Australasian government-sector issuers’ funding views
In January 2017, KangaNews asked Australia and New Zealand’s most significant government-sector borrowers to share their views on funding strategy, liquidity conditions, issuance avenues and demand profile. The sovereign, agency and semi-government issuers explain how their strategies attempt to deliver consistency even as they adapt to both market realities and the ever-changing nature of their funding tasks.
LIQUIDITY MANAGEMENT
Craig Bond liquidity seems to be ever-more concentrated – and not just by issuer but by specific lines or liquidity points. Are issuers thinking about concentrating their issuance into the most liquid points on the curve to take advantage of apparent investor preferences? Could the market move towards less consistent intra-curve volume?
We have always been and will continue to be very conscious of liquidity. We discuss liquidity at investor meetings because it is important that investors know what we are trying to achieve.
As an example, I’d point to the repurchase of the December 2017 bond, which we have been undertaking over the past six months. So far, we have bought back around NZ$3 billion (US$2.2 billion) of this line. Buying back our older lines helps investors recycle their stock and avoid capital-intensive holdings. These kinds of activities support investor and intermediary confidence, which in turn helps build liquidity.
The shape of demand at the time of issuance and exposures from borrowing-client loans dictates the point of the curve on which we will focus. In the last year, TCorp has tendered bond lines where investor demand has been strong. We have also been active in tapping existing lines via our dealer panel.
TCorp is very active in managing mismatch risk on the balance sheet. We will therefore look at opportunities to issue across the curve in response to client borrowing demand and market conditions.
This investor migration is consistent with how we have accessed markets over time and we have received positive feedback about this approach. Having a curve and liquid benchmarks depends on the overall borrowing programme, but an issuer of our size can have a liquid curve.
During 2015/16, syndicated transactions, tenders and taps into our benchmark lines accounted for 100 per cent of issuance. This is clearly our strategy and it is a migration that we are consistent with. Having said this, we will issue outside our benchmarks to meet specific investor demand and will not issue exclusively in benchmark lines at the expense of being flexible.
At the moment, we are focusing on our 2028 line, which is our longest benchmark and the one that we are hoping to build out. It is unlikely that we will put a new benchmark line in place in calendar year 2017.
On top of this, as an organisation we are active in our own programmes and are very conscious of what we can do in our own portfolio to support liquidity. We are obviously unable to buy back every bond we have issued but what we can do is facilitate liquidity as much as we can within the confines of our own balance sheet. The issuance curve is a unique concept for the group of Australian semi-government issuers and is one of the strengths of our collective bond programme.
What might prevent the states having jumbo-sized bond lines going forward is risk limits and balance-sheet management. Having a concentrated risk profile makes refinancing a very difficult proposition, whereas a broad spread of benchmark bond lines diversifies the risk to the states’ balance sheets.
For the last five years, our strategy has been to achieve large, liquid lines because we believe greater liquidity in bond tranches will lead to tighter spreads over an interest-rate and credit cycle.
Liquidity doesn’t just mean larger lines, though. For the New Zealand Local Government Funding Agency (LGFA), liquidity is having our bonds held by a diverse set of investors and LGFA providing support to our banks so they can continue to make markets in our bonds. We have an ongoing funding programme so we need liquidity in our bonds.
This is why we track turnover so closely. We estimate there is around 3-4 times more secondary-market activity than our primary issuance on a monthly basis, and this is growing. Given we now issue almost monthly, we need a healthy secondary market to ensure these bonds are finding homes.
Issuance focus - long-dated bonds
In 2016, the Australian Office of Financial Management (AOFM) debuted a 30-year Australian Commonwealth government bond in a record-breaking, A$9.6 billion (US$7.2 billion) syndication. Demand for long-dated paper is evident, but how many will follow the AOFM remains to be seen.
JONES We have had appetite to lengthen the duration of the funding portfolio, in line with the assets on the Crown’s balance sheet, for several years. However, we are also conscious that in doing this we must get the right mix between outstanding bond volume, available capacity and overall liquidity in each line given the total funding requirement of the Crown.
Earlier in the 2016/17 fiscal year we extended the nominal bond curve by six years, issuing the longest bond in the New Zealand Debt Management Office (NZDMO)’s history – the April 2037 nominal bond. In the near term, our focus is on building liquidity in this line through regular tendered issuance.
Even though we can’t pump large volumes into liquid buckets, what we do have is our credit rating and the explicit guarantee of the Commonwealth of Australia.
In times of crisis, investors tend to head for the best credit available. I also think it is important to remember that large lines do not always mean actual liquidity for an investor. It does not matter how large the buckets are, the line is not liquid if the investor can’t get a price for the stock. This is what happened in the fourth quarter of 2008.
Craig How would issuers characterise liquidity in their bonds through the course of 2016? What we are particularly interested in is investor feedback issuers have received and any noteworthy changes in observed secondary-market conditions.
