Government-sector issuers roundtable part two: New Zealand perspectives

The New Zealand government-sector bond market is well placed going into 2018, issuers tell KangaNews. A positive economic story and projected lower issuance from the sovereign should support a solid supply-demand dynamic – though issuers say they continue to work hard at investor engagement at home and abroad.

PARTICIPANTS

John Bishop Treasurer and General Manager, Transaction Services AUCKLAND COUNCIL
Mark Butcher Chief Executive NEW ZEALAND LOCAL GOVERNMENT FUNDING AGENCY

Andrew John Funding Manager AUCKLAND COUNCIL
Sarah Vrede Director, Financial Operations and Head of New Zealand Debt Management Office NEW ZEALAND TREASURY

NEW ZEALAND ROUNDTABLE MODERATOR

Helen Craig Deputy Editor KANGANEWS

MARKET VIEWS

Craig How would New Zealand issuers sum up their experience of market conditions in 2017?

BUTCHER While global credit-market sentiment remained supportive, we found that issuance conditions were slightly more difficult than previous years. We responded to market conditions accordingly throughout the year.

At the start of 2017, I would not have expected that by year end the New Zealand Local Government Funding Agency (LGFA) yield curve would be 60-80 basis points lower in yield and spreads would be 25 basis points tighter to swap. Spread movement gains to New Zealand government bonds (NZGBs) were maturity-dependent, with gains in front-end spreads while longer-dated spreads were unchanged.

Demand from domestic investors was more subdued over 2017 but offshore investor holdings of LGFA bonds increased to 40 per cent from 25 per cent. We benefited from the low levels of Kauri issuance and saw continued switching from NZGBs into LGFA bonds as investors sought the additional yield pick-up. Demand at our tenders was inconsistent, with bid-cover ratios below historic trend, but secondary-market activity was very strong.

VREDE We saw solid demand for New Zealand government bonds (NZGBs) in 2017 as illustrated by a number of metrics. Tenders generally performed well, with an average bid-cover ratio over the year of more than three times. The syndication of the new September 2035 inflation-indexed bond attracted good demand within the initial price-guidance range. The proportion of nonresident holdings of NZGBs also remained above 60 per cent during the year. Finally, NZGB yield spreads to key peers narrowed over the course of 2017 - also reflecting consistent demand.

BISHOP Generally we found funding conditions to be relatively strong, bearing in mind that Auckland Council’s focus was predominantly on offshore markets during 2017. We saw significant demand for our paper at attractive spreads, culminating in a euro-denominated transaction issued towards the end of 2017 that was well supported by a wide range of European investors.

JOHN In 2016 we issued more than NZ$400 million (US$289.6 million) of domestic bonds but take up was patchy. This led us to focus more heavily on offshore markets and to issue our first euro deal in January last year, which we followed in November. We also issued a Kangaroo-format transaction in the middle of 2017.

“Offshore buyers don’t have concerns relating to New Zealand and will continue to have these exposures in their portfolios. In fact, we experienced continued accumulation by offshore investors throughout the New Zealand election period at the end of 2017.”

SUPPLY OUTLOOK

Craig Issuance by the New Zealand sovereign is not expected to grow in the coming years. Do other New Zealand high-grade issuers have to find investors that aren’t being brought into a growing NZGB programme?

VREDE Steady gross issuance of NZGBs will continue, at NZ$7 billion per fiscal year, even though total net issuance will be flat over the New Zealand Debt Management Office (NZDMO)’s forecast period to June 2022.

Regardless of the net issuance programme for NZGBs, the NZDMO maintains a structured and proactive investor-relations strategy to continue to build and diversify its investor base. The NZDMO continues to value diversity in its investor base – by investor type and location and also by term and product preferences.

BUTCHER Our investor strategy has been unashamedly to seek out existing NZGB and high-grade Kauri investors and market to them either the LGFA's additional yield pick-up over NZGBs or the additional liquidity and diversification relative to Kauris. Offshore accounts remain underinvested in LGFA bonds relative to the other high-grade New Zealand dollar opportunities, so it is good to continue to see growth in their holdings month to month.

BISHOP The more we engage with offshore investors the better the response we receive from these buyers. Bear in mind, too, that outside the New Zealand major banks, which are all subsidiaries of Australian banks, the number of New Zealand issuers that target offshore markets is low. It takes a while for investors to get up to speed on New Zealand as a credit and to find the effort it takes to carry out the credit work on a New Zealand entity worthwhile.

The NZDMO has done a great job over the years building up a strong and diverse offshore investor base and I am sure it will continue to do so going forward. We have no concerns regarding diminished support.

JOHN The challenge for us remains the same as it has always been – that because Auckland Council issues in foreign currencies our investor base is already different from that of the NZDMO.

The NZDMO not projecting new-issuance growth doesn’t really change anything for us. We continue to need to go offshore to look for and market to offshore investors and grow our international investor base just as we have done in the last few years.

Craig Perhaps the biggest news from the New Zealand high-grade market in 2017 was the government commitment to maintaining a minimum supply of NZGBs on issue even as the new-issuance requirement falls. How has the market responded?

