New Zealand issuers comfortable despite larger tasks

New Zealand’s sovereign and semi-government issuers are facing some of the same challenges as their Australian peers, most notably declining relative yield and larger issuance tasks driven by infrastructure investment. But the trans-Tasman stories are not identical, as New Zealand’s issuers explained at a KangaNews roundtable in Wellington in January.

  • John Bishop Group Treasurer AUCKLAND COUNCIL
  • Kim Martin Acting Director, Capital Markets NEW ZEALAND DEBT MANAGEMENT
  • Laurence Davison Head of Content and Editor KANGANEWS

Davison What have been New Zealand issuers’ experiences over the last 12 months when it comes to liquidity and demand?

BUTCHER We have seen a big fall in interest rates over the past year. New Zealand Local Government Funding Agency (LGFA) bond yields fell between 70 and 115 basis points with the curve flatter, spreads to swap moved tighter by 2-20 basis points across the curve, and our spreads to government bonds moved by 15-50 basis points.

Despite the volatility, we still have a functional New Zealand market and we are still seeing reasonable coverage of tenders at auction. It hasn’t been as strong as previous years, but it is still good.

We haven’t had any failed auctions and we have had two syndications over the past year – both of which were successful.

When it comes to politics, the New Zealand market is affected more by what is happening around the globe than what is going on locally.

DIREEN We kicked off 2019 with the launch of our sustainability-finance framework in March, followed by the first transaction from it in April. This was a highly successful transaction, considering it was the first of its kind in New Zealand. It had 21 per cent offshore participation and four new ESG [environmental, social and governance]-specific – or ‘dark-green’ – investors. As the year progressed, demand for New Zealand dollars weakened generally, and we saw some of this follow through into our transactions later in the year.

We announced a mandate in July and then had to delay until September due to a cabinet reshuffle and the government’s housing build programme reset. This was an unfortunate window to miss, given the significant supply that came in between. Our November transaction followed shortly thereafter and achieved our volume aspirations but was allocated to a narrower investor base than we had seen in previous transactions.

On liquidity, we are starting to see positive signs in our curve. This is encouraging given we are still relatively new to markets. We always heard that our bonds were taken and put in the bottom drawer, to buy and hold. While this is still largely the case, there appears to be increasing activity in the secondary market, as is evident in turnover details provided to us by key intermediaries. This is what we would hope and expect to see as our volume grows.

“Housing affordability and homelessness are global issues and investors found our story to be a very positive one, particularly given our focus on wellbeing. In many cases, this was in contrast to the approach in other jurisdictions.”

Davison Would this also be helped if you could start increasing investor diversity again?

DIREEN Yes, and as an issuer that is still relatively new to market, building our investor base is always front of mind. We met with more than 20 accounts across Europe in November last year and were encouraged by how engaged they were. Housing affordability and homelessness are global issues and investors found our story to be a very positive one, particularly given our focus on wellbeing. In many cases, this was in contrast to the approach in other jurisdictions.

We are stepping up investor engagement in 2020, including working with KangaNews to host our inaugural Investor Day in August. We want investors to know that we are always keen to meet, listen and share our story.

BUTCHER We had a record year for issuance in 2019: NZ$2.5 billion (US$1.6 billion) where we would normally be doing around NZ$1.5 billion. Offshore investor holdings increased slightly in nominal terms but were down as a percentage of outstanding because these buyers didn’t participate as much relative to the increase in supply.

Kauri and NZGB [New Zealand government bond] holdings dropped in nominal terms as well as proportionally. Overall, it was a pleasing outcome for the LGFA.

BISHOP There was very little offshore demand for our New Zealand dollar green bond priced in 2019. It would have been very difficult for us to get interest because the deal is too small for offshore investors, when it is looked at in US dollar-equivalent terms.

Overall, I would say demand for high-grade New Zealand dollars softened in 2019. With interest rates where they are there was no true retail interest so we were all very dependent on bank and institutional support.

On the other hand, we did another euro denominated transaction in September last year and investor demand there continued to grow. These investors see New Zealand as a safe place with a stable political environment and an economy that is still ticking along. Investors like the diversity of New Zealand and Auckland Council, because we are not just another financial institution.