We haven’t received any negative feedback around liquidity in the past year. Based on our data, on an annualised basis about 70 per cent of our total outstandings is turning over in the secondary market. This is reasonably high on a global scale for benchmark lines.
We have always been very careful not to oversell the extent of liquidity in our lines so investors are under no illusion around how much liquidity there is in LGFA bonds.
As well as solid turnover, anecdotally we hear from investors that liquidity in New Zealand held up very well relative to other global markets during 2016.
SAFA is structured as a department of state finance rather than a treasury corporation. Given this different structure compared with other states, and the comparitively small size of our balance sheet, we are unable to transact in our own paper to help support market liquidity.
We are very clear to investors that SAFA bonds may not have equivalent levels of liquidity to some of our peers’ bonds. Investors who buy SAFA do so because they like the investment, not to trade the bonds because they believe there is excellent liquidity in the paper. The fact is bonds do turn over but investors may either need to pay a small concession for this or appreciate that it may take a little longer to access or divest their investment.
We have heard from investors, and this is probably not a great surprise, that liquidity improves significantly around the time of new primary issuance. We are seeing a bit of a split in investor preference. Some prefer to deal via primary transactions either by syndication or tender. For others, it suits better from a timing perspective to operate in the secondary market.
Bid-offer spreads have not blown out and we don’t have investors coming to us saying liquidity is in crisis. I think the biggest issue with liquidity is supply side, since many of the states’ new-money requirements are smaller. This has created some investor angst. Obviously, the Commonwealth government has moved in the opposite direction with a strong supply of bonds in the marketplace.
The result is that the semi-government bond spread has narrowed quite significantly – to the point where many investors have become ambivalent as to whether they hold a Commonwealth or a semi-government bond. This is an area we are watching for the future.
I would note, however, that any time the semi-government bond spread widens we have immediate investor interest. Overall, demand is certainly still there. It is just a matter of how the relativity sits on any given day.
TCorp continues to provide liquidity in its own bond lines where it is able to do so, and this is an important differentiating factor for us as a semi-government issuer. We do this using our dealer panel, by buying and selling bonds or engaging in switches.
This also provides liquidity and turnover to the market and is particularly important given the banks aren’t in a position to provide as much liquidity as they used to do.
MARKET-SHAPING DYNAMICS
Craig Australian Prudential Regulation Authority (APRA) statistics show that authorised deposit-taking institution (ADI) holdings of Australian Commonwealth government bonds (ACGBs) increased quite substantially in 2016 while holdings of semi-government bonds remained relatively stable. What have issuers learned, including from investors and dealers, about domestic ADI demand dynamics in 2016?
Our perception is that ADIs’ holdings of QTC bonds were relatively stable over the course of 2016 or possibly their holdings grew very modestly as a collective. So while we have seen growth in holdings of government bonds this has been accretive and not necessarily at the absolute expense of semi-government bonds.
Issuance focus - inflation-linked bonds
The Australian and New Zealand sovereigns were the only issuers in the Australasian government sector to place inflation-linked bonds in 2016. Both remain committed to the product, but there is little sign of an explosion in issuance breadth or depth.
JONES Inflation-linked bonds is a product we are very comfortable with as part of our funding mix, because of the fiscal variability offsets it provides and the investor diversification benefits it offers.
When we reintroduced the product in 2012, we noted that we would be committed to the product – and we remain so. An element of commitment is the provision of regular supply through tender to support ongoing liquidity. The New Zealand Debt Management Office is very comfortable with its current approach.
Thus we have been focusing more of our marketing efforts on fund managers and offshore investors. We have recommenced our offshore investor-marketing programme after a two-year hiatus and we are seeing the benefits of this. For instance, North Asian and European accounts comprised most of the 40 per cent offshore component of our 2024 syndication.
At present, we are the highest-yielding of the state-government issuers. This is attractive to some offshore investors and probably helped us achieve more than our fair share of the ADI market over the last couple of years.
We have also seen reduced supply from the semis. This slowdown in velocity of issuance has prevented investors from being able to access large volumes of semis in primary markets. Unless we see a global credit event it is very difficult to envisage a significant widening in the semis-versus-government spread. In this environment, the appetite for ADIs to continue to invest in ACGBs will remain.
Symonds Australian fund managers seem to be focusing more and more on liquidity in the contemporary environment, and as a result this investor sector appears to have developed a clear preference for large, liquid bond issuers and lines. Have government-sector issuers benefited by attracting more local fund-manager interest?
We find that some investors have a strong preference to participate in new issues as a liquidity play while others tend to be more active in the secondary market.
Our offshore investors are also very focused on liquidity, and invest in bond lines that are large and liquid. Overall, participation from real-money accounts in our primary issuance has been stable over the past year.
If we look at statistics over time our offshore portion remains relatively static in the 15-20 per cent band. Our ADI market has grown to account for 40 per cent, and this growth has obviously been at the expense of the domestic real-money investor.
Having said this, in recent times I believe we have benefited from investor focus on liquidity. The semi-government sector remains the liquid, risk-free asset class between Commonwealth bonds and the bottom end of the corporate and bank curves.
