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With the sharemarket's surge tipped to continue, how will the bond market compare in 2013?

Posted in Bonds

By Gareth Vaughan

Off the back of a 24.2% surge in the NZX50 Gross Index last year, dividend yields of 5.5% to 10% on offer, and high profile state owned enterprise floats led by Mighty River Power set to hit the market, investors with a near record high NZ$108.6 billion held in bank term deposits may be tempted to wade into the sharemarket in 2013.

However, whether there'll be much to tempt term depositors into the fixed interest market is another question altogether. Next to the sharemarket's 2012 gains, not to mention a 10.5% annual rise in Auckland house prices, 4.5% to 6.3% annual gains in fixed income indices (see chart below), based on the running yield and capital gain from movement in interest rates, look pretty lacklustre.


And most market watchers are predicting 2013 will again see returns from bond investments pale in comparison with equities.

"Fixed income will be a poor second cousin to equity markets this year. Equities will outperform bonds," says Grant Hassell, AMP Capital's head of fixed income.

In the lower for longer interest rate environment, where the Official Cash Rate remains marooned at its record low of 2.5% and many major countries around the world have official interest rates at, or near, zero, even a margin of 277 basis points over the five year swap rate recently only gave a coupon of 5.80% on a Kiwibank "junk" bond issue. Then there was Auckland Council's 4.41% coupon on its NZ$125 million inaugural retail bond issue and ASB's 4.48% coupon on a NZ$400 million bond issue.

ASB's 5-year term deposit rate higher

That ASB rate comes with the same bank advertising a five-year term deposit rate of 5%, for a minimum deposit of NZ$10,000 with interest paid monthly. And banks are advertising six-month term deposit rates of up to 4.40% with new bank Heartland, based on a minimum NZ$1,000 deposit and with interest paid quarterly, leading the way. See all advertised term deposit rates here.

And in a sign of the times, holders of French bank Credit Agricole's NZ$250 million of bonds, which were issued in 2007, saw their coupon halve to 5.04% after the rate was reset at 190 basis points over swap just before Christmas. See more on the Credit Agricole issue here.

Nonetheless, interest rates on local bonds in the 4% and 5% ranges, whilst low compared with the recent past, look attractive when compared with many on offer overseas. Witness Auckland Council's CHF100 million (about NZ$130 million) 11-year bond issue this month, which has a coupon of just 1.125%.

'Mental break made'

Christian Hawkesby, head of fixed income at Harbour Asset Management, reckons a "mental break" was made by traditionally yield hungry retail investors last year enabling domestic bond issues offering interest of as low as 4% to be acceptable. And Hawkesby also points out that part of the reason for holding fixed income securities as part of an investment portfolio is as a hedge for more risky investments in your portfolio such as equities. If, as he puts it, "the world blows up" in 2013, those bond holdings should serve you well, whereas if 2013 turns out to be - what many pundits are picking - a year of global economic recovery, bond performance will trail in the wake of equities.

A total of NZ$10.1 billion of debt was issued through domestic bond issues last year, slightly below the NZ$10.2 billion in 2011.  The biggest slice of the total, at about 43%, came from bank issues, although this was slightly down from 44% in 2011. Corporate issuance was down to about 18% of the the total from 24%, local authority issuance was steady at about 17%, despite the NZ$1.5 billion issued by the Local Government Funding Agency in its first year of operation, and supranational, or kauri debt issues, rose to about 23% of the total from 17%.

More new bond issues seen in 2013 than 2012

In terms of likely new domestic bond issuance in 2013, one senior market source suggests there'll be more than last year, where a famine of corporate issuance - banks excluded - was offset to some degree by a late flurry of issues including from Auckland International Airport and Christchurch International Airport. This source suggests more entities are in the "reasonably likely to do a bond deal category" than a year ago. Further issues are tipped from Auckland Council and Transpower, but perhaps just one or two deals from each of the big four banks during 2013 given soft lending growth and strong funding positions.

And Hawkesby describes the corporate bond market as a "flood and famine type of market" with it often only taking one corporate to issue bonds and provide a reference point for others.

Meanwhile, Hassell says with more debt maturities scheduled this year than last, there will be more capital markets activity.  And although borrowers may look for increased tenor - both the airport bond issues in December were for seven-years - investors' interests will be better served by holding shorter-term bonds.

"Short-term bonds are better for investors because when interest rates go up, the capital loss is much less on shorter-term bonds than long-term ones. Interest rate sensitivity is far less on short-term bonds," says Hassell, who expects New Zealand interest rates to "slowly drift up."

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5 Comments

...investors with a near

...investors with a near record high NZ$108.6 billion held in bank term deposits may be tempted to wade into the sharemarket in 2013.
 
Is it possibe to accelerate the dash for NTA trash before coherent farmers throw in the towel and opt for a dignified retirement?
 
More importantly the NZ$108.6 billion of bank deposits represents the so-called sticky cornerstone of the RBNZ's "core funding ratio" regulatory strategy.
 
You note elsewhere the IMF's view on the matter :
 
"The core funding ratio could also be raised to more than the planned 75% to reduce short term external debt further. The planned counter-cyclical capital buffer framework and other macroprudential instruments under consideration would help improve the resilience of New Zealand’s banking system to extremes in the credit cycle."
 
Introduced in April 2010 as a move designed to reduce New Zealand banks' reliance on short-term overseas borrowing, the core funding ratio sets out that banks must secure at least 75% of their funding from either retail deposits, or wholesale sources such as bonds with durations of at least a year. The Reserve Bank lifted the core funding ratio to 70% from 65% on July 1, 2011 and to 75%, from January 1, 2013.
 
Based on RBNZ data, banks as a group had a core funding ratio of 85.2% as of November last year.
 
The cash hungry attractions of unlimited sharemarket gains will be tempered by AAPL's recent shenanigans and the serious amount of Government loot becoming available when the 6.5% 15 April 2013 government stock issue redeems. Hence the regulatory deposits will  hopefully remain where they are most needed. 

If the banks want to keep the

If the banks want to keep the vast majority of that NZ$108b Stephen they might need to lift their rates...

THEsharemarket may be in for

THEsharemarket may be in for another good year but unfortunately most of the companies on the nzx50 don't produce or export anything .
How can this be good for our countries future.

Anyone with the Credit

Anyone with the Credit Agricole bonds ought to take a look at this - https://www.nzx.com/files/attachments/171129.pdf and this - http://www.bbc.co.uk/news/business-21516253

That's as expected, but not

That's as expected, but not so for our very own Kauri market.
 
Kanga News:
Tuesday, 19 February 2013 13:26 Record early year issuance in the Kauri market continued on February 19 as International Finance Corporation (IFC) (AAA/Aaa) – the only one of the market’s four largest borrowers not to have issued previously in 2013 – priced a new five-year transaction. The deal achieved record size for a Kauri, of NZ$650 million (US$553