In our last issue of “Treasury Broadsheet” in August 2008 we intimated that corporate borrowers in New Zealand would be attracted to issue bonds to retail investors as market interest rates fell and bank lending margins increased. The investor demand and issuer interest to meet that demand has been spectacular ever since. Mum and Dad investors has rushed the attractive yield returns on offer compared to plummeting bank deposit rates to 3.00%. The numerous corporate issuers have thrown previous “margins above swap” credit spread benchmarks out of the window and concluded that a 6% and 7% all-up borrowing cost suits them in the wider context of a credit-restricted world. The increase in volumes issued has been impressive, as has been the level of insatiable investor demand. However the frenzy of activity in new issues coming to the market is raising some interesting questions about the management of debt in some of our major companies.

Why does corporate New Zealand suddenly need to raise a whole lot of debt through the corporate bond market when there are no major investment projects of takeover activity occurring? The answer is of course that most are re-financing existing bank debt. They want longer debt terms than what the banks are offering and they want to diversify funding sources away from over-reliance on banks. It is all a bit after the horse has bolted in our opinion. Why weren't these borrowers accessing the long-term US Private Placement debt market and credit-wrapped market when issue spreads where less than 100 basis points just a few years ago for 10 to 15-year money? They are now paying 400 points above swap for shorter terms! Their Board directors should be asking the serious question around funding risk management.

Fonterra receiving bids for $800m on a $300m retail bond issue tells you something about miss-pricing an issue. On this evidence the borrowers are paying far too much. It does raise questions as to the sort of advice issuers are receiving about demand levels in the retail investor market. The retail investors would have taken 6.75% in our view on the Fonterra bonds and the borrower would still get its money. Borrowers perhaps should be more cautious about who they use to organise such bond issues. If the organiser is a bank, who is also an existing lender to the company, than the conflicts need to be understood. However the main motivation is the 5 years plus term of the debt which is nigh impossible to get from the banks.

Fonterra should not be too happy at the massive over-subscriptions, it is certainly not a raging success. It tells us that the pricing was far too generous to the investors. Even though they have had their share of adverse publicity recently and some aspects of the bond offer where not as tidy as they should have been, Fonterra is a far stronger credit than what this bond issue pricing implies. To compare Fonterra's credit quality (as some financial media commentators have done) to be near to that of failed finance companies is totally inaccurate and mischievous. In terms of income and cashflow quality/certainty, if the near monopoly that processes our largest industry is scored the same as the moneylenders to property developers, then our economic/financial problems are far greater than we all think. The scaremongering from some quarters however had no impact on the very strong investor demand for the very generous yield return.

A summary of issues announced since October 2008 reads something like a who's who of corporate NZ:-

October

• Kiwibank Subordinated (A+) $60m, 10 years, swap + 185 bps.
• Telstra (A) $55m, 6 years, swap + 150.
• Auckland Int. Airport (A) $80m, 8 years, swap + 150.
• Fonterra (A+) $50m, 6 years, swap + 160.

November

• PGG Wrightson Finance (NR) $50m, 2 years, swap +365.
• Tauranga City Council (A) $30m, 5 years, swap + 75 (retail issue)
• TrustPower Subordinated Capital Notes (NR) $100m, 7 years, swap + ?
• Genesis Energy (BBB+) $120m, 5 years, swap +180 and $105m, 7 years, swap + 210.
• Fletcher Building Subordinated Capital Notes (NR) $112m, 6 years, swap + 340.
• Wellington Airport (BBB+) $50m, 5 years, swap + 220.

December

• South Canterbury Finance (BBB-) $100m, 1 ½ years, swap + 325.
• Auckland City Council (AA) $100m, 5 years, swap + 200.
• Auckland Int. Airport (A) $50m, 5 years, swap + 265.
• NZ Post Subordinated (AA) $150m, 5 years, not yet priced, likely to be swap + 400.
• Tower (NR) $100m, 5 years, swap + 450.
• Fonterra (A+) $300m, 6 years, swap + 340.