I agree, though, that there is not a lot of understanding of New Zealand, especially when it comes to local government. This is largely because there are few New Zealand issuers, especially in foreign-currency markets. It takes two or three meetings for a European investor to understand our credit thoroughly.

We have been to Europe for three benchmark euro transactions, we now see more investors getting interested. They now know it is not a one-off deal so they are willing to spend the time analysing our credit.

Davison Is greater investor interest in the form of bigger tickets or new buyers?

BISHOP A mixture. It depends on tenor and other factors, but there is certainly wider interest. A lot of investors that had some interest also gave feedback that they would like us to build out a curve so it is worth their time to do the credit work.

The level of engagement has picked up materially. We do roadshows with the same core investors each time. Some others are very comfortable with our credit and do not need a meeting, but there are new ones coming on as well.

MARTIN Overall, we saw demand as pretty solid in 2019. We were happy with the traditional metrics for our tenders and with the book size and pricing of our syndication.

The proportion of NZGBs that offshore investors hold stabilised at just more than 50 per cent last year, after trending down in recent years. The actual value of offshore holdings picked up from around mid-year.

I think it is also interesting to see what bonds were being bought and sold. Offshore investors were selling shorter-dated bonds and increasing the value of their long-dated bonds. They were still pretty well engaged on a risk-adjusted basis.

Davison Why has international investors’ share of New Zealand dollar bonds been declining? Is this purely a product of the lower official cash rate (OCR)?

MARTIN The declining trend in offshore holdings has coincided with New Zealand’s cash rate declining below the Fed [US Federal Reserve] funds rate. Along with this, NZGBs have outperformed the equivalent US Treasury lines.

What we hear now is a more nuanced argument. Investors still appear to be very comfortable with New Zealand’s sovereign stability and institutional structure, and the clarity of our funding programme – but they are aware that they have had a good run. Investors will always make what they believe are the right choices for themselves on a relative-value basis.

DIREEN I agree with this. For most of the post-crisis period we had a yield advantage and we had the ‘rock-star economy’ period as well. The yield advantage has disappeared, though, and if you are an offshore investor looking for diversification you are probably looking to Australia. New Zealand is just a harder sell than it used to be.

Davison Does New Zealand Debt Management (NZDM) retain baseline interest from international investors because NZGBs still offer positive yield?

MARTIN Yes, though I think the zero limit is more psychological than actually important. At the end of the day, investors look at relative yields and there will be support as long as ours appear to be good value.

Of course every investor looks at our market differently, including whether it is on a hedged or unhedged basis, so I don’t think I can speak to the investor base in its entirety. This goes to the importance of having a diverse investor base so that at any particular time someone, somewhere is going to find our bonds attractive on a relative basis.

“Investors still appear to be very comfortable with New Zealand’s sovereign stability and institutional structure, and the clarity of our funding programme – but they are aware that they have had a good run.”

Davison How actively are issuers pursuing incremental offshore investors, and where are they focusing their efforts?

BUTCHER International investors are an important part of the New Zealand market and always have been. Some have been supporters of New Zealand government bonds for 25-30 years.

Offshore investors have always been attracted to New Zealand and they have had several reasons to be so. In the past, they have always had the diversification benefit plus a yield pickup.

They no longer have the yield pickup, but they still have the diversification benefit of being in New Zealand.

We continue to pursue these investors, as they certainly remain important. What we have seen in the past year is that some offshore investors have reduced their holdings of LGFA bonds but others have increased theirs. There is still interest, though in aggregate it is slightly less than it was a year ago.

Investors now tell us LGFA securities are among the first bonds they will consider buying if they are looking at increasing their New Zealand dollar portfolio and they are one of the last they will sell if they are looking to exit New Zealand dollars.

We also have quite a diverse offshore ownership profile, so it is not as if we are relying on one geography or one type of investor from offshore. We will continue to be active in expanding our offshore investor capability.

BISHOP Our programme has three components: we fund through the LGFA, and in our own name domestically and in offshore markets. Our total debt is getting to NZ$10 billion and it will go to NZ$14 billion in the near future, but even this does not make us big enough to focus on all the offshore markets.

We have chosen the euro market as our strategic offshore option and, incrementally, we look at the Swiss and certain Asian markets. The Australian dollar market tends to be a tactical option for us.

