Roger J Kerr notes there are 'winners all round' with the launch of LGFA bonds. Your view?

 By Roger J Kerr

Apart from term swap interest rates continuing to turn upwards last week in response to generally stronger than expected local economic data (housing, retail sales and farm incomes), the highlight of the week was the inaugural issue of Local Government New Zealand (“LGFA”) bonds to the market.

Our advisory firm kicked off this initiative to consolidate and aggregate local government debt some four year ago.

It was very satisfying to see the project come to fruition with the establishment of the LGFA and a successful first bond issue.

The issuance margins at 80 basis points over NZ Govt Bonds for the 3-year maturity and 118 over for the almost 6-year term were generally below pre-tender expectations from bank dealers and fixed interest brokers.

While the demand from investors was strong with 4.4 time coverage in the tender (the NZDMO average 2.9 times coverage in NZ Govt Bond tenders), the margins were a little higher than what I thought may have been obtainable for the first issue.

There was certainly a fair amount of uncertainty around the price discovery process with this being the first ever tender.

Equivalent benchmarks of Australian “semi-Government” State Treasury Corp trade between 110 to 130 basis points over Commonwealth of Australia Government Bonds. The LGFA December 2017 bonds were issued at a yield some 25 to 30 basis points below what equivalent term Auckland Council bonds trade at.

What was encouraging for the LGFA for future issues is that the 2017 bond traded down five basis points in yield in the secondary market after the primary issue tender.

Another tender of the 2017 bonds within a few weeks should see some of the unfulfilled investor demand produce even lower issuance spreads to NZ Government bonds.

There was a fair amount of market opposition to consolidating local government debt into a single issuer in the early days. Not only did the individual council borrowers need to be convinced that the change was going to be worthwhile; a number of the fixed interest fund managers, bankers and brokers who invested into and arranged individual council debt issues were wary about the status-quo changing.

However, it was always our belief that local government debt was mispriced (i.e. spreads to swap and NZ Government bonds too high) in the New Zealand debt market as there was no proper competitive tension in the pricing as Councils could not issue debt outside New Zealand.

The big advantage the LGFA now has is that if investors in New Zealand start pricing the spreads up, LGFA can issue its debt offshore - thus much greater power as a borrower to control credit spreads through supply and demand of its bonds into the domestic market.

For Mum and Dad investors there is now a high quality, high rated, highly liquid non-Government fixed interest security available that delivers a yield return well above short-term bank deposits.

For institutional funds managers there is another high quality fixed interest asset class to invest into that is not Government and not bank risk.

For Council borrowers there is now both term and pricing advantages.

For ratepayers there is the benefit of lower cost debt, which would have to be the only local government cost that has reduced in a very long time.

Winners all round really.

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* Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com