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* Kauri bonds struggle as relative pricing advantage fades (Recasts with reopening of market via KBN tap)
By John Weavers
SYDNEY, May 8 (IFR) - Norwegian local government funding agency Kommunalbanken Norway is set to become the first foreign issuer to raise debt in New Zealand since the so-called Kauri bond market stalled in late February.
The Aaa/AAA (Moody's/S&P) rated agency will make a NZ$50 million ($34 million) minimum tap of its NZ$325 million 4.00% August 20 2025 Kauri bond via sole lead manager ANZ.
So far this year, only four sovereign, supranational or agency (SSA) issuers raising just NZ$1.3 billion ($910 million) from five trades.
This is less than half the NZ$3.2 billion issued in the same period last year, when 10 SSAs accessed the New Zealand bond market in 14 separate deals.
In the whole of 2016, issuance of Kauri bonds, the nickname for local Kiwi dollar offerings from foreign issuers, reached NZ$4.8 billion, which was well below the 2014 annual record of NZ$6.3 billion, which was matched the following year.
Glen Sorensen, syndication manager at ANZ Bank New Zealand, said the contraction had been largely supply-led, as more potential SSA issuers utilise the strong US dollar and, to a lesser extent Kangaroo, markets where spread compression has been greater so far this year.
On the buyside, the declining absolute yield pick-up for high-grade New Zealand paper has dented offshore demand. Non-residents held 42.4 percent of the NZ$28.7 billion outstanding Kauri bonds in March 2017 versus 47.5 percent of the NZ$25.6 billion total a year earlier, according to Reserve Bank of New Zealand data.
The five-year New Zealand government benchmark bond spread over US Treasuries was close to 300 basis points (bps) in November 2013, but dropped subsequently to 195 bps at the end of 2014, 120 bps at the end of 2015 and 75 bps at the end of 2016. The spread narrowed further in 2017 and was quoted at 62 bps last week.
With Kauri supply falling, domestic high-grade investors have sought alternative assets, thereby increasing the local bids for sovereign and Local Government Funding Agency bonds, both of which are rated AA+/AA+ (S&P/Fitch).
This increased demand has put downward pressure on central and local government bond yields to the extent that the sovereign's 5.5 percent April 2023s were yielding 2.67 percent last week, 33bp below local swap rates.
This downward yield pressure is set to increase as net central government supply turns negative. For fiscal year 2016–17, ending on June 30, domestic sovereign bond sales are projected to amount to NZ$8 billion, and NZ$2.5 billion of this is to be raised through inflation-linked paper.
With NZ$2.2 billion of redemptions due in the 12-month period, the New Zealand Debt Management Office sees net issuance of NZ$5.8 billion for the current fiscal year, before redemptions exceed gross issuance in the following four years by NZ$2.1 billion, NZ$4.5 billion, NZ$1.3 billion and NZ$5.1 billion, respectively.
Furthermore, almost 20 percent of outstanding government bonds are index-linked and, as such, appeal to a specialist investor base. They are not a relevant Kauri alternative for high-grade nominal bond investors.
Kauri supply is usually front-loaded with, for example, NZ$5.1 billion of 2015’s NZ$6.3 billion whole-year total raised between January and June, but Sorensen believes there is scope this year for a better second half of primary activity than is typical.
“Kauri supply has traditionally been very light at the end of calendar years, but, given the solid amount of Kauri and LGFA redemptions in December 2017, as well as the maturing NZ$7 billion NZGB 6.0 percent December 15 2017s, there will be plenty of high-grade money around looking to refinance,” he said. (Reporting by John Weavers; Editing by Daniel Stanton and Vincent Baby)