The Reserve Bank looks set to start buying council bonds as well as Government bonds to unfreeze financial markets and allow councils to defer rates and jointly invest in infrastructure with the central Government, Dileepa Fonseka reports
In what would be another unprecedented move to calm financial markets and help Government borrow to support businesses and workers in crisis, the Reserve Bank could start buying local government bonds as soon as next week, adding to the buying of Government bonds it has already committed to.
Assistant Governor Christian Hawkesby has replied to calls from councils and economists for the Reserve Bank to buy local government bonds by saying the bank stands “ready to do more” with its efforts to make financial markets functional.
The Large Scale Asset Purchase Programme (LSAP) was announced as a plan for RBNZ to purchase $30 billion of Government bonds on the secondary market over a year. Councils have $10.6 billion in debt on issue, with Auckland the biggest borrower on $2.7b.
Hawkesby said any decision to expand that quantitative easing programme to cover local government bonds would be one for RBNZ’s Monetary Policy Committee to make.
“The Reserve Bank has an additional objective of supporting the smooth functioning of financial markets,” Hawkesby said.
“We continue to closely monitor them and stand ready to do more,” he said.
Local government bonds are some of the safest investments around, but the market has seized up just as more councils look to draw on it.
Several councils are looking to patch up declining rates revenues and fund extra investment with extended borrowing.
LGNZ President Dave Cull said councils were discussing funding operational expenses through debt rather than rates due to the economic downturn brought on by the Covid-19 lockdown.
Wellington and Christchurch City Councils have signalled they want to defer rates with some of the funding for that likely to come through borrowing.
Assisting that borrowing at a time of market turmoil is one reason several bank economists have suggested the Reserve Bank of New Zealand extend its Quantitative Easing (QE) programme to include local government bonds as well.
A set of Local Government Funding Agency (LGFA) bonds will be tendered on Wednesday 8 April. Ninety percent of council borrowing is