We will continue to target European interest. When it comes to Asian investors, we will look to Taiwan, Japan, Hong Kong and South Korea for longer-dated issuance.


Davison Can borrowers foresee a change in the currency mix of their funding?

BISHOP Big picture, we are ambivalent because everything is swapped back to New Zealand dollars. We are conscious of being meaningful in the markets in which we are active, that is why we have done three public euro transactions in reasonably quick succession. This builds investor confidence.

There is still interest in Australian dollars although Japanese life-insurance demand has fallen away recently as the Australian curve has gone down.

DIREEN The immediate focus for us is very much on our New Zealand dollar MTN programme. In calendar 2020, we plan to issue about NZ$2.5 billion of domestic bonds across the curve, and we are also open to private placements of longer-dated bonds. While the latter is not a new message, we are actively pursuing opportunities and are encouraged by feedback we have received recently.

We like to think the market will adjust to our increased planned volume, and we are seeing some evidence that this is correct. Capacity is not binary. It’s not true that an issuer can only do a hard volume limit or that what the LGFA, for instance, has done is the only possible outcome.

We offer Crown risk and a triple-A rating with Moody’s Investors Service – which notes no meaningful distinction from the Crown in a credit sense.

All in all, we are optimistic about achieving our volume aspirations in 2020 and beyond. Notwithstanding this, we are exploring a backup programme, subject to board approval. But it’s important to reiterate that our focus is on New Zealand dollars.

BUTCHER We have an Australian MTN programme that we can issue from if we want to, but we have not done so. This generally comes down to pricing and whether issuing in another currency would reduce liquidity and affect pricing in the domestic market. We assess on a regular basis but have yet to see the benefits outweigh the disadvantages.

We would probably consider foreign-currency issuance if there was a pricing opportunity or if for some reason the domestic market closed or shrank for us, but our indications are that is not likely to happen. We will continue to monitor offshore markets as a potential source of funding but at this stage we still have no immediate intention to go offshore.

Issuer Credit Profiles

Several of New Zealand’s government-sector issuers – including the sovereign and, perhaps most obviously, Kāinga Ora – Homes and Communities (Kāinga Ora) – have seen their issuance programmes grow. None are concerned about credit metrics or debt headroom.

DAVISON What does a large infrastructure programme mean for Auckland Council’s credit profile? Is it important to tell investors a persuasive story about ‘good debt’ and ‘bad debt’ in the context of a substantial infrastructure investment task?

BISHOP Maintaining a double-A rating is a key focus for us. We have debt-capacity constraints that influence some of our long-term planning. The other initiatives we are exploring, including alternative funding vehicles, will allow us to undertake additional infrastructure investment we wouldn’t have been able to do with our current debt constraints.

DIREEN We are still finessing our long-term projections but we have a relatively short period of concentrated build activity – three-quarters of our houses need to be renewed in the next 20 years.

Of course this means certain ratios might, for a short period, go beyond what would be expected in normal times. But we will have the free cash flows for several decades. I am glad to hear rating agencies are being pragmatic about their approach to this – it is good for the market.

DAVISON Kāinga Ora has also ramped up its funding task. What does this mean for headroom in credit metrics?

DIREEN Our borrowing protocol limit – how much we can finance in markets – has been increased from NZ$150 million (US$97.6 million) to NZ$1 billion to NZ$3 billion and now to NZ$7 billion in the space of a few years.

This reflects the scale of the housing programme and how important the provision of adequate public housing is to the government and the general public.

In relation to headroom on credit metrics, it comes back to projecting fundamentals – how many people we need to house, or provide placements – how much funding is required to make these placements and how much financing is required to build the houses to make it happen.

The answers to these questions are incredibly complex but teams of people are currently working on them. We hope to be in a position to advise the market on the long-term implications for our financing programmes later in the year.

DAVISON What is the situation for New Zealand Debt Management when it comes to headroom?

MARTIN We see a fair bit of headroom. The feedback we get is there is not going to be a ratings problem from an incremental increase in our issuance.


Davison Syndicated supply of New Zealand government-sector bonds has ticked up, driven largely by the LGFA making its syndicated debut and Kāinga Ora – Homes and Communities (Kāinga Ora)’s increased activity. How has the market responded?

