Australia Corporate Loan Market
The Australia lending market is traditionally dominated by the big 4 Australian banks. Pre-GFC foreign banks and the securitization market took market share however the capital market options were eliminated during the subsequent credit crunch.
Recently following APRA’s tightening of bank capital requirements, non-bank lenders came back to the market, particularly in the real state asset back sector. However the total quantum of the capital deployed had minimal impact on the total market share of the major banks which still make up more than 70% of the total lending market.
The major Australian banks do lead syndicated loans which are loans which they originated and subsequently selldown to investors in the form of fixed income securities.
How do investors gain exposure to fixed income securities?
As the market is opening up to retail investors, it is still dominated by institutions which can be difficult for investors to gain a meaningful diversified exposure. There various avenues include:
Direct Investments: Owning fixed income directly – companies have been issuing debt directly and traded on the ASX.
Indirect Investments: Investing in credit funds which invests in corporate loans
The easiest and most liquid form is investing in fixed income ETFS. However there are specific risks in investing in credit ETFs as investors should be aware of the liquidity transformation the funds goes through where whilst investors can trade in and out of theses ETFs, the underlying loans are illquid and can mask the illiquidity risk of investing in bond ETFs.
Fixed Income Ratings
A large portion of the borrowers in the corporate loan market do not have credit ratings. Instead, lenders use their own proprietary credit rating models and underwrite the loans individually in line with global credit rating agency practices.
Typically this is in the form of establishing credit ratings for borrowers based on a sliding scale such as:
|AAA||The highest rating possible, typically associated with sovereign borrowers. Obligations are the highest quality, with the lowest level of credit risk.|
|AA||Only a slight difference to a ‘AAA’ rating. Obligations have very low credit risk with very strong capacity to meet financial commitments.|
|A||High credit quality and capacity for payment of financial commitments is still strong.|
|B||Moderate credit quality and capacity to pay financial commitments is satisfactory.|
Sub- Investment Grade
|BB||Higher vulnerability to credit risks and may face exposure to adverse business, financial or economic conditions.|
|B||Considered speculative and subject to material credit risks.|
Junk / High Yield
|CCC||Substantial credit risk and obligor is vulnerable to non-payment of financial commitments.|
|CC||Very high levels of credit risk and obligor is highly vulnerable to non-payment of financial commitments.|
|C||Exceptionally high levels of credit risk. Default is considered a near certainty.|
|D||Obligation is in default or breach.|
Type of Corporate Fixed Income Securities
Corporate loans are privately negotiated agreements between a lender and a borrower and can incorporate a range of features including:
- single or multiple of lenders (single, few or many);
- revolving facilities (a flexible loan structure that allows a borrower to draw down and to repay the loan on an ongoing basis);
- term (contracted loan term for repayment) (typically 3-5 years);
- single or multi-currency;
- use of proceeds (e.g. working capital, acquisition, capital expenditure, term funding requirements); and
- lender protections (security, covenants, performance reporting obligations).
Fees and interest charged on corporate loans follow market standard but most are bespoke based on
- the investment grade and quality of the borrower;
- market conditions; and
- structure and term of the loan.
The majority of corporate loans in the Australian market are fixed term (i.e 3 or 5 year terms) .
What is the difference between loans and bonds?
There are a number of notable differences between loans and bonds:
- loans often comprise a drawn and undrawn component, whereas bonds are typically fully drawn;
- loans are typically available to both rated and un-rated borrowers, whereas bonds are predominantly issued where the issuer has one or more credit ratings from the global credit rating agencies;
- loans are typically floating-rate instruments, whereas corporate bonds are typically fixed-rate instruments;
- a loan can be denominated in multiple different currencies, whereas bonds will typically be issued in only one currency; and
- loans are usually held by a bank to maturity and generally contain assignment restrictions on their transfer, whereas most bonds are often freely traded between investors.
Australia Corporate Loans
Loans are typically short to medium term maturity securities with 1, 3 or 5 year terms and are floating interest rates. If the borrower want to fix the interest rate they will enter to a swap contract with the bank to fix the base rate.
Loans once issued are held by banks until maturity and are no traded.
Australia Corporate Bonds
Corporate bonds unlike loans are issued and can be traded. typically terms are longer starting at 5 years and extend to up to 10 years.
They are originated by institutions (super funds, insurance companies or debt funds) or directly to retail investors.
Since they are issued securities the bonds can be traded however liquidity can be patchy during periods of market dislocation as Australian investors are well known to underweight bonds compared to global peers.
Types of Corporate Loans
Within the Corporate Lending space there are also types of loans. These can be simplified into:
Corporate Loans which are secured and lent against whole companies or subsidiaries of companies
Project Finance Loans which are loans secured against specific projects (LNG plan, mining project or solar farm)
Real Estate Loans which are loans secured against specific real estate assets (commercial properties or houses)
What is the difference between senior and subordinated loans?
A senior loan is when the borrower provides collateral which is secured against the facility and have rights from and first ranking priority to the cashflow. In the event of default, the lender’s recourse is against the borrower but the security first and foremost can be sold off to repay the loan.
Senior loan given its protected position on the capital stack earns a lower rate of return because the value of the collateral is usually higher than the total amount lent.
A subordinate or mezzanine loan is behind the senior debt where senior ranking debt and generally carry higher interest rates as they carry a higher risk of not being paid where the borrower is insolvent and there is senior debt in place.
In addition, a higher form of debt is high yield debt which sits further below on the capital stack behind senior and subordinate tranches. The returns are higher to compensate the risk but they are usually the highest risk tranche in debt stack. High yield bonds still rank ahead of equity.