No Yes Financial covenants - gearing, interest cover, priority debt/tta Fairfax (BBB) High High Yes No Change of control and asset sale. If 40 per cent of shares are sold and ratings falls below BBB- ,notes can be redeemed at par. Foster’s (BBB/Baa2) High Low No No Negative pledge GPT (BBB+) Low Medium No Yes Total borrowings must remain less than or equal to 25 per cent of authorised investments. Investa (BBB+) High Medium No Yes Financial covenants - total debt/tta; interest cover, priority debt/tta , total net worth. PBL (A-/A3) Low High No No Negative pledge. Qantas (BBB+/Baa1) Low Low No No Santos (BBB+) Low Medium No No Negative pledge Stockland (A-) Low Medium No Yes Financial covenants; total liabilitites/ tta, interest cover, priority debt/assets Suncorp (A/A2) High Low No No Negative pledge Tabcorp (BBB+) Low Medium No No Negative pledge TCNZ (A/A2) Medium Low No No Negative pledge Telstra (A/A2) Low High No No 2008 notes do have covenants (step ups for ratings downgrades) therefore trade tighter to other Telstra notes Wesfarmers (A-) Low High No No Negative pledge WestfieldTrust (A-) Low Medium No No Negative pledge Woolworths (A-/A3) Medium Medium No No Negative pledge Poison pill While issuers may be reluctant to issue covenants, they could potentially be used to ward off unwelcome suitors. By adding covenants that compensate noteholders, the issuer can create additional expenses for the acquirer. This is known in M&A lingo as a ‘poison pill’, which the buyer must effectively swallow. “I still think short-termism prevails. The treasurer gets most of his brownie points from basis points rather than constructing barriers of protection,” said an observer on why covenants are unlikely to appear in this form. There could be other reasons. One observer suggested that a takeover is “not the worst thing” for senior management, who may receive payouts and be able to exercise share options. Also under ASIC regulations, certain actions that could be regarded as inhibiting a takeover must be brought to their attention. In this case, issuers may prefer a looser covenant package if it results in less difficulty. Asian attraction As private equity coffers continue to amass cash, the region is attracting the attention of the some of the industry’s big guns. “Asia generally is emerging as a region of interest. Locally we have stable political, economic and regulatory regimes, and in many industries we have duopoly or oligopoly type concentrated industries that are attractive,” said Viol from Citigroup. Australian credit is sliding. The average credit rating has transitioned from a high A to the cusp of low BBB. The threat of LBOs, as much as LBOs themselves, look set to accelerate the process. “You can expect the credit quality of corporate Australia to continue to decline. Potentially it’s going to open up a high yield market,” says ANZ’s Percy-Dove. Corporate Australia and its lenders are now facing a world they had not contemplated before August 17.

Distressed for Success - Opportunity in dislocated markets

As the ‘Goldilocks era of global credit draws to an abrupt close, distressed debt funds, and private equity, are forming a line to pick up the pieces. Jonathan Shapiro reports. They’re known in some circle as vultures, ready to feed off the remains of faltering companies. To others, they’re knights, guiding damsels out of danger to live once again. Regardless of how they are perceived, there’s plenty of skin in the game for distressed debt funds. Distressed debt is not for the feint hearted. While the rewards are lucrative, the risks are high, and skills, experience and knowledge are required to avert disaster. A distressed debt security can be loosely defined as a bond or loan that trades below 80 per cent of par value or at a spread above 1000 basis points over government securities. Distressed debt is more of an investment strategy than an asset class. Once a security deteriorates to the extent that it becomes distressed, and existing debt holders head to the exits, opportunities are created. It’s a highly complex game that remains the domain of dedicated and specialist distressed funds, hedge funds, private equity houses and specialist teams within private investment banks. “What constitutes ‘distressed’ is a very broad range of situations from straight liquidations to refinancing and even to the extent of contributing equity value,” says Tod Macri, managing director of the strategic investments group at Deutsche Bank in Hong Kong. Distressed debt is regarded as part of an “event driven” investment strategy in which a passive or an active approach can be taken. On the active side investment can be “controlled” or “non-controlled”. “Distressed investors could assume a degree of control of the company and restructure it to turn a profit. It’s more of the private equity approach,” says Urs Alder, , head of institutional sales, Man Investments Australia. (remainder of article not available) .

