New Zealand set for record bond year

Mon Jun 23, 2014 3:04am EDT

* Foreign issuers see appeal of niche market

* Higher rates driving demand for investments

* World Bank unit sells biggest Kauri bond

By John Weavers

June 23 (IFR) - New Zealand's local currency bond market is poised for a record year, spurring hopes that high demand for the Kiwi dollar will attract new names.

Four regular sovereign, supranational and agency issuers have tapped the Kauri bond market in recent days, pushing the year-to-date tally of new bond sales to over NZD4.7bn (USD4.07bn), in sight of the 2007 record of NZD5.53bn.

Kauri bonds, named after the country's largest native tree, refer to securities sold by overseas issuers in New Zealand's local currency debt market.

Leading the recent rush was the International Bank for Reconstruction and Development, which raised a record-busting NZD800m from an increase to its 4.625% February 26 2019 Kauri line on June 13. That deal marks the largest single-tranche offering on record in the Kauri market.

Nordic Investment Bank, Germany's Rentenbank and Asian Development Bank followed the World Bank arm last week with taps totalling over NZD775m.

There are several reasons for the market's revival, including the appeal of the relatively high yields that have contributed to the Kiwi dollar's 6.5% appreciation against the US dollar so far this year. The Reserve Bank of New Zealand implemented rate hikes of 25bp three times, in March, April and June, to take the official cash rate to 3.25%.

"Relatively high interest rates, when combined with a strong economy and a stable exchange rate, are certainly going to attract demand into New Zealand dollar assets," said Glen Sorensen, syndication manager at ANZ Bank New Zealand.

New Zealand dollar five-year swap rates, quoted at 4.49% last Friday, are 114bp higher than the Australian equivalent. This compares with an 85bp differential at the end of February and around 70bp last summer.

As recently as December 2011, Kiwi five-year swap rates were 100bp below their Aussie equivalents.

Then, it made little economic sense for international investors to buy Kiwi dollars as the same names were available in Australian dollars at a higher yield. Indeed, Kauri bond sales totalled just NZD2.1bn in 2011 and NZD2.3bn in 2012.

GOVERNMENT ALTERNATIVE

While local rates are rising, the changing currency dynamics have also tilted the basis swap market in favour of overseas issuers, who can save against their US dollar or euro funding costs by issuing in New Zealand and swapping the proceeds.

"I do not see higher rates as impacting Kauri issuer decisions as they will typically swap back to floating Libor or Euribor. So, basis markets, rather than interest-rate levels, are the key for them," said Sorensen.

The Kauri revival began last year, when overseas issuers raised NZD5.46bn, just shy of the 2007 record, and has continued into 2014, partly because of a lack of alternative high-quality New Zealand dollar assets.

In particular, the growth of the Kauri market has coincided with a slowdown in New Zealand government bond sales, after a surge in borrowing in the aftermath of the Canterbury and Christchurch earthquakes of 2010 and 2011.

Top-rated bonds from overseas agencies and supranationals represent an obvious alternative to local government paper, particularly as they provide attractive yield pick-ups. IBRD's February 2019 tap priced to yield 57bp over New Zealand's March 2019 government benchmark.

While Kauri demand has deepened and broadened substantially over the last two years, the pool of issuers remains rather limited.

This year's 18 Kauri offerings came from just six issuers. In contrast, 34 overseas issuers have sold so-called Kangaroo bonds in the Australian dollar market so far in 2014 - 20 of which are governments or agencies.

Sorensen believes the expanding Kauri investor base, with the growing participation of sovereign wealth funds and official institutions, will help encourage new issuers.

"Growing volumes are also likely to incentivise on the issuer side of the equation. Therefore, I believe there is growing potential and opportunity for a more diverse range of issuers in the Kauri market," Sorensen said.

However, Mike Faville, head of debt capital markets at Bank of New Zealand, doubts there will be a substantial expansion of issuers.

"While the market would love to see some new names, I think the fact that not all names visit the New Zealand market is partly to do with overall market size," Faville said.

"The New Zealand domestic investor base is finite in size, and the offshore investors typically have smaller allocations to New Zealand dollar product, so they can 'get their fill' from a smaller group of issuers." (Reporting By John Weavers. Editing by Abby Schultz and Steve Garton.)

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