Bank of New Zealand announced on Wednesday it had raised NZ$180 million through the first government guaranteed domestic bond issue aimed at institutional investors. The offer of 5 year bonds (Feb 20, 2014) at an interest rate of 4.775% was placed with local fund managers and institutions and was due to settle on Friday, BNZ said. The bond carries the New Zealand government's AAA local currency credit rating and was priced at 80 basis points over the 5 year swap mid rate (See chart below). BNZ will eventually pay a total of 5.675% once the 90 basis point cost of the government guarantee is included. The transaction was lead managed by BNZ Capital. What I think This means that BNZ will struggle to make much profit on any 5 year fixed mortgage loan with an interest rate of lower than 7%, given a typical 150-200 basis point profit margin on such a loan. BNZ's standard 5 year mortgage rate is currently 6.59%. See all mortgage rates here.

The issuance of this bond reinforces the chances that longer term fixed mortgage rates (2,3,4, and 5 year mortgages) are unlikely to fall much further than the current 6% to 6.5%, even if the OCR is dropped as expected to 2% from its current 3.5%.

That's before any profit margin and before the bank can use the power of its portfolio, which includes cheaper term deposit funding, to help offset the cost. But even with that, banks are unlikely to be able to cut fixed mortgage rates much below the current 6% they are charging. Economy watchers are eagerly awaiting the first issue by a New Zealand bank of a government guaranteed bond on international wholesale markets as banks here look to refinance shorter term foreign debt with longer term debt. About 40% of New Zealand bank lending is funded through these short term foreign debt markets and Reserve Bank Governor Alan Bollard has said they are likely to issue such bonds in coming months.  Banks are expecting the guaranteed international bond issues to cost as much as 250 basis points over swap rates, once the cost of the guarantee is included and the 'sovereign' risk of New Zealand is included. Given the 2 year swap rate is currently 3.29%, that means the banks' basic funding costs for such fixed mortgage loans are up at around 5.8%. Even accounting for cheaper retail deposit funding costs, banks are unlikely to drive fixed mortgage rates much lower than 6%. They could even rise towards 7% in the coming 6 to 12 months. As an aside, the BNZ term sheet for the first guaranteed bond refers to the guarantor as: "Her Majesty the Queen in right of New Zealand."