New Zealand's debt market is experiencing the perfect storm in terms of interest rates, investor appetite and issuers' preference, writes Jonathan Underhill

New Zealand's listed debt market tells a good story at the moment -- the average bond yield is more than 200 basis points below the bond's coupon rate, according to NZX data.

There's just one problem: most Mum and Dad savers have no idea what that means.

In plain language, NZDX bonds on average are becoming more valuable. For an investment that started life as a fixed interest opportunity paying better than the bank, that makes them particularly attractive. Six years ago, the average yield and coupon (the fixed interest rate on a bond) were just 30 basis points apart.

Bonds are currently in a sweet spot. Investors are hungry for yield and willing to look at fixed-income securities that offer more than bank deposits with less risk than stocks.


On the sell side, things are sweet too. The new Financial Markets Conduct Act makes it easier for corporates to issue bonds, allowing them to make offers on the strength of a two-page term sheet rather than a full prospectus, provided they've sold bonds previously or are already listed with the NZX.

Telecommunications network operator Chorus raised $400 million this month selling May 2021 bonds that pay 4.12 per cent annual interest. It used the funds to repay most of the $450 million it had drawn against a bank facility that matures in July, reducing its interest costs in the process.

For Chorus chief financial officer Andrew Carroll there are other attractions -- the bonds offer ease of execution, more flexibility than bank facilities with their covenant requirements, lower costs and the ability to issue longer-dated debt that matches Chorus's long-term assets.

"When we speak to the brokers they say retail investors are getting such terrible returns from the banks at the moment. They're looking for these types of investments," Carroll says. The 2021 bond issue was "well oversubscribed".

It's "scratch me, I'm dreaming" time for well-rated issuers, given the prolonged period of low interest rates. In March, Auckland Council raised $250 million selling four-year bonds at a coupon of 3.04 per cent, a record low for the city, and below the 4.41 per cent rate on its existing December 2018 bonds.

However, the latest sale by the council, whose credit rating is only one notch behind the country's, is unlikely to woo Mums and Dads who can get a better 3.53 per cent on term deposit. They are more likely to appeal to institutional fund managers who need investments across a wide spectrum of risk. But retail investors may have been tempted by Wellington International Airport's $75 million of May 2023 bonds sold this month at an interest rate of 4.25 per cent and with an investment grade BBB+ rating.

"Retail bonds are quite cost-competitive at the moment," says the airport company's chief financial officer Martin Harrington. "Recently they've been the most price-competitive option for corporates."

He says there is "a strong appetite from retail investors -- the facts of retail bonds is they are tradable and you get a coupon for the term. In a portfolio of risks you might have some of them."

Record low borrowing costs have lured many corporates to the listed bond market this year, including Genesis Energy, Meridian Energy, Spark New Zealand, Auckland International Airport and Fonterra Cooperative Group.

They join a market whose value has climbed about 66 per cent in the past year to stand at $20.9 billion at the end of April.

The pipeline still looks strong -- we'll probably see more listed instruments coming through.


The debt market went through one of its biggest ever growth spurts last November, when the Local Government Funding Agency (LGFA) listed six bonds, or about $5.56 billion of debt that it had sold on behalf of local authorities.

There were 3218 trades in total on the NZDX market last month, up 34 per cent from April 2015.

The value of trading jumped 61 per cent to $174 million, which is still a miniscule 0.8 per cent of the debt market's value. For comparison, NZX sharemarket trading last month was $3.9 billion, or 3.3 per cent of the $117 billion market capitalisation for listed companies.

That partly reflects the tendency of debt investors to hold to maturity -- the so-called "bottom drawer" investment strategy -- because they're typically looking for income rather than speculative capital gains.

But NZX head of markets Mark Peterson says trading and liquidity are increasing as the market broadens and issuers take advantage of ease with which they can tap programmes again and again, with only a short-form term sheet.

The Financial Markets Conduct Act is "a wonderful piece of legislation that's been welcomed incredibly by the market and seen as a real improvement to efficiency," Peterson says.

"It sets us apart from other markets -- Australia, in particular, where you need a full prospectus.

If you do not fully understand how they work or the risks associated with them, you should not invest in them.


"Conditions right now are a perfect storm the right point in the interest rate cycle, strong investor appetite and the preference of issuers looking for diversity in their debt," he says.

Added to that, issuers say execution risk has risen in offshore markets such as Europe, where talk of the Brexit, or British exit from the European Union, is ratting bond investors.

"The pipeline still looks strong -- we'll probably see more listed instruments coming through," he said.

Corporate bonds are typically priced at a margin over the comparable swap rate. Five-year swaps are currently around 2.35 per cent, near record lows and down from 4.75 per cent in early 2014.

Both Chorus and Wellington Airport say they'd tap the NZDX market again, assuming conditions were broadly the same. The airport's Harrington says it has debt maturing next year and "may look to prefund some of that."

Chorus was saddled with bank debt when it was split off from Telecom (now Spark) in 2011. Its debt diversification plans were thwarted by "regulatory surprises" when the regulator began looking at prices it could charge for access to its copper network. That created too much uncertainty to successfully promote a bond sale, Carroll says.

At December 31 last year it had senior debt of about $1.8 billion, of which $1.08 billion was in bank facilities and $667 million in European medium-term notes. By then, though, it also had the certainty of a final pricing determination for its network from the Commerce Commission. Hello bond market.

"Our preference ultimately is to not have much bank debt at all," he said, although a second issue of NZDX-listed bonds was unlikely to be as large as the initial $400 million sale.

Retail investors should talk to a financial adviser before diving into the market unless they have a good level of sophistication and understanding, Peterson says.

Insurance Australia Group (IAG) this month launched the most complex debt offer so far in 2016, with an offer of up to $350 million of unsecured subordinated convertible notes, notionally maturing in June 2043 -- 27 years away.

They will pay a fixed interest rate for their first six years then switch to a floating rate tied to the three-month bank bill rate.

IAG has the option to repay them early and investors can elect to have them converted to ordinary shares after nine years, if the notes are still outstanding.

IAG even warns amateur investors off, saying the notes "are complex financial products and are not suitable for many investors.

"If you do not fully understand how they work or the risks associated with them, you should not invest in them."