Interest Rate Research
Strategy
21 December 2016
O Come All Ye Faithful
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•
•
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Global risk appetite is supportive of New Year 2017
‘Kauri season’
Demand for NZD rates product has faded a little
Some compromises will also be required on pricing
Overall we see a steady rather than explosive
issuance season
But issuance later in the year will likely be supported
by significant maturities due in H2
Another Solid Year of Issuance in 2016
Kauri SSA Issuance
$NZm
7,000
36%
42%
6,000
31%
51%
5,000
4,000
45%
3,000
0%
14%
Overall, 2016 was another solid year of Kauri issuance.
However, after a strong start, issuance petered out in
the latter part of the year, with only one recent issue
since early-August. Still, as issuance has outpaced
maturities over the past 18 months, total outstanding
Kauris have increased from NZD23b to NZD28b,
according to RBNZ data.
We are now approaching the time of year that faithfully
shows strong Kauri issuance. Over the past four years,
30-50% of annual Kauri SSA issuance has occurred in the
first two months of the year. We look at the prospects for
‘the season’ and the full year ahead, broken down into
supply and demand considerations:
Supply Considerations
Along with the normal seasonality, SSA issuers may want
to issue promptly this new year while healthy global risk
appetite reigns. Our global risk appetite index currently
sits at a hearty 70%, its highest level since November
2014. Myriad political or economic risks could undermine
this in the year ahead.
The decision by SSAs to issue in NZD will primarily be
determined by pricing. But it will also be influenced by the
secondary purpose of diversifying funding sources. Within
the NZ market, making the pricing equation work for
issuers and investors depends on both NZ basis swap and
swap-bond spread levels. (Pricing works best for issuers
when basis swap and swap-bond spreads are higher).
Currently, these appear at decent levels for issuance.
NZ 5-year basis swap levels are much higher than at
the start of 2016 (chart next column) and swap-bond
spreads are within the upper portion of their current
10-40bps range.
This enhances the potential for new issues (issued relative
to swap) to appear attractive to investors who may
compare value relative to NZGBs.
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2,000
0%
2%
66%
1,000
0
2007
2008
2009
2010
2011
2012
2013
2014
2015
Kauri SSA full year issuance
2016
ytd
(%) proportion of full year issuance implemented in Jan-Feb
Source: Thomson Reuters, BNZ
Making pricing work relative to offshore alternatives may
be the greater near-term challenge. Current indicative
pricing in the secondary market (table over page), shows
Kauri SSA might have to work hard for competitive
issuance levels relative to AUD and USD equivalents.
That said, precise pricing will take into account additional
factors relevant to the primary market. In addition, the
desire to maintain market presence will likely be a factor
in choosing to issue in the NZD market.
Demand Considerations
Aside from outright price, there are a number of factors
that will impact on investor demand for Kauri SSA new
issuance. These include: sentiment toward NZD product
more broadly, the extent of pending Kauri maturities,
relative value and broad risk appetite.
Basis Swap & Swap Spreads At Decent Levels For Issuers
(bps)
(bps)
50
70
45
60
40
50
35
40
30
30
25
20
20
10
15
Jan 2012
Source: Bloomberg
Jan 2013
Jan 2014
NZ 5-year basis swap
Jan 2015
Jan 2016
0
Jan 2017
NZ 5-year swap-bond spread (rh)
Page 1
Interest Rate Research
21 December 2016
Relative Pricing of SSAs in the Secondary Market
Issuer
Crcy
Bond
IBRD
IBRD
IBRD
Asian Development Bank
Asian Development Bank
Asian Development Bank
Kommunalbanken Norway
Kommunalbanken Norway
Kommunalbanken Norway
Rentenbank
Rentenbank
Rentenbank
NZD
AUD
USD
NZD
AUD
USD
NZD
AUD
USD
NZD
AUD
USD
IBRD. Jan 21
IBRD. Jan 21
IBRD. Mar 21
ASIA. Apr 21
ASIA. Jan 21
ASIA. Mar 21
KBN. May 21
KBN. Apr 21
KBN. Feb 21
RTB. May 21
RTB. Apr 21
RTB. Mar 21
Increased Maturities in 2017
NZD USD ASM Difference
ASM ASM
to NZD Bond
48
22
42
16
-6
44
16
-6
50
23
43
16
-7
45
16
-7
71
43
71
43
0
59
31
-12
58
31
50
23
-8
53
25
-6
$NZb
6000
5000
4000
3000
2000
1000
Source: NZFMA,NAB, Yieldbroker, Bloomberg. *indicative pricing only, as at 21 Dec 2016
0
2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
Demand for NZD Product
Kauri SSA Maturities
Source: Thomson Reuters, BNZ
Over the course of 2016 there appears to have been a
modest decline in offshore demand for NZD rates
product. This was seen across NZGBs and Kauris. Nonresident holdings of NZGBs declined from a peak of 70%
in 2015, to 64% currently. Similarly, non-resident holdings
of Kauri bonds have declined from 47% to 44% this year.
These are still good levels on an historic basis. However,
contributing factors to reduced appetite have likely been
(i) 175bps of OCR cuts over the past 18 months that have
reduced the yield differential between NZ rates and their
offshore equivalents (ii) increased NZD currency concern
as a strong USD trend re-asserted itself earlier this year.
