The present conditions in debt markets follow 12 months of instability that had its origins in the US sub-prime mortgage market and sub-optimal risk pricing in international capital markets for some years. The asset write-downs, lack of liquidity and low confidence in the market that followed, led to a repricing of risk, a significant increase in spreads (risk premiums) in interbank markets and higher corporate borrowing costs. These conditions were recognition of the deterioration in risk management practices in the financial services industry and lack of trust in financial institutions and capital markets over the preceding 12 months. A decade of low interest rates, bank asset disintermediation and high leverage in buoyant market conditions created circumstances for a pro-cyclical correction which was amplified by tighter liquidity conditions (Reserve Bank 2008).
Capital markets in Australia and overseas are presently characterised by:
1. Historically low share prices
2. Limited opportunity for new on-market capital raisings
3. Reduced activity in mergers, acquisitions & divestments
4. A fall in asset values at odds with underlying fundamentals.
The instability in debt markets has spread to equity markets with sharp falls in share prices experienced in all OECD countries. The ASX's 200 Share Price Index fell 29.95% in the 12 months to 30 September 2008 and ASX market capitalisation stood at $1.333 trillion on 31 August 2008, a fall of 14.98% over the previous year (RBA 2008). In the past 12 months, uncertainty in capital markets was accompanied by volatile currency exchange rates. In the 12 months to 27 October 2008, the Australian dollar fell 27.4% against the US dollar and 38% against the Japanese yen (RBA 2008d; Australian Financial Review 27 October 2008). Market conditions have stabilised in recent weeks although the survey of capital market executives suggests that asset price and exchange rate instability may be the predominant market characteristic in the medium term. A number of survey respondents held the view that equity prices and the falling exchange rate may not stabilise before mid 2009 (see Appendix 3).
In tandem with uncertainty in the equity market, international and Australian debt markets are experiencing a liquidity squeeze following the collapse of the United States property market and write-downs in sub-prime debt that has threatened most United States financial services corporations. Additionally, risk has been re-priced and distortions introduced with state interventions.8 International portfolio investment in the sub-prime debt market has produced a default risk in other capital markets and led to a crisis in confidence.
A consequence of present market conditions and reduced liquidity is the reduced availability of corporate and project finance, increased borrowing costs and by extension, increased cost of equity capital. Project finance is a specialised form of finance although not commonly used for Australian PPP projects where the benefits of short-term revaluation and refinancing of assets favours medium-term corporate finance (Regan 2007b, pp. 21-24). There will also be significant demand for medium-term corporate finance in the infrastructure sector with the refinancing of existing listed assets in the period 2009-12 including Transurban, the ConnectEast and RiverCity Motorway Groups.
Capital market uncertainty in the past 6 months has also had a significant impact on the listed infrastructure sector. The major Australian investment banks actively packaging and managing assets experienced sharp declines in share price with consequential impacts on portfolio debt structures, borrowing covenants and asset liquidity. The IPO model is not presently an option for PPP projects and the ASX is unlikely to be a source of equity capital for some time yet in this country.
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8 For example, cash deposits in Australian banks guaranteed by the commonwealth are now, in effect, risk free. This has effectively altered the cost of capital for individual and portfolio investors.