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Basis swapped foreign issued AUD debt2004

Below is an interesting article explaining the mechanics of basis swapped foreign issued AUD debt (Kangaroo bonds), a concept discussed on this site in respect of the same NZD securities of foreign sovereigns, supranationals and government agencies - namely Eurokiwi and Uridashi issues.

The point of difference, other than currency and nomenclature, is the recent decision by the Reserve Bank of Australia  to decree that the majority of these issues are eligble as repo collateral for open market operation purposes, unlike the RBNZ. 

Among the perils of this type of structured finance, other than volatile currency swings associated with the isssuance and subsequent redemption cycles is the masking of indebtedness of large current account deficit nations such as Australia and New Zealand. Much is made of the high level of government surpluses and dwindling sovereign debt in both of these nations and yet their huge and rising international liabilities caused by yawning trade imbalances are being funded by foreign quasi government entities.
 
Prior to the development of intricate swap markets, the domestic central banks in these countries on behalf of their respective governments would have had to soak up the excess local currency credits, used to purchase imported goods, with the issuance of government bonds for foreign purchase, thereby exposing themselves to punitative credit risk downgrades. The previous reality of such cyclical stabilisers used to serve these nations well as headline grabbing interest rate increases brought about a return to sustainable demand growth. 
 
Substitution of domestic sovereign liabilities with non-reportable, repo eligible (Aust.), basis swapped issuance by the AAA rated World Bank agencies and other lookalike foriegn entities sustains the  funding of bulging trade deficits without the politically uncomfortable reality of interest rate hikes.

Article:

April 21 (Bloomberg) -- Citigroup Inc., the world's biggest financial services firm, and KfW Group, Germany's state-owned development bank, are among borrowers tapping Australia's bond market, taking advantage of a dearth of government bond sales.

Foreign borrowers have this year sold A$8.43 billion ($6.26 billion), or 64 percent, of the A$13.13 billion of company debt in Australia, up from 32 percent in 2003, data compiled by Bloomberg shows. Australia hasn't sold bonds since May 2002 and had an A$7.5 billion budget surplus in the year ended June 30.

Overseas issuers have saved as companies such as Melbourne Airport borrowed outside the country to access more buyers, said Mark Beardow at AMP Capital Investors in Sydney. The extra yield Australian-dollar corporate debt due in five to 10 years offers over similar-maturity government debt has shrunk to 88.9 basis points from 106.65 basis points in November 2002, Merrill Lynch & Co. data shows. A basis point is 0.01 percentage point.

Foreign sellers are making up for ``a lack of domestic corporate issuance,'' said Ky Van Tang, a bond manager for Aberdeen Asset Management Ltd. in Sydney. Tang said she bought debt sold last quarter by Travelers Insurance Co. Institutional Funding Ltd., a Citigroup unit, to include in the equivalent of $2.23 billion of bonds she manages.

Australia has slashed outstanding government debt by 57 percent to A$46 billion on March 31 from A$81 billion in June 1994, government figures show. Sales of so-called Kangaroo bonds, or Australian dollar-denominated debt issued by foreign companies, agencies and governments, increased outstanding debt to A$63 billion as of April 20 from A$47 billion a year prior, according to data compiled by Bloomberg.

`Looking for Diversification'

Last year, foreign borrowers sold A$7.35 billion. About 95 percent of overseas issuers selling debt in Australia this year were rated Aa3 and higher from Moody's Investors Service, according to Bloomberg data.

Citigroup sold A$1.5 billion of Kangaroo bonds, including A$1.15 billion of three- and five-year notes in February, the biggest Australian sale this year. Frankfurt-based KfW Group increased last month's sale by 20 percent to A$600 million. KfW has top AAA ratings from both Standard & Poor's and Moody's. Citigroup's Aa1 ranking from Moody's is one step lower, while S&P rates the New York-based bank a fourth-highest AA-.

``Investors are looking for diversification and so are we,'' Gerhard Lewark, KfW's Frankfurt-based treasurer, said in an interview. The company used swaps to protect against foreign- exchange and interest-rate risk, exchanging most of its Australian dollar proceeds for U.S. dollars, he said. KfW makes loans in euros as well as in dollars to fund projects such as telecommunications and transportation.