Big Boys & toys - Asset Finance takes off

It was once the “grubby” end of banking, but as globalisation brings economies closer, banks are seeing opportunities in asset finance, writes Jonathan Shapiro.

Every day thousands of ships, planes, trucks and trains keep the economy ticking by moving people and goods around the world.

Under the ground, earth moving machinery extracts resources which are then placed on trains and trucks and transported to ports.

On the seas, 50,000 ships carry 650 billion tonnes of goods. In the air, 72.7 million flights move 4.5 billion passengers and 85.6 million tonnes of cargo each year.

Underlying the hundreds of carriages, tankers, jets and drills is an intricate system of financing that is growing ever more important. Welcome to the world of asset finance.

Asset finance focuses on movable assets. If it can be unbolted, boxed and sent somewhere else, it falls into asset finance. Asset finance often overlaps with project or infrastructure finance but it’s the financing of trains, rather than the railway system, the aircraft rather than the airport.

“Our portfolio is quite diverse… major mobile mining equipment , exposure in passenger and freight rolling stock, ships, commercial aircraft, a good range of diversified and manufacturing equipment,” said Nick Fletcher of the CBA.

Fletcher heads up CBA’s asset based finance team of 35, which looks to structure and fund asset finance transactions for a range of clients.

In a typical asset finance transaction, the bank lends to the owner, who enters into an operating lease agreement with the user for a term – usually five to seven years. The rentals paid to the owner by the user pays down the debt, but only to a residual value.

The user has access to an asset without having to own the asset and hold it on its balance sheet, the financier earns the rental income and the difference between the residual value and the realised value and the bank or lender earns the interest on the debt, backed by a real asset.

Financing moveable objects has its nuances.

“It takes a blended view on both the credit covenant needing to establish serviceability for lease or rental payments as well as forming a critical view of the security the underlying asset provides in terms of resale or reuse,” said Fletcher. Historically, the role of an asset finance team was to optimise tax and accounting laws that can technically be operated anywhere.

(remainder of article not available) 

New Dimensions in Credit - the rapid growth of credit derivatives

This article, written in April 2007 explored the rapid growth of credit derivatives. Little did we know the damage these products would unleash! 

Credit derivatives continue to transform the credit world and open up new dimensions for fund managers, banks and speculators. Jonathan Shapiro reports.

It has been over a decade since the wonder-kids of JPMorgan dreamt up the notion of credit derivatives.

A group within the bank’s global derivatives department assembled in Boca Raton to brainstorm the next big thing in their field.

High on the agenda was the idea of creating securities to insure against the risk of a credit default. For the bank, it would allow them to manage the risk of its portfolio of loans and bonds, and for investors, if the price was right, it provided a healthy return.

Today the global market for credit derivatives is worth over US$26 trillion and still growing at breakneck pace. ‘‘The recent global growth in CDS has been dramatic with CDS outstandings now dwarfing bonds,” said Chris Viol, head of credit analysis, Citigroup.

The CDS universe

The most common form of credit derivatives is a credit default swap. A CDS is quite simply an insurance contract whereby one party - ‘a buyer of protection’ agrees pay another party - ‘a seller of protection’ a premium in exchange for cover if a borrower defaults on a debt obligation.

In many respects, a CDS resembles a bond exposure; the seller of protection who receives the premium is ‘long’ the credit while the buyer of protection, who pays the premium is ‘short’ the credit.

The price of a CDS is quoted by a basis point spread, which just like a bond spread widens as the credit is perceived to weaken and tighten as it strengthens. If a company’s credit worsens the CDS spread which reflects the price of insurance will rise and will increase the value of an existing contract. If the credit improves, the price of insurance will decrease and the value of an existing contract will fall.

