By Bernard Hickey If John Key was still an investment banker, this deal would have earned him a big enough bonus to buy another bach at Omaha. As New Zealand Prime Minister he will receive nothing more than a thank-you from New Zealand's biggest bank and a quiet pat on the back from Reserve Bank Governor Alan Bollard. But John Key should get a good part of the credit for a deal that has paved the way for New Zealand's banks to start borrowing for long terms again on international markets. It's a deal that is unlikely to win him an election or even get him a mention on talkback radio, but it is a deal that makes New Zealand's banking system, and therefore the economy, that little bit safer. On Friday ANZ National confirmed it raised US$1 billion through an issue of government guaranteed three year bonds to US investors. In the days before the Credit Crunch froze credit markets in September last year this would have been an unremarkable announcement. Even now, most of the mainstream media ignored it. Fair enough. It's a long way from the real world, but actually not as far as many would think. Here's how the deal played out and why Key's comments in a newspaper interview turned out to be worth at least US$1 billion.
Back in July last year New Zealand's largest bank, ANZ National, raised US$2 billion with a five year bond issue to US investors. It was difficult and expensive even then, but another such bond issue became impossible after the collapse of Lehman Bros in September, which froze credit markets for months. By October governments all around the world were having to offer government guarantees for such bond issues because investors had lost faith in all banks. The New Zealand government, in the final days of Helen Clark and Michael Cullen, also offered such a guarantee. The cost of this wholesale guarantee was then set at 140 basis points. The assumption was that New Zealand banks would be able to use the wholesale guarantee reasonably quickly and reduce their vulnerability to a complete freeze on credit markets. For some time the Reserve Bank has been pushing the banks to borrow longer term offshore than the 30-90 days that banks are using currently to roll over their foreign debt, which makes up about 40% or NZ$94 billion of the banks' total funding of NZ$234 billion. The longer it took for banks to refinance on terms of three years or more, the greater the vulnerability of New Zealand's banking system. The quicker the banks could start borrowing long term the better. The details of the wholesale guarantee were announced on November 1. The parent Australian banks started using the Australian government guarantee heavily just before Christmas. Reserve Bank Governor Alan Bollard expressed confidence in early December that New Zealand banks would be able to use the guarantee soon. Then...nothing...until a bombshell. On January 13 Standard and Poor's revised the outlook on New Zealand's AA+ sovereign credit rating to negative because of our rising twin deficits (current account deficit and budget deficit). In the eyes of international investors New Zealand sovereign guaranteed debt, like that to be issued by banks, was damaged goods. New Zealand had to demonstrate that it was going to get its public debt under control if it wanted to keep that credit rating. International investors lumped us in the same basket as Ireland, Spain and a host of others on notice of a downgrade. Since then, every decision in cabinet, every razor gang and every cap on core public sector staff numbers has been aimed at reassuring Standard and Poor's that New Zealand should keep its credit rating. A downgrade would have the immediate effect of increasing New Zealand interest rates. A few weeks after the downgrade warning, Bollard and Treasury Secretary John Whitehead jumped on a plane to reassure international investors ahead of any guaranteed bank bond issues. A clearly exhausted and flu-racked Bollard told reporters on his return that he was confident New Zealand would keep its credit rating and that the banks would be able to raise money with the guaranteed bonds. Treasury even cut the fee for the wholesale guarantee to 90 basis points from 140 basis points to make sure the bonds could be issued. And then....nothing. Weeks went by. Some bankers began to think a guaranteed bond issue would not be possible until the budget on May 28 at the earliest. This is the earliest that Standard and Poor's could give New Zealand the tick. Finance Minister Bill English would have to prove in that budget that the public debt track is under control, rather than rising forever into the forecasting distance as it was in the pre-Christmas budget forecast. Under this scenario, New Zealand would have been locked out of the inernational long term debt markets for almost a year. Then something either lucky or very well orchestrated happened. Prime Minister John Key gave an interview on the 9th floor of the Beehive to Mary Kissel, the editorial page editor of the Wall St Journal Asia. Key took a quite different approach to dealing with the recession than he had in his comments up until then to the New Zealand media. He said inflation was his biggest fear and he saw no point in the government trying to borrow and spend its way out of a recession. Here's a taste.
That's "risky," Mr. Key says (of borrow and spend). "You've saddled future generations with an enormous amount of debt that then they have to repay," he explains. "There is actually a limit to what governments can do." "Economic theory will tell you that inflation is going to rise -- and that inflation will be exported around the world. . . . In the short term, I'm not criticizing U.S. policy: I think inflation is probably the thing that's going to be necessary to get them out of the current issue. [Federal Reserve Chairman Ben] Bernanke sort of signaled that. But longer term, inflation is cancerous to your economy"
It turned out this was music to the ears of international investors worried about too much borrowing, too much money printing and too much inflationary risk. Many in the Northern Hemispher are deeply sceptical of the Barack Obama/Gordon Brown approach to dealing with the Great Recession. John Key stood out as a Prime Minister who was a fiscal conservative at a time of fiscal spendthrifts. His pitch to this crucial audience was just right, as was the vehicle of the Wall St Journal. This certainly wasn't the Key we heard before the election, or the one who had said at various stages late last year and early this year that the government would play a large role in boosting the economy. But it was the right Key at the right time. And it was a view consistent with a more fiscally conservative Bill English. Last week ANZ National CEO Graham Hodges went to the United States for a roadshow to promote this US$1 billion bond issue. Its success was no sure thing. Time and again, Hodges says, investors told him Key's interview in the Wall St Journal had reassured them, despite the uncertainty of a potential credit rating downgrade. Sometimes it's a struggle to get foreign investors to look past the shorthand of credit ratings and the headlines of research notes. Key's interview made them sit up and take notice. Hodges said it seemed to strike a chord. It turns out the interview was a crucial factor in the success of the bond issue, the first long term issue by a New Zealand bank since July last year. It is likely to set the tone for more. The Reserve Bank will breathe a little easier. We can be a little bit more confident that if the world's financial markets were to shut down completely, which they did for a few weeks in September and early October, then our banks would not be forced to shut down their lending. John Key may well have already earned his salary for this year. No bonus though. They're not so popular in this day and age.