We are witnessing increasing interest from superannuation funds in infrastructure investment and I think this trend will continue into the future. But these funds need to retain a portion of their portfolio for liquid assets, and the semi-government sector remains one of the most liquid assets in the market.
Issuance focus - green bonds
Interest in green-bond issuance appears to be growing for some, though far from all, Australasian government-sector issuers. So far only one – Treasury Corporation of Victoria (TCV) – has come to market, but further deal flow may not be far away.
BISHOP It has been on our radar in the last 12-18 months in particular. The main reason for us to explore a green-bond transaction is that, as a New Zealand council, we pride ourselves on being environmentally friendly. From a reputational point of view it would be a beneficial funding option for us. On top of this, there is an aspect of investor diversification that could be achieved via green bonds.
Even so, domestic fund managers are more engaged with our programme than they were three or four years ago – owing in part to SAFA’s consistent issuance activity during this period. This approach has enabled us quite easily to engage domestic investors in conversations.
Symonds What can New Zealand issuers say about the current state of play in domestic demand?
We have seen rapid growth in our offshore bond holdings since 2009. The pleasing element is that over this period the proportion of on- and offshore holdings has stayed reasonably steady in a range of 60-65 per cent, with growth in the onshore component being supported by both local bank liquidity requirements and KiwiSaver growth over the period.
More generally, demand for LGFA paper is solid. Now that we have a liquid curve we are seeing investors taking curve positions in our bonds, so some of our turnover is made up of switching and not just buying and selling. It is a sign of a healthy market when investors are not just buying and holding to maturity.
Our assessment of the local market is that demand is very strong. But it’s important to note that the demand patterns we are seeing in our bonds may be quite different from other issuers’ experiences. The LGFA has established a liquid curve and our bonds offer a pickup relative to NZGBs, with the same credit rating as the government.
INVESTOR ENGAGEMENT
Craig How important is it to issuers to maintain global investor-relations work even when these buyers are not ‘needed’?
We have differentiated ourselves by having 144A capability in our Australian dollar programme. This gives us the ability to sell primary issuance into the US 144A market and is a very tangible example of how we have tried to create a product that is as attractive as possible to the broadest investor base.
Having the greatest level of diversity in the investor base is most important, because this is what provides stability and reliability over time.
We find the offshore bid to be generally reliable throughout our funding year. As for which specific groups of investors are going to be more or less active at particular points in time, this is not as predictable.
We find that investors still want to talk to us even when they may not have an immediate investment intention. There are different ways investors look to come into Victoria, and a core understanding of the state’s credit and the government’s fiscal-management credentials are the basis for this.
So when we talk to investors it’s not just about TCV bonds – it’s about direct investment opportunities too, either through infrastructure investment, both debt and equity, or direct business investment. It all starts with putting Victoria on the global investment map.
Issuance focus - foreign-currency deals
The Australian Office of Financial Management is barred by law from foreign-currency issuance. Auckland Council debuted in the euro benchmark market in January 2017. In general, government-sector issuers are closer to the former position than the latter based on relative-value considerations.
BUSH I don’t envisage an immediate change in the relevance of foreign-currency issuance and our benchmark lines will more than likely remain the cornerstone of our funding programme for the foreseeable future. We are open to issuing foreign-currency denominated bonds if market opportunities are compelling. There are no ideological obstacles to other products, but they need to be competitive with respect to our core product – which is our benchmark, domestic currency bond lines.
One of the benefits of engaging with investors is the opportunity to ensure they are aware of technical factors and they fully understand supply developments in the government and semi-government space as well as the relevant economic factors. Investors who are fully versed in these dynamics can make their decisions based on all the information and not just on information on one issuer’s plans for its programme.
In 2016, TCorp visited the US, Europe, UK, south-east Asia, Japan, Korea, China and Hong Kong. TCorp has also visited investors based in Sydney, Melbourne and Brisbane.
Communication with investors is extremely important to TCorp. Investors appreciate us informing them about activities in New South Wales, including the impact of the long-term state asset leases and how they affect TCorp’s borrowing requirement.
If we can’t see our investors face-to-face we offer them conference calls. Consistency and making oneself accessible to investors is very important – irrespective of the funding task.
Our programme has not changed significantly, so the key element of our investor-relations work is around updating investors on New Zealand’s economic and fiscal outlook, and our funding strategy.
Global investors continue to see value in our spreads – a situation which is a little different from the recent experience of the Australian states. We still offer, as a spread to NZGB, a 35-90 basis points pick up in yield, and we have remained at this level for about the last year.
When global investors allocate to New Zealand bonds they are taking an overweight exposure relative to the indices so they need to be confident about the credit. This is why we focus heavily on ensuring that they understand both the New Zealand and the LGFA story.
We have seen investors in Japan several times now and we have noticed a big difference in their familiarity with our story relative to investor groups with which we have not spent as much time.
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