(remainder of article not available) 

The Death of the Bookmaker -Betfair arrives in Australia

The bookmaker is dead, again
As the arrival of the online betting exchange threatens the TAB monopoly, will it also bring about the end of the bookmaker?

‘I’m living the dream’ says Nathan Snow, revelling in the manic tension of his first Melbourne cup as a bookmaker. The sleaves of his blue shirt are folded up neatly to reveal his slight elbows. The blend of adrenalin and anxiety beams from his wide blue eyes.

He is on his mobile phone, scribbling numbers on a paper, punching keys onto a small pad, scratching the back of his head, climbing up onto the podium and climbing back down again. He darts into the crowd, and hastily returns, followed reluctantly by his stiff red necktie.

Across the Randwick pavilion, veteran bookie Bill Waterhouse stands calmly by his board, hands behind his back, surveying his kingdom. Between them are a swelling mass of eager punters, and a full two generations.

The dream of 24 year old Snow and the legacy of 83 year old Waterhouse is under threat. The Tasmanian government has broken ranks with its mainland counterparts by granting the online betting exchange - Betfair, a license to legally operate in the state. Freedom of trade across state borders dictates that punters across nation will then be free to use Betfair.

It is a move that will dismantle a state established ‘tote’ monopoly and alter the Australian racing industry forever.

‘There’s a lot of scaremongering going on, I suspect the Tasmanian government has been worked on quite a bit’ says Greg Fraser a market analyst at SHAW stockbroking that has been following the fortunes of Betfair.

During its brief history, the online betting exchange has turned the betting world on its head, garnered the praise of her majesty the queen, and the infuriated Australian racing authorities. It’s a name the bet-crazy Australian public will be hearing more often.

The UK based Betfair can justly claim that it has revolutionised wagering. On Betfair.com punters bet against each other and not the bookmaker. Betfair’s complex systems match up buyers and sellers in an online marketplace with all gains and loses distributed between punters.

It makes its cut by charging a small commission for its service. The online innovation, that eliminates the bookmaker, and discounts the totes attracts hundreds of thousands of clients and turns over 50 million dollars a week.

Betfair and its sleek new market friendly wagering platform openly threatened the status quo. Its first marketing exercise, in 2000, was to march an actor placed in a coffin though the streets of London. ‘The death of the traditional bookmaker’ – proclaimed the accompanying banner.

Since then Betfair has done untold damage to UK bookies, slashing the takings of the established trinity of corporate bookmaking houses.

Last year Betfair turned its attention to Australia, and local versions of the bookmaker obituary were being redrafted.

“There were always fears for the future of bookmakers. Indeed, when my father started he felt it was just a short stint, as there was a new invention, the Totalisator, which was feared to be the death knell of bookmaking.” wrote Bill Waterhouse earlier this year.

The totalisator was in its original form a bizarre contraption invented almost 100 years ago by the son of a minister, who wanted to use science to give punters a fairer shot. His system, which tallied up bets, adjusted prices and paid out the winners was gradually modernized. In the 1960’s it was adopted by State governments in the form of the TABs to bring wagering under control.

The racing industry flourished as The TABs poured a sizeable percentage of their massive revenues back into the racing industry. When off-site betting was legalised in the mid 1980’s the TABs boomed, and the bookies began to feel the pinch.

The ‘dedicated’ punter now no longer needed to go to track and run the gauntlet of bookmakers. A good deal were culled. In 1985 NSW had 1500 registered bookmakers. Twenty years later only 300 exist in the state.

In 1992 the state governments set about privatising the TABs. As part of the process, competition was restricted but TABs now had to feed a new mouth – that of the shareholder. The state imposed dominance facilitated an increase in ‘takes’ – the commission charged by the TABs for facilitating the bet.

‘These agreements were essentially put in place to deal with the free rider problem’ explains Robert Raeher, the economist that was comissioned by the Australian Racing Board to investigate the effects of betting exchanges on the racing agency and government revenue. He explains that they ensure the racing industry is sustained from the revenue gained by the TABs from bets placed on its events.