But the NZD has actually shown itself to be remarkably
resilient to USD strength. Furthermore, although there is
likely further downside to the NZD/USD in this cycle,
Reduced Proportion of Offshore Holdings of Kauris
(%)
(%)
48
18
replacement demand from investors as maturities roll-off,
later in the year. But this will be less of a driver of demand
early in 2017.
Relative Value
Relative value will remain a dominant driver of demand
for Kauri SSAs. Spread to NZGBs remains a crucial point
of reference. Spreads to the likes of LGFA
(Local Government Funding Agency) bonds may also
be important. Offshore investors may also compare the
value of similar SSA issues in different currencies.
Currently, core ‘Washington’ names trade at fairly
attractive valuations relative to NZGBs. Spreads on core
low-beta SSAs now sit toward the upper-end of their
range of the past few years (chart below).
However, European-associated names do not trade much
wider than ‘low-beta’ names. In some cases this may be
justified. But the premium that was applied for ‘European
16
46
14
44
‘Washington’ Names Near Top Of Range To NZGBs
12
10
42
8
40
6
(bps)
90
80
4
70
2
60
0
Nov 2016
50
38
36
Jul 2015
Source: RBNZ
Nov 2015
Mar 2016
Jul 2016
Proportion held by non-residents
Proportion held by financial corporations
Proportion held by central government (rh)
Other (rh)
we see it as fairly limited. Our forecasts see a trough in
the NZD/USD around 0.6700 later in 2017. We also see
little further downside to the trade-weighted NZD and
crucially, expect the NZD to hold its own against the AUD.
Maturities
After limited Kauri SSA maturities in 2016, 2017 is the first
year in a period of much more significant maturities.
(chart next column). About NZD5b of bonds will mature
this year, although mostly late in the year. Only NZD700m
is set to mature in Q1. This suggests potential for
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40
30
20
10
0
Aug 11
Source: BNZ
Aug 12
Aug 13
Aug 14
IBRD (interpolated) 5-year spread to NZGB
Aug 15
Aug 16
average
risk’ during the heights of the European crisis has now
virtually been eliminated (chart over page).
The inclusion of some European SSA names in the ECB’s
bond buying programme may be helping to support these
issues in EUR. But within the NZD market their pricing
relative to ‘low-beta’ names leaves little room for adverse
developments in the Eurozone area in 2017.
Page 2
Interest Rate Research
21 December 2016
Very Little European Risk Premium
Spread To Swap Impacted By General Credit Risk Appetite
bps
Kauri And LGFA Spreads To Swap
(bps)
200
90
180
80
160
70
140
60
120
100
50
100
80
40
80
60
30
60
40
20
40
10
20
180
160
140
120
20
Spread to Swap
0
Aug 2009
Source: BNZ
Aug 2010
Aug 2011
Aug 2012
Aug 2013
Aug 2014
Aug 2015
IFC 6.25% 15/12/17
RTB 7.49% 15/12/17
BNG 7.27% 15/12/17
COE 7.50% 30/04/18
Aug 2016
For those comparing SSA issues across currencies,
demand in the secondary market may be supported by the
value of some Kauris relative to USD and AUD equivalents
(table, top of page 2). The challenge will be at what levels
primary issues are priced at. In addition, aside from
apparent relative value, investor preferences will also be
influenced by currency views. In this regard, as already
explained, we do not see significant downside risk for the
NZD, either against the USD or AUD.
Broad Risk Appetite
Demand for, and pricing of Kauri SSAs will be impacted by
large swings in broad global risk appetite. We have found
the iTraxx Australia Index 1 is the best indicator for this
purpose. When global risk aversion is expressed in a
sustained and extended rise in this index we find that NZ
credit spreads tend to feel the impact (chart next column).
We continue to see circa 140 on this index as the ‘danger’
level for NZ credit spreads. With the current reading at
104bps, it suggests a fairly fertile backdrop of sentiment
to assist demand for new Kauri issues.
0
Jul 13
Source: BNZ
0
Jan 14
Jul 14
Jan 15
Jul 15
NIB 4.13% 19/03/20
RENTEN 4 01/30/20 Corp
iTraxx Australia index (rh)
Jan 16
Jul 16
IFC 3.63% 20/05/20
NZLGFA 3 04/15/20
In summary, if solid risk appetite prevails in the coming
weeks it will likely prompt SSA issuers to get out of the
starting blocks early with their seasonally strong new year
issuance. The challenges for SSA issuers in the Kauri
market will be (i) some apparent decline in offshore
demand for NZD product (ii) relative pricing to offshore
alternatives.
However, current secondary market pricing for core lowbeta names appears fairly attractive for investors relative
to NZGBs. Therefore some compromise will likely be
required between issuers and investors on pricing, with
the first issues acting as test cases. We expect this may
lead to a steady rather than explosive ‘Kauri season’.
However, issuance over the full year may be supported by
a heavy schedule of maturities in H2, which may also lead
to additional replacement demand.
[email protected]
1
The index comprises 25 equally-weighted investment grade
Australian entities. The CDS index represents the price of
protecting against the risk of default of constituents.
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Interest Rate Research
21 December 2016
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