New Local Government Funding Agency to seek NZ$300 mln through two bonds in Wednesday's inaugural auction

By Gareth Vaughan

The Local Government Funding Agency (LGFA), the new council bond bank that's aiming to borrow and on-lend at least NZ$1.4 billion to its council members within two and half years, wants to borrow NZ$300 million in its first ever debt issue this Wednesday and is offering investors 6% interest.

The LGFA is offering two bonds, one of just over three years duration that matures on April 15, 2015 and a second that matures in about five and half years, on December 15, 2017. Both offer investors' coupon rates of 6%. The LGFA is seeking to raise NZ$50 million through the 2015 bond and NZ$250 million through the 2017 bond. Bids close at 2pm on Wednesday. See more on the LGFA's website here.

The LGFA is allowed to borrow money either domestically and/or offshore in either New Zealand dollars or foreign currency and on-lend it to its local authority owners. It aims to borrow about NZ$1 billion this year, chairman Craig Stobo has said. It was created by Parliament passing the Local Government Borrowing Act last September.

'Price won't be as good as the NZDMO'

Speaking on Friday before the announcement today detailing the two LGFA bond offers, LGFA chief executive Phil Combes said he expected the LGFA - which has the same credit ratings as the Crown - to pay more to borrow money than the government.

"The fact remains it's a first up issue from a brand new issuer so obviously there's a little bit more uncertainty than normal about where these securities are going to price," said Combes whose previous role was heading up government debt manager the NZDMO. "And as I've always said when you're tendering, the ultimate test is on the day."

The LGFA's Statement of Intent notes its performance targets include that its average cost of funds relative to the average cost of funds for New Zealand Government Securities for the periods to June 30, 2012 and June 30, 2013 will be less than 0.50% higher. Then for the year to June 30, 2014 it's aiming for its average cost of funds relative to the average cost of government funds to be less than 0.40% higher.

In its most recent bond tender the NZDMO sold NZ$200 million worth of 11-year bonds to 16 successful bidders in an offer that attracted 29 bids worth NZ$415 million. The tender had a weighted average successful yield of 4.09% giving a coupon of 5.50%.

Another target is that the average margin above LGFA's cost of funds charged to the highest rated participating local authorities will be no more than 0.40% The aim is for total lending to participating councils to reach at least NZ$500 million by June 30 this year, at least NZ$900 million by June 30 next year, and at least NZ$1.4 billion by June 30. 2014. There are no limits in either the Local Government Borrowing Act or the LGFA's constitution on the LGFA’s borrowing, nor any deriving from the Local Government Act 2002.

The LGFA is the only other entity in New Zealand to carry credit ratings as strong as the Crown's. International credit rating agencies Standard & Poor's and Fitch Ratings have both issued an AA+ long-term local currency rating for the LGFA, long-term foreign currency ratings of AA and Fitch a short-term foreign and local currency rating, used on the likes of commercial paper debt issues, of F1. The outlook on the long-term ratings is stable. See an explanation of credit ratings here.

Combes said although both the Crown and the LGFA carry the same credit ratings, there was no doubt in his mind that as a first up issue the LGFA won't be able to match the NZDMO's pricing.

"They've been around for a long time, they've built up substantial liquidity in each of their bond lines (NZ$10 billion in some). So the main point I'm making is you would expect the pricing in our early tenders would offer value to investors and then over time you would expect to see our pricing improve as people get more familiar with us and as we build up liquidity in our lines."

Deciding on the tenor of the LGFA bonds has been a matter of balancing the desire for longer-term bonds from LGFA council owners and fund managers, and interest in shorter-term issues for banks, interested in local council bonds for their liquid asset portfolios, Combes acknowledged.

"It's not unusual for investors to be split between those who focus on the shorter maturities, and that applies for obvious reasons to the liquidity books of some of the banks where they're wanting the shorter dated securities," Combes said. "That means it's often a little bit easier to get in and out of those and also doesn't have quite  the same market risk."

"On the other hand you get some funds and insurance companies and the like who have a preference for longer term maturities. That's common to a number of issuers that you've got different pockets of demand for your various securities."

'Council debt heading to NZ$11 bln'

The LGFA is 20% owned by the central government, with the remaining 80% initially held by 18 local councils including the Auckland Council, Christchurch City Council, Whangarei District Council, Western Bay of Plenty District Council, Tauranga City Council, Hamilton City Council, Wellington Regional Council, Wellington City Council, and Tasman District Council. Stobo told interest.co.nz last month he expects more than 40 councils will join before year's end, just over half the country's 78 local authorities.

Local authority lobbyist  Local Government New Zealand suggests a pooled funding approach will help local authorities borrow money at lower interest rates than they currently can, ultimately saving councils - and their rate payers - about NZ$25 million annually. Long-term council plans suggest local authority debt will more than double over the next five years to more than NZ$11 billion. Councils say their debt funding options have previously been limited to the domestic banks, private placements and wholesale bond issues to domestic institutional investors and, to a lesser extent, retail bond issues to domestic retail investors.

Grant Hassell, head of fixed income at AMP Capital Investors, said he viewed the LGFA as the most efficient way for New Zealand local councils to fund themselves.

"We're very supportive of what they're doing and likely to have interest (in their bonds) at the right (price) level," Hassell said.

The LGFA's Statement of Intent also notes it'll operate with the primary objective of optimising the debt funding terms and conditions for participating councils. This includes providing debt to councils at the lowest possible interest rates commensurate with the relevant debt maturity, making longer-term borrowings available to participating councils, and enhancing the certainty of access to debt markets for local authorities.

Pre-establishment costs ran to NZ$4.6 million with the LGFA expected to lose NZ$4.4 million in the year to June 2012, then deliver a NZ$1.2 million profit the following year and a NZ$1.6 million profit in the year to June 30, 2014 paying NZ$700,000 dividends in each of the June 2013 and June 2014 years. It's targeting total liabilities of NZ$1.56 billion by June 2014 and total assets of NZ$1.6 billion giving total equity of NZ$43.8 million.

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