‘The arrangement is an unholy alliance of racing bodies set up to pick the pocket of punters” says Bill Saunders, a veteran horse breeder and editor of the Virtual Form guide, a popular racing website. ‘They feel- We’re entitled to be paid a lot of money from people that lose on our sport’.

Then along came Betfair, who saw Australia as the perfect location to replicate its operational hub in London, and gain better access to a market of eager punters. The online exchange also made an alliance of its own when Kerry Packer’s PBL corporation took a 50% stake in the Australian operation. Its next step was to convince the state governments to grant them a license to operate.

The bookmakers may have been concerned but the TABs, and the racing industry heads who had flourished from TAB revenues, were terrified. They could not prevent Australians from logging on to Betfair to place their bets but they could hamper their progress by lobbying state governments not to grant them the license they needed to legitimately operate and promote their presence.

Their case against Betfair centred on the ability of the punter to essentially bet for a horse to lose by accepting a bet from another party who believes the horse will win. A privilege previously only given to bookmakers, who were licensed to accept bets.

"Betting exchanges ... will almost certainly invite corruption, conspiracy and in the extreme, criminal behaviour," says the NSW TAB. "Insiders can manipulate the odds, mislead the market and deceive punters. This could totally devastate the wagering industry."

James Packer the PBL chairman, not surprisingly saw things differently. He would ‘back the integrity of the Australian public over the bookmaker any day’.

One by one the state governments rejected Betfair, siding with the powerful racing industry lobby.

It seemed that they had seen off the Betfair invasion.

Tasmania was the only state that had yet to turn Betfair away. The battle moved across the Tasman, and the intensity was turned up. The premier -Paul Lennon would now determine the future of Australian wagering.
Victorian premier Steve Bracks was ‘not happy’ and openly opposed ‘the internet system’. Tasmania was accused of exploiting the racing industry.

"Tasmania is bludging off the rest of Australia by allowing Betfair to make money out of racing in other states while returning nothing to the racing industry," says Robert Schwatren, Queenslands racing minister.

Lennon remained defiant. Two days after the Melbourne Cup, he announced that his cabinet would approve Betfair’s request for a wagering license. Betfair would invest $50 million in building a second global headquarters in Hobart and would and distribute 15% of its racing revenues from back into Tasmanian racing.

"This is providing choice and opportunity for the people who keep racing alive in the country – punters. This is the best deal that punters could have - more competition in the marketplace.” he said after the announcement.

The bookmakers scuffle with shrewd punters and champion horses takes place on a daily basis. The threat of technological innovation always looms in the background.

Saunders thinks the bookies may finally be beaten.

‘They’ve got to get with it. They’re a great curiosity, but in terms of matching bets, they can’t afford to do what they do. Standing on their little stands by their boards with bags of money, it’s about the most inefficient way to run a book’

The rookie bookmaker is feeling the pinch -‘Betfair is grossly unfair for us, I have to pay stand fees, for the board, and wages – they don’t have any of these costs” says Nathan Snow.

‘But we’re not going anywhere, All the information that’s traded on Betfair comes from the course, we’ll always be a part of racing’

In all the madness, greed and fear of the Betfair saga, few seem to have asked why it is that Australia loves a punt.

‘It’s fundamental to the Australian psyche’ says Fraser.

Snow agrees, ‘It’s such a part of our culture’.

‘Betfair is not for everyone’ says Saunders. An avid computer programmer, who developed software to monitor horse breeding, he admits that he initially found the complexity of Betfair baffling.

‘I heard most of the users are actually stockbrokers’ says Snow.

The Betfair experience is hardly enthralling. ‘It’s tedious to spend your Saturday arvo in front of the screen watching price changes. ‘The process is pretty anti-social, its the exact opposite of going down to the pub with your mates, having a few beers and a bet’ says Saunders

And nothing beats the track - The hats, the champagne, the majestic horses, and of course the curious bookmakers. On Melbourne Cup day the glamour, revel and enchantment of victory reaches fever pitch. Snow loves it -‘It’s the best office in the world’. He ain’t going anywhere.