The bank's A$600 million of 5.5 percent October 2007 notes were sold March 10 to yield 32.5 basis points more than comparable maturity Australian government debt.

New Investors

Eighty-one percent of Citigroup's February sale, its first in Australian dollars, was sold to local fund managers, the company said.

``An Australian issue provided us with investors we would not see in the other currencies in which we borrow,'' Charles Wainhouse, the New York-based head of funding and Treasury at Citigroup, said in an e-mail response to questions.

Citigroup's A$750 million of 6 percent February 2009 notes yielded 67.7 basis points more than Australian government August 2008 debt as of April 19, compared with 65 basis points when they were sold.

Deficit Effect

Landwirtschaftliche Rentenbank, Germany's AAA rated refinancing agency for banks lending to farms and food producers, sold a total of A$1.35 billion of Australian dollar bonds in five sales during the first quarter.

Demand was good because ``the Australian government does not run deficits, so if that continues, there's a chance they will not have any debt,'' Stefan Goebel, co-head of funding and assets for Rentenbank said in an interview from Frankfurt.

Australia's government in December forecast surpluses through June 2005.

Like KfW, Rentenbank said it hedged against foreign-exchange swings by swapping Australian dollar proceeds into euros. Companies that borrow at floating rates protect themselves against rising interest rates by using so-called basis swaps to lock in Australian-dollar costs.

`Imbalance'

Swap dealers charge overseas borrowers less to protect their Australian-dollar bonds because the deals offset hedges for foreign sales by Australian companies, said John Lynam, head of capital markets research at Westpac Banking Corp., Australia's fourth-biggest lender.

``As a swap provider, you want to receive U.S. dollars and pay Australian dollars'' because of the ``imbalance'' from Australian companies selling bonds abroad, Sydney-based Lynam said.

Rentenbank's fixed-rate Australian dollar bonds were swapped into floating-rate euro-denominated debt, said Goebel.

Borrowers such as Rentenbank lowered interest costs as the currency swap widened in March to 13.75 basis points, from almost zero in November 2002. The swap was 11 basis points on April 20, allowing a borrower to save A$550,000 for every A$100 million of five-year bonds.

`Cheapest Funding'

Domestic bond sales by Australian companies have stagnated as companies tapped foreign markets. Australian borrowers are willing to pay 11 basis points to swap their obligations back into Australian dollars, said AMP's Beardow, who oversees the equivalent of $14.9 billion of bonds and cash.

Australian companies sold $11 billion of bonds outside the country in 2004, about 60 percent more than foreign borrowers sold in Australia, according to Bloomberg data. Melbourne Airport, a unit of Australia Pacific Airports Corp., said on April 7 it sold $175 million of seven-year bonds denominated in Australian dollars to U.S. investors.

Overseas borrowers ``go for the cheapest funding,'' said Roger Bridges, who bought some of Rentenbank's bonds for the $3.5 billion of debt he manages in Sydney at Tyndall Investment Management, a unit of Australia's second-biggest property and casualty insurer by premiums.

`Filled the Gap'

About half of the expected A$30 billion in bond issuance this year will come from foreign sellers, said Brad Scott, 39, head of corporate bond research at Citigroup in Sydney. Scott was voted the Australia's best credit analyst for the past four years, according to Insto, a local institutional investors' magazine.

Citigroup rose to become the No. 2 manager of Australian- dollar debt this year from No. 13 in 2003. Sydney-based Commonwealth Bank of Australia, which managed A$1.85 billion, was the top arranger.

``Investors have the cash, and offshore issuers have filled the gap,'' said James Alexander, 39, who manages A$12 billion of cash and debt securities at Alliance Capital Management Corp. in Melbourne. Alexander said he holds some of Herndon, Virginia- based National Rural Utilities Cooperative Finance Corp.'s Australian-dollar bonds, rated A2 by Moody's and A by S&P.


To contact the reporters on this story: Beth Thomas in Tokyo or bthomas1@bloomberg.net. To contact the editor of this story: Dan Moss at or dmoss@bloomberg.net.

 

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