VREDE The New Zealand government first announced a commitment to maintain NZGBs on issue at not less than 20 percent of GDP over time at budget 2017. Prior to this, the NZDMO had been fielding questions from investors and intermediaries on what the government’s focus on paying down net debt and running sustained budget surpluses would mean for NZGB programmes and levels of bond outstandings over time.

The commitment to maintain NZGBs on issue was reiterated by the new government in the December 2017 budget-policy statement. The commitment by successive governments has further supported investor and intermediary confidence in the sustainability of the NZGB market and has been very positively received by NZGB market participants.

Craig How do other New Zealand issuers feel this commitment will affect the market?

BISHOP We aren’t expecting any impact. Having a minimum issuance commitment will generally be positive for the New Zealand dollar market but I am not sure there will be any direct flow-on effect to Auckland Council.

BUTCHER We appreciate this as a positive commitment. Given we align LGFA maturities and coupons to those of the NZGB curve, it is positive for us to see a yield curve between the three-month and 2033 maturities maintained. Investors and issuers alike need a sovereign issuer to ensure a healthy capital market and to provide a comparable benchmark.

“The more we engage with offshore investors the better the response we receive from these buyers. Bear in mind, too, that outside the New Zealand major banks the number of New Zealand issuers that target offshore markets is low.”

Craig What is the view of the NZDMO – and other Kiwi issuers – on duration of issuance? Are there any changes to strategy around weighted-average maturity?

VREDE The WAM of the NZDMO’s debt portfolio, including Treasury bills, has increased to 7.1 years at the end of 2017 from four years in 2008. We envisage the WAM remaining close to the current level in 2018.

BUTCHER We extended the term of our issuance each year for the first five years we issued bonds until mid-2017, when a combination of slightly higher interest rates and wider spreads to swap led our council borrowers to shorten their maturity preferences.

We extended our curve out to 2033 in the past year but are unlikely to go further than that in the near term. While the longer-dated New Zealand dollar swaps market has deepened over the past year, many of our council borrowers are restricted by their treasury policies from borrowing beyond 2033.

BISHOP We intend to maintain our WAM at 6-7 years. Given the council’s long-dated assets and the interrelated infrastructure focus, it serves us well to issue long-term debt provided it is appropriately priced.

The potential issue we have is that we swap everything back to New Zealand dollars and a cross-currency swap beyond 20 years is difficult, so we have a hard cap at 20 years.

On the other hand, we are also conscious of our double-A rating. This means we think we should be able to access markets relatively easily, and as such we don’t want to have too long a WAM. Having at least some short-term debt in our book enables us to benefit from a lower yield cost.

JOHN We don’t feel it is justified to pay excessively for additional tenor. At 10 years the curve becomes relatively flat and we find it challenging to pay more than the margin at 10 years to extend our WAM. The challenge we have had in the last year or so, which has been a feature of the wider market to some extent too, is that some investors are demonstrating a preference for shorter duration in anticipation of higher yield.

CURRENCY DEMAND

Craig We have heard some dealers suggesting New Zealand could benefit from flows, out of Australian dollars in particular, if the official cash rate (OCR) starts to rise – though rate hikes are yet to emerge. What are New Zealand issuers hearing from dealers and investors about outlook for relative yields and the consequences for demand?

BISHOP I don’t think anyone is expecting a significant rise in the OCR, certainly not in the 2018 calendar year, so I am not sure the yield differential will be significantly greater in 12 months compared with now. But obviously rising yield in New Zealand – whenever it happens – will benefit our market and will attract greater offshore investor interest.

VREDE Investors’ decisions will continue to be influenced by their views of relative cash rates, supply dynamics, sovereign risk and market liquidity among other factors.

A broad investor base helps ensure diversity in the various motivations that investors have for participating in the NZGB market and in the timing of their participation. Our aim is to have a diversified set of investors that participate in the market at different times and with different objectives, contributing to consistent demand through time.

The NZDMO has a solid plan for investor engagement this year as activity was a little lighter around the period of the New Zealand general elections in 2017 - but this is standard practice.

BUTCHER The question we thought was going to be answered in 2017 might finally be answered in 2018: what will the impact be on international investor appetite for New Zealand be if global interest rates rise, curves steepen, credit spreads widen and New Zealand spreads compress further to US and Australian markets?

Our offshore investor feedback has been that these buyers don’t have concerns relating to New Zealand and will continue to have these exposures in their portfolios. In fact, we experienced continued accumulation by offshore investors throughout the New Zealand election period at the end of 2017. Admittedly our investor base is predominantly long-term, real-money accounts that have held New Zealand dollars for many years.

Our domestic investor feedback is that – relative to other New Zealand issuers – the larger size of our maturities, our relative liquidity and the ability to take curve trades in LGFA bonds will ensure we remain attractive for the ever-growing KiwiSaver portfolios.

BISHOP The biggest story is centred around the long end. The differential between long-dated New Zealand and US government bonds is relatively slim and the more US rates increase the more demand for US dollar assets relative to New Zealand dollar assets increases.

We have observed strong demand from true retail investors further down the credit spectrum, particularly at the triple-B level and for issuance of between four and seven years. We expect this bid to grow if interest rates increase.

“Regardless of the net issuance programme for NZGBs, the NZDMO maintains a structured and proactive investor-relations strategy to continue to build and diversify its investor base.”