BUTCHER It is certainly a theme for us. We have seen a big increase in our secondary-market activity over the past year – probably a 40 per cent increase. Primary is still quite healthy, too. Year-on-year, the additional supply was picked up by domestic institutional investors. They increased holdings by the largest amount, though the domestic banks were also supportive.

There has been a reduction in SSA [supranational, sovereign and agency] Kauri and NZGB issuance as well as a falling interest-rate environment, so investors are looking for additional yield. We have been fortunate in that we have been the only nonsovereign issuer of long-dated bonds, so we have been able to offer investors that wanted duration or to benefit from the steep yield curve a range of maturities to choose from.

DIREEN I think it’s fairly obvious that the market prefers a broader set of issuers and to this extent our emergence as a new issuer is welcomed. In an aggregate sense, volume of high-grade New Zealand dollar issuance is largely unchanged – it’s just a question of who is issuing. It takes time for credit limits to be established and lifted, but we think our presence and programmes are positive overall for the market.

Davison Does the emergence of a more active Kāinga Ora have a competitive consequence for other issuers?

BISHOP It is not negative for us at all but it is not a direct positive either. We are not deliberately playing in different areas, but there are a lot of offshore investors out there. In particular, we issue in euros and we could do deal sizes three or four times greater quite easily, so there is no lack of demand.

We are never going to be able to issue NZ$1 billion lines in the local market. We don’t have a high enough credit rating for a lot of offshore investors. We also don’t follow New Zealand government or LGFA issuance maturities, otherwise we would be getting a lot of concentration in our issuance because we also fund through the LGFA.

Davison The SSA Kauri market was quiet in 2019. How does activity in this sector interplay with NZDM’s issuance programme?

MARTIN At a very high level, we are a tiny market on the global stage and generally anything that increases New Zealand dollar volume – and thus market visibility – is a good thing.

How we get there is obviously important, and this takes into account the potential for near-term saturation and the rate of supply. Kauris are part of this, but overall we see those issuers’ presence in our market as beneficial rather than in direct competition with us.

The important thing to note is that SSAs are the discretionary issuer in our market, which means they can adjust to demand. Our funding is determined by the government’s policies and needs, whereas the Kauri issuers have greater flexibility to come and go as they please.

Davison Some market users might look at relative issuance volume and assume that Kāinga Ora squeezed the SSAs out of the New Zealand market last year. Would this be an accurate perception?

DIREEN I would be surprised if our NZ$1.5 billion of issuance last year – NZ$1 billion of which occurred in the last four months – was the key driver behind the issuance choices of such a significant set of borrowers over the course of 2019.

It’s true that SSAs are generally more tactical than domestic high-grade issuers. But they also add depth and provide relative benchmarks in our market, which we welcome.

Davison NZDM’s borrowing requirement is NZ$10 billion for each of 2019/20 and 2020/21, which is NZ$2-3 billion higher than what has been typical in recent years. What effect does this have on the NZGB market and on other government-sector issuers?

MARTIN The way our programme has panned out means we did NZ$10 billion in calendar year 2019. We don’t feel there has been any degree of indigestion with that level of issuance.

DIREEN It doesn’t come up in our discussion with investors, other than to the extent that if we weren’t active issuers in the market it’s likely that the Crown would have an even larger task than it does currently.

“We have quite a diverse offshore ownership profile, so it is not as if we are relying on one geography or one type of investor from offshore. We will continue to be active in growing our offshore investor capability.”


Davison What feedback have issuers received from local banks about the impact of the Reserve Bank of New Zealand (RBNZ)’s latest regulatory changes on bank balance-sheet demand for government and semi-government bonds?

BUTCHER The banks have increased their holdings over the past year. They have all increased their limits to the LGFA, which is a positive.

We still haven’t had a clear message on whether regulatory changes mean more or less demand. Anyway, on the flip side, there is less SSA and NZGB issuance and the banks still have to hold high-quality liquid assets.

If there is less lending, one would think there would also be more cash around for liquidity books unless the banks also scale back their deposit taking.

We are unsure where this will eventually land but we are certainly watching because the banks are our largest investor group as a whole – as a combination of liquid-asset books and trading books. Even so, the changes probably have more of an impact on lower-grade than higher-grade credits across the corporate and nonbank financial market in New Zealand.

