I did expect that strong investor demand, starved of other fixed interest investment opportunities at this time, would swamp the Air New Zealand $150 million corporate bond issue. That prediction was correct as they closed-off the offer immediately last Friday as institutional and broker client funds took the full $150 million, leaving absolutely no bonds for Mum and Dad retail investors not big or important enough to be on the broker’s allocation list. What I did not expect was that Air New Zealand would allow their bonds to be priced at a 6.90% yield, 2.80% above the five-year swap rate of 4.10%. As stated last week, I thought Air New Zealand would be able to raise their money at a much lower interest rate, nearer to 2.00% above the swap benchmark.
“Given this outlook for interest rates, Mum and Dad retail investors should swamp the current Air New Zealand $150 million corporate bond offering. In normal market conditions an airline with a Moody’s Baa3 credit rating (equivalent to S & P rating of BBB-) on credit outlook “negative” would have to pay 250 to 275 basis points (2.50% to 2.75%) over the five-year swap rate. However, do not be surprised to see Air New Zealand issue their bonds at 200 points over swap rates for an all-up interest rate of 6.20%”
Where a bond issue is priced in terms of the interest rate offered is based off the issuer’s view of investor demand and the maximum margin (credit spread) they want to pay relative to their alternative sources of debt finance (e.g. bank debt).
The Air New Zealand bond issue raises a number of questions in terms of the market price discovery process and whether investors and the issuer were happy with the transaction:-
§ Air New Zealand would have observed secondary market credit spreads for bank securities zooming upwards over recent weeks and decided that non-bank sourced debt was a good move at this time as bank borrowing margins are about to increase. Therefore, paying a little over the odds for five-year non-bank debt was probably a prudent move.
§ It was not a great look for the company to appear in the business section of weekend newspapers with a report that all the bonds has been allocated to institutional and broker client investors with nothing left over for the public pool, and then on the very next page of the newspaper a large advert promoting the bond issue as open to investors at 6.90%. Should not the FMA have some concerns about mis-leading advertising as there are no bonds available for sale?
§ From all accounts the bonds were 100% over-subscribed with $300m wanted by institutional and broker client investors. The excessive demand tells you that the bond was miss-priced i.e. Air New Zealand have their money in, however they have paid too much for it. The strong demand was even after some institutional investors could not take the bonds under their investment mandates as the bond itself was not credit rated, the company Air New Zealand being only rated by Moody’s at Baa3 (BBB-).
§ The real test of a successful corporate bond issue is the post-issuance secondary market pricing of the credit spread being very near to the primary issuance margin six and 12 months after the issue i.e. investors and the borrower are both satisfied they got a fair deal. If the credit spread moves out significantly (increases) post issuance, the investors feel ripped off. If the credit spread moves in significantly (decreases) the borrower feels they have paid too much for their money. Time will tell if Air New Zealand feels this way in six months time, however my view is that they will!
§ To what extent were Air New Zealand persuaded by the organising brokers/banks that 6.90% was the rate that they would have to pay to raise the funds? – A borrower taking market advice from a fixed interest broker whose first loyalty is to get the highest yield return possible for their investor clients has conflicts written all over it. However, the Air New Zealand treasury team are big boys who can make their own decisions.
§ Unless Air New Zealand plan a second issue very soon, there will be some unhappy investor campers out there – those who were scaled significantly and those that missed out completely.
NEW ZEALAND DOLLAR MARKET COMMENTARY
Australian data and Euro direction to lead the Kiwi dollar this week
The big difference between this week and last week in the foreign exchange markets is that the EUR/USD rate after taking a peek at $1.4500 last week now trades at $1.4150. FX market positioning and sentiment has reversed as global investors move on from the US debt debacle and realise that Europe has considerably more economic and debt problems than the US.
The direction of the EUR/USD rate is also driven by expectations of whether the US Federal Reserve will print more USD’s under a QE3 monetary loosening, or not. Further monetary easing by the Federal Reserve is negative for the USD value; however the USD gains from $1.4500 to $1.4150 late last week suggest that the markets are now not so sure that Ben Bernanke will deliver this in a few weeks time. As a consequence of the USD reversal of direction against the Euro, the NZD and AUD are both tracking lower.
Weaker global equity markets seem likely over the near term following the weak US jobs numbers on Friday; therefore the “risk-off” button for international investors should see the antipodean currencies lower this week. A decisive break below the support level at $1.4000 for the EUR/USD rate may well see technically driven buying of the USD and thus cause the Kiwi to break below its 0.8000 support area.
The NZD/USD exchange rate still remains somewhat elevated vis-a-vis the EUR/USD following the flood of funds that parked into the Kiwi ahead of the US debt ceiling ultimatum in early August. There needs to be some surprise negative news for the Kiwi to force a catch up on the lower EUR/USD rate. That negative news could well be a more dovish than expected RBNZ monetary policy statement on 15 September.
The EUR/USD direction is however not just about the US economy and the probability of QE3 happening. The increase in official European interest rates back in March by the ECB could well be reversed over coming months as inflation threats diminish and the powerhouse of European economic fortunes, the German economy suffers weaker numbers. Add on the Italian and Greek sovereign debt problems and there are not too many reasons to buy the Euro and plenty of reasons to sell it. The parliamentary vote in Germany later in the month on the Greek bailout package could be telling for the Euro exchange rate value.
The local currency markets will be focussed on a stack of Australian economic data this week with a RBA interest rate review tomorrow, GDP growth on Wednesday, a speech by RBA Governor Stevens also on Wednesday and employment data on Thursday. More confirmation of the high AUD value slowing the Australian economy will enhance the current pricing of lower interest rates by their moneymarkets. Lower commodity prices from here off the back of lower global GDP growth forecasts should also weigh the AUD down.