Big companies cash in on bond fever

Fonterra offered $800 million of six-year bonds at 7.75 per cent. Photo / Sarah Ivey

Lending money to cash-strapped corporates, councils and dairy co-operatives has become the investment du jour for retirees and ageing baby boomers desperate for a decent return on their nest eggs.

Issues of bonds, or notes as they are sometimes called, are streaming on to the market and are being snapped up even before the prospectuses hit brokers' desks.

Fonterra's bond issue last month, initially intended to raise $300 million. It was 267 per cent oversubscribed and ended up boosting the dairy giant's coffers by $800 million.

It followed the heavily oversubscribed Auckland City Council bond issue which raised $150 million.

Current issues include Contact Energy's $550 million of five-year bonds at 8 per cent, $384 million of AMP notes at up to 8.9 per cent, and Tower Capital's $100 million of five-year bonds at 8.5 per cent.

It's easy to see the attraction.

After the debacle of the finance company sector, investors fled to the safety of the retail banks. But with term deposit rates now languishing at around 4 per cent, the 6 per cent to 8.9 per cent return bonds offer is a no-brainer.

Bonds and notes are effectively an IOU. You lend money to a company, local body, government or other entity for a set period of time, usually somewhere between five and 10 years. It agrees to pay you interest and to repay your funds when the bond matures.

As the credit contagion has spread, short-term bank debt has rolled over and become extremely difficult to replace. Organisations have had to look elsewhere to raise funds.

Add to this the fact that New Zealand has a unique debt market and you have a happy convergence of factors that is benefiting both small investors and the entities so energetically raising funds from them.

"It's probably one of the few markets in the world at the moment that remains open," says Geoff Brown, head of market products at the NZX.

The credit crunch has added momentum but New Zealand's debt market was already growing exponentially.

Unlike many other countries including Australia we have an active exchange trading listed debt products. The value of the NZDX has grown from $4.5 billion in 2003 to $13 billion currently. It is expected to grow to around $15 billion by year end.

But that's only the debt products listed on the NZX's exchange. Big amounts are also raised which are not listed. Graeme Beckett, head of fixed interest at First NZ Capital, estimates $6.25 billion was raised last year, compared with the $2.1 billion listed on the NZDX in the same period.

The exchange obviously wants to encourage as many issuers as possible to list their product. While many investors hold their bonds to maturity, Brown says their tradeability is one of the factors which has made them increasingly attractive as an investment.

"You can see on a day-to-day basis what it's worth, and if your circumstances change you can trade. That's the critical difference between that and an unlisted finance company debenture."

One of the other attractions is that many bonds are now rated by credit rating agencies such as Standard & Poor's and Moody's, he says.

It means it is clear if the product is "investment grade" - BBB or above. This wider range of product availability, particularly of investment grade issues, has appealed to the institutions and thereby widened demand, Brown says.

"And that's really been the thing that's been the catalyst for that sharp growth in the underlying market, because we've now got a market which involves not just mum and dad retail but wholesale institutions as well."

It starts to sound as if an investor would be mad to put their money anywhere other than bonds. But while they are considered low- to medium-risk, there is no such thing as a no-risk investment.

For a start, they do not come with a Government guarantee as bank deposits now do.

Their value, if you do want to sell before maturity, can also fluctuate. It takes some getting your head around but as interest rates on offer rise, prices fall - a bond paying 6 per cent interest, for example, won't be worth as much as a newly issued bond paying 8 per cent.

Commentator and Milford Asset Management executive director Brian Gaynor says the Fonterra issue at 7.75 per cent to some degree flooded the market and pushed values down.

Gaynor also argues that the heavyweights such as Fonterra, Auckland City and the upcoming Contact Energy issue set a precedent. They are all solid organisations offering a reasonably safe bet for the investor. But not all debt products are created equal.

"You'll have a swag of these in the next few months, and some of them will be dodgy and the public will go into them because they've seen the other ones be successful."

Investors need to carefully consider the financial health of the organisation they are lending to and how it plans to spend the funds raised, he says.

Contact Energy chief executive David Baldwin has said his company intends to use its bond issue to invest in generation, for general operations and possibly to repay debt.

While Gaynor says a utility such as Contact is going to be fairly predictable, "I'd still like to see the prospectus and know exactly what they're doing with the money".

Debt products also come in a wide variety of shapes and sizes. They can be secured or unsecured (backed by an asset or not), subordinated (be ranked behind other debt the organisation has, so in a collapse other lenders are paid out ahead of you), and can come with the option of converting into shares at a later date.

The majority of small investors rely on their advisers to inform them and this in many cases is where they've come unstuck, says former BNZ chief economist Len Bayliss. Where New Zealand investors next put their money is an issue he follows closely.

"Most of these people who've lost millions in these finance companies were put in there by financial advisers looking for big commissions and not thinking of their clients' safety.

"All bond issues aren't the same ... They're not the same as bank

deposits or buying a Government security. Things can go wrong even with Fonterra."

The bond phenomenon is a new one, and a lot of financial advisers would not fully understand it, he believes. "Anyone investing should seek advice from somebody qualified to give it."

Meanwhile can the bond bull market run out?

"I thought it would have happened before now to be honest, the volume coming through has been so big," First NZ Capital's Beckett says. While the market has gained out of the flight from finance companies and bank deposits "I'm not sure where the next pool of money comes from".

Beckett says he's been asking bankers where the massive outflow of funds leaves them.

He believes he saw the beginnings of an answer last week when Westpac offered a five-year term deposit at 6 per cent, paid quarterly.

"We have to expect a response from the banks. They really wouldn't want to see all this running out the door."

Q & A

What is a bond?
It is like an IOU issued by a corporate, council or government. You lend them money for a certain period, they promise to pay you interest and repay you when the bond matures.

What is the difference between a bond and a note?
Nothing really, the terms are interchangeable. What differs is the way the individual debt products are structured - for example, they can be subordinated or unsubordinated, or can convert into shares after a period of time.

What do secured and unsubordinated mean?
A secured debt is backed by an asset to reduce the risk associated with the lending. For example your mortgage is secured on your house. Many bonds are unsecured. An unsubordinated debt ranks above other loans the organisation may have, so if the entity collapses you will get paid out ahead of other lenders. Subordinated debt is lower in the pecking order, meaning others get paid out first.

Are bonds and notes tradeable?
Yes. Unlike a finance company debenture, a bond or note can be listed on the stock exchange's debt market the NZDX, meaning it can be bought and sold before maturity. However not all debt products are listed.

Do bonds and notes have credit ratings?
These days many do, and it's making them more attractive. Using Standard & Poor's ratings, anything BBB and above is investment grade. Anything below that is considered junk.

UP FOR GRABS

Contact Energy
* Five-year bonds at 8 per cent a year, paid quarterly
* Unsecured and unsubordinated, rated BBB
* $550 million available
* $5000 minimum investment, offer closes March 31

AMP Notes
* 10-year with a five-year call option, 8.4 per cent to 8.9 per cent paid quarterly
* Unsecured and subordinated, rated A-
* Initial $384 million available, but offer open to oversubscriptions
* $5000 minimum investment, offer closes on April 2

RECENT ISSUES
* Fonterra - $800 million of six-year unsecured, unsubordinated bonds at 7.75 per cent, rated A+
* Auckland City Council - $150 million of five-year secured, unsubordinated bonds at 6 per cent, rated AA
* Auckland International Airport - $130 million of eight-year unsecured, unsubordinated bonds at 8 per cent, rated A
* Trustpower - $100 million of seven-year unsecured, subordinated bonds at 8.4 per cent, not rated