* Local currency debt issuance already over prior full-year record
* Drop in government bond sales leaves excess demand
* Stable currency and higher yields lure overseas buyers
By John Weavers
SYDNEY, Aug 26 (IFR) - As the New Zealand government scales back bond issuance, overseas appetite for the New Zealand dollar is driving a record year for the Kauri market, where foreign entities offer bonds denominated in the New Zealand currency.
Two deals in Kiwi dollars, as the currency is also known, last week lifted this year’s record total of so-called Kauri bonds, named after the country’s iconic giant trees, to more than double the amount raised in all 2012.
That shows investors are widening their hunt for assets in a currency seen as offering a relatively high yield for relatively low risk.
New Zealand government bond issuance is forecast to shrink to NZ$10bn (US$7.8bn) in the fiscal year that began on July 1. That is a big drop from the NZ$19.5bn issued in fiscal year 2010-2011 as reconstruction costs mounted after the Canterbury and Christchurch earthquakes.
Issuance had already fallen to NZ$13.5bn and NZ$14bn in the following two years.
The supply slowdown has been accompanied by an elevated bid from overseas investors for high-quality government bonds in non-core currencies. Foreigners owned 67.9% of New Zealand government bonds in July 2013, up from 60.1% in July 2011 and 62.8% in July 2012.
This demand has helped keep government bond yields relatively low in New Zealand which in turn boosted the attractiveness of Kauri bonds as spreads widened. It also meant that as investors found less government bonds available and wanted to continue to invest in bonds denominated in Kiwi dollars, they had to find other options.
Issuers have taken full advantage of this increased interest. Two deals last week by International Bank for Reconstruction and Development and International Finance Corp have brought year-to-date Kauri sales up to NZ$4.95bn. This is more than twice 2012’s NZ$2.3bn whole year total, and exceeds 2007’s NZ$4.3bn annual supply record.
New Zealand has become a prime destination for global investors in recent years given that its local bond market has offered a significant yield premium to Treasuries, in spite of the country’s high Aaa/AA/AA credit rating. The average premium offered by 10-year New Zealand government bonds over US Treasuries with the same maturity has ranged from 190bp to 250bp.
Meanwhile, the close-to-close volatility over 21 days of the New Zealand dollar has ranged from 6% to 12% in the past two years, remaining at the bottom of the band most of the time. With a track record of few nasty surprises, Kiwi fixed-income investments have become even more attractive.
Kauri issuers are typically well established, Triple A rated multilateral banks that provide an attractive pick-up over New Zealand government bonds in a currency where high-quality alternatives are limited. Hence, they have always been favored by local investors.
Local banks are especially keen on high-rated Kauri bonds, given that New Zealand regulators allow their use in repurchase agreements and as collateral for short-term interbank lending.
Foreign demand has also expanded, especially among Asian official institutions, asset managers and private banks. For IBRD’s NZ$500m five-year Kauri issue in February, for instance, New Zealand accounts were allocated 53%, Asia 46% and Europe 1%.
“In previous years over two-thirds of Kauri issuance might typically be bought by domestic investors, whereas this year the split has been more fifty-fifty with offshore accounts sometimes taking the majority,” said ANZ Bank New Zealand syndication manager Glen Sorensen.
The other major factor behind the Kauri market’s expansion has been the relative rise of Kiwi swap rates, particularly in comparison with Australia.
Kiwi five-year swap rates were around 100bp below Aussie five-year swap rates in December 2011. This represented a significant disincentive for international investors to buy in New Zealand dollars when the same names were available in Australian dollars at a higher yield.
However, the subsequent turnaround has been dramatic, with Kiwi five-year swap rates 71bp higher last Wednesday at 4.37% versus 3.66% in Australia.
The redemption of a jumbo, NZ$11.4bn New Zealand government bond on April 15 this year also forced investors into large Kauri deals at the start of 2013 as they sought to reinvest in the same currency.
The supply and demand equation looks good for next year, too. The government is due to redeem a NZ$10.805bn bond in April 2015, and the New Zealand Debt Management Office sees a further decline in government bond issuance in 2014-2015 to NZ$8bn.