Australian miners head for high-yield bonds

Debt addiction was the curse that brought down the global house in 2008-2009, but now the same impulse is helping to fuel a worldwide resurgence in mineral resources.

Australian miners of all sizes have caught on to the trend. Not only are they the prime beneficiaries of Asian growth as China's demand for commodities continues, they are using low interest rates in the US to cheapen their financing costs.

Conditions in the high-yield bond market have been extremely favourable as low rates on US government bonds have compelled investors to seek higher fixed-income returns on lower-rated corporate bonds.

The return to such funding in the mining sector has been gathering pace. The biggest player started the ball rolling when BHP Billiton took a US$45 billion (Dh165.27bn) bank loan to cover its bid for the Canadian fertiliser giant PotashCorp.

This was followed by Fortescue Metals's fully subscribed $2.05bn high-yield bond issue last October.

Having watched the bigger players enjoy so much easy debt demand, the mid-tier and junior miners have moved into the arena.

Last February, Midwest Vanadium raised $335 million of project debt, followed a month later when the mining equipment company Boart Longyear raised $300m in 10-year notes.

With Australian and overseas banks still holding back on lending for riskier projects - especially those by unrated companies - the high-yield market, which has proved to be so resilient over the past two years, is the easiest means to finance projects.

Fortescue's bonds were priced to yield 7 per cent but performed strongly in the secondary market, forcing the yield down to 6.1 per cent by the time the issue was launched.

While this shows market perception of the company's credit risk has improved, investors realise the bonds remained attractively priced. The Fortescue bond offered a margin 5.75 percentage points higher than US government bonds.

Fortescue does not carry an investment-grade credit rating. It is rated "B" by Standard & Poor's, "B1" by Moody's Investors Service, and several notches higher at "BB plus" by Fitch Ratings, which began providing a rating in October.

Deutsche Bank's local head of capital markets, Diane Raposio, says Fortescue realised there was barely any new paper in the metals and mining space.

High-yield investors could thus have exposure to commodities and/or the China boom that has previously been unavailable.

Last year, about $275bn of non-investment grade bonds have been sold in the US market. The next new thing is creating synthetic junk bonds that enable investors access to the US junk bond market without owning the underlying securities.

The instruments, created by using credit derivatives on junk bond or high-yield indexes, resemble transactions linked to US mortgages that proliferated before the financial crisis.

Nobody needs reminding of the synthetic mortgage-backed collateralised debt obligations that initiated the crisis, but they may need prompting to recall synthetic junk bonds have been around before.

They were known as collateralised bond obligations, which blew up after corporate defaults unexpectedly soared when the telecommunications bubble burst in the early 2000s.

This is not to say that Australia's miners, or for that matter mining companies anywhere, are heading for widespread defaults but the risks are always there.

The country's miners here are looking to lift minerals investment to $76bn in 2011-2012 from $34bn in 2009-2010.

Committed spending in minerals and energy projects already hit a record $132.9bn at the end of October, a rise of nearly a quarter on the previous six months. This is tipped to hit a record when March half-year figures are released.

Given the rise of hard commodities markets and the commitments to invest, it would be no surprise if junk or high-yield bonds - and even leveraged loans - become part of the expansion thinking of any junior miner wanting to make a name for itself.

If investment banks can find ways to financially engineer a hot asset, they will. But China, in this case, will have the final say.