The structured finance market has produced Australia's longest-dated non-government bond - a 20-year instrument which has been incorporated into the key UBS Warburg Australia corporate and composite bond indices and which, according to the banks supporting the transaction, could change investor habits in the wider market, encouraging them to lengthen the duration of their corporate credit portfolios.
The bond comprises one of three tranches on a A$687 million (US$393 million) issue for the Victorian Rail Trust Entity (Virtue Trust), a special purpose vehicle financing new rolling stock for National Express Group (Australia) Pty Ltd., a privately-owned rail and tram operator in and around Melbourne, Victoria. One of the deal's unusual features is its lack of core credit enhancements: the AAA ratings (from Standard & Poor's) are supported by recourse to the state government of Victoria.
Cashflows supporting the transaction come from leases on which the obligations of the lessees (NEG entities) are supported by the state government. Support during the construction phase comes from an AA-rated guarantee provided by Siemens Ltd. (Australia), which is supplying the rolling stock; and from AAA-rated performance bonds provided by Bayerische Landesbank Girozentrale.
The deal consists of A$192 million of fixed rate amortizing Class A1 notes with a March 15, 2010 maturity (the only tranche not eligible for inclusion in the UBS Warburg index); A$234 million of Class A2 fixed rate bullet notes maturing March 15, 2015; and A$253 million of Class A3 fixed rate bullet notes, maturing March 15, 2020.
The Structure
According to the investment banks involved - Deutsche Bank, Macquarie Bank and Westpac Banking Corp. as arrangers and lead managers, and UBS Warburg as co-manager (Macquarie also advised) - part of the proceeds will go towards an initial payment to Siemens and to finance establishment costs, with the rest placed on deposit in a guaranteed investment contract with Rabobank (the monies could also be invested in AAA/A1+ short-term securities).
Progress payments to Siemens will come out of the GIC, while further capital will be injected into the transaction by unnamed equity participants, who will retain the residual interest in the rolling stock. Money from the GIC will also be used to make coupon payments, and any investment income from it will be swapped to yield a fixed cash flow during the construction period.
Construction lasts five years, with the first items of rolling stock due within three years. As soon as a given piece of rolling stock has been certified and delivered, the relevant lease begins. There are two lessees, one for NEG's tram franchise in the suburb of Bayside, the other for a similar operation in Swanston. Should either default on its obligations, the state government is obliged to take its place.
In the information memorandum, the sponsoring banks argue that future cash flows from many infrastructure deals are "complicated and may be derived from a number of sources and may be contingent on a range of events. Virtue, on the other hand, derives virtually all of its cash flows from a single source that is not contingent - a lease stream directly supported by the State of Victoria."
Targeted to Investors Needs
The lease stream cash flows have been targeted to meet specific investor needs, principally as standard amortizing and bullet securities. The cash flows from the A2 and A3 notes will be collected in a redemption GIC and paid as a single bullet principal payment.
This helps to make the resulting standard fixed rate bonds eligible for inclusion in the indices. "Further, there is no refinancing risk when the notes reach maturity since all of the funds required to make the principal repayment will already be available in the GIC. There are very few bond issues, be they corporate, fixed-rate mortgages or structured deals that can make this claim," said the information memorandum.
In the event, the tranches were priced on the wide side of their marketed range at 32, 37 and 43 basis points over swap respectively. The deal was marketed at a difficult time, when the Australian curve was unusually flat. Despite this, the leads argued that it had priced better than some comparable corporate transactions. Although fewer investors participated than had been expected, the leads said the deal had been extensively pre-marketed and final placement had not been a problem.
Domestic Renaissance
Back in the home loan market, Interstar, one of the country's biggest non-bank wholesale home loan financiers, has reinforced the trend for large domestic issues with a $700 million mortgage-backed transaction. The deal, which is lead managed by Macquarie and co-managed by National Australia Bank, is the second-biggest to date locally, ranking after PUMA Finance's $750 million issue earlier this year, and brings to nearly $1.5 billion the amount issued by Interstar through its Millennium Trust, launched last November.
The domestic market is enjoying a renaissance, driven by the exercise of step-up-or-call options on many existing deals and the increasing skillfulness of issuers in fine-tuning deal structures to cater for specific investor requirements. According to one Macquarie executive, such expertise is essential in order to achieve significant deal volumes in the local market.
The transaction - called Millennium Series 2000-2 - consists of A$320 million of Class A2 floating rate notes with an average life of 1.43 years, callable on November 7, 2001; A$210 million of Class A3 FRNs with a 4.4 year average life, callable November 7, 2004; A$21 million of structured Class A3 notes with a 4.4 year average life, callable November 7, 2004; and A$100 million of Class A4 FRNs, callable November 20, 2004.
All Class A notes were rated AAA by S&P and Fitch IBCA, with the structured tranche rated AAAr by S&P. The deal also includes A$49 million of Class B FRNs with a 4.5 average life, callable November 7, 2004 and rated AA-minus.
The structured tranche features a coupon linked to an index specified by investors: a similar concept featured in one of the tranches on the Millennium Trust's inaugural A$400 million deal last November. The unusually close maturity dates of the Class A3 and A4 FRNs also reflect tailoring to suit investors' needs, said the Macquarie executive.
Pricing was 30 basis points over swap for the A2 FRNs, 44 over for the A3 FRNs and 70 over for the A4 FRNs. The pricing on the private A3 structured notes was undisclosed. There is also an unissued A1 tranche, of undisclosed size, which may be issued at a later date.
The pricing was regarded as "pretty good" by competitors, although the highly subordinated structure caused comment.
The A$49 million subordinated Class B notes comprised 7% of the transaction. According to Fitch, however, only 2.7% subordination was necessary to qualify for AAA. Interstar was said to have opted for over-subordination as protection against a possible ratings downgrade of one or more of the structure's five underlying mortgage insurers.
The over-subordination appeared capable of protecting the ratings against a two-notch insurer's downgrade. Some market participants questioned whether the expense of the excess subordination - estimated at around A$500,000 - was justified.
Macquarie Bank, which led the transaction, argued that it was, and that the cost was offset by better pricing on the senior tranches.