Davison How engaged have offshore investors been with the bank-capital changes in New Zealand? Do issuers include the subject in investor presentations?

MARTIN Last year it was a big enough issue that offshore investors were aware of it. We don’t present a view on whether it is going to be positive or negative when it comes to demand for our bonds. Rather, a lot of the questions we received last year were around what the changes might do to the economy, in areas such as bank lending and growth.

BISHOP We got some questions on our European roadshow. But we roadshowed soon after a couple of the New Zealand banks, so it had been pretty well covered by them.


Davison How are investors thinking about the New Zealand economy at the beginning of calendar 2020?

BUTCHER Offshore investors that are active nowadays are much more heavily focused and interested in what is going on in New Zealand. It is no longer a market where investors buy bonds without engaging. They are a lot more knowledgeable now – which is positive.

There is still very much a view that we are aligned with Australia, in particular around the Reserve Bank of Australia and its approach to monetary policy. The RBNZ is also now much more in step with global monetary policy. Investors recognise the fiscal strength of New Zealand relative to other countries around the world.

Possibly, some investors are becoming more opportunistic regarding New Zealand. But this is part of a longer-term focus. Global volatility is creating opportunities around the world, so investors tend to be a bit more active. This might explain why we have noticed an increase in secondary-market activity.

MARTIN Investors generally appear comfortable with the fiscal outlook. On the economic side, market participants have been relatively sanguine on the New Zealand outlook in the context of what has been going on globally.

Given this, some were a little surprised by the rate at which OCR [overnight cash rate] cuts happened. But they acknowledged inflation was still below the RBNZ’s target and there may be some downside risks lurking.

DIREEN There has been some interest in the extent of any fiscal stimulus, which includes our build programme and other infrastructure.

How much more the government could do if required comes up from time to time when we meet investors.

BISHOP When overseas investors look at New Zealand, they don’t see a lot of difference between a Labour and a National government. We occasionally get questions around house prices but we are still seen as a relatively good place to invest.

“There is a lot of investment required in transport, water and housing, and we are starting to see this ramp up. But there is still lots we can do, which means working very closely with central government on alternative ways of financing.”

Davison How interested are investors in the RBNZ’s mandate and the government’s new budget approach?

DIREEN The government’s approach to wellbeing resonates very strongly with investors who are encouraged by a focus on a broader range of indicators than traditional measures.

The Treasury’s Living Standards Framework, which was developed over a decade, is focused on improving the wellbeing of New Zealanders. As this framework underpins economic and fiscal advice to the government, and with housing polling as the number one issue in New Zealand, it makes sense for us to promote this by issuing Wellbeing Bonds.

Our new name – Kāinga Ora – was gifted to us by the honourable Nanaia Mahuta, the minister for Māori development. It is about wellbeing – for which housing is key.

We are really excited about telling the wellbeing story in our 2020 impact report, as it provides a great incentive to broaden our story from narrow housing indicators to our intervention narrative and the real impact we are having on people’s lives.

Davison What is the outlook for Auckland’s economy specifically?

BISHOP The Auckland economy is still performing strongly. There is a lot of investment required in transport, water and housing, and we are starting to see this ramp up. But there is still lots we can do, which means working very closely with central government on alternative ways of financing.

Davison How have New Zealand’s other regions performed?

BUTCHER Some other parts of the country are receiving the spill-over effects from the growth in Hamilton and Tauranga. They are seeing an increase in population as well as in house prices. Their infrastructure appetite remains very strong.

The rest of the country has a lot of infrastructure requirements and much of that is also coming to terms with climate change and existing infrastructure renewals. Having said this, the rest of the country is not running at the same pace as the high-growth areas such as Auckland. The next big test will be when councils start working on their 10-year infrastructure and borrowing plans, at the end of this year.

Davison From the outside looking in, there doesn’t appear to be as much focus on the potential for QE in New Zealand as in Australia. Do investors ask about the possibility of further monetary or fiscal policy measures?

MARTIN There was certainly a period when it was topical but it has dropped away. Market users recognise that our OCR is at 100 basis points so we still have a bit of leeway. The market is pricing less than 25 basis points worth of cuts for the coming year, so there is still a bit of ammunition left. I think market participants recognise that we are also in the fortunate position of having fiscal headroom. QE is seen as a last resort.