* Australian state debt offers attractive yields; high
* Investors see scope for further strong performance
* Banks seen as captive buyers because of regulatory demands
* Australian federal bond supply to outpace state issuance
By Cecile Lefort
SYDNEY, March 18 Bondholders look set for
windfall gains as Australian states sell assets from hospitals
to ports and power stations to reduce their substantial debt
and lower steep funding costs.
The windfalls will come as states redeem large numbers of
bonds, making the remaining debt on issue more valuable and
underpinning prices in the secondary market.
Reducing their debt levels could also see some states
winning a credit-rating upgrade, instantly granting bondholders
a healthy bonus as bonds rise in value.
Australian investors have snapped up much of the A$200
billion ($179 billion) in state bonds on issue because it is
highly-rated debt that yields about twice as much as bonds
issued for example by Spain - one of the weakest and most
debt-laden European economies - yet carries only a fraction of
Five-year Australian dollar bonds issued by AAA-rated New
South Wales and Victoria, the nation's two most populous states,
pay between 3.7 percent and 4 percent. This compares with a mere
2.0 percent offered by Spain's euro-denominated debt rated some
nine notches below at BBB-minus.
Australian states are selling "non-critical" public assets
to lower their debt and reduce their funding costs, which will
make big planned investments in infrastructure more affordable.
"Asset sales will improve the states' overall debt ratio
even as they reinvest some of the proceeds in new projects,"
said Anthony Kirkham of Western Asset Management, which invests
A$18 billion in fixed-income securities. "They are moving in the
Investors are heartened by states' efforts to put their
fiscal houses in order, prompted in part by Standard & Poor's
cut in the ratings of the resource-rich states of Queensland and
Western Australia to AA+ and South Australia to AA because of
falling revenues. S&P also placed New South Wales's top rating
on negative outlook.
Simon Warner, head of fixed-income at AMP Capital,
one of Australia's largest fund managers with A$140 billion
globally, hopes debt reduction will return AAA ratings to
Queensland and Western Australia.
The five largest states plan to cut their combined funding
needs by two-thirds to below an annual A$10 billion in total by
June next year on a cash flow deficit basis, UBS data shows.
By contrast, the federal government plans to double its debt
issuance to A$42 billion in the same period. Triple A-rated
Australia has A$277 billion of bonds on issue.
Increased issuance has seen the yield gap between sovereign
and state bonds narrow considerably since 2007/08 when it was
around 115 basis points. Western Australia's 10-year debt was
last at 58 basis points over federal government bonds with some
seeing scope for further contraction to around 40 bps over.
A key factor underpinning state debt, also known as
semi-government debt, is demand from local banks scrambling to
find highly liquid assets to meet prudential requirements.
"We are selectively adding semi-government bonds to our
holdings, particularly in the 6- to 9-year part of the curve
where value is more attractive," said Nigel Bradshaw, a senior
dealer at ING Bank Australia, which has a balance sheet of A$50
Still, some economists warn that regional governments have
disappointed before, largely because politics has got in the way
"The budgeted fiscal consolidation requires a sustained
period of spending restraint that has never been achieved, or at
least not in the past decade," said Matthew Johnson, a rate
strategist at UBS. "Promising to do it is one thing. They need
to prove they can do it."
($1 = 1.1135 Australian dollars)
(Editing by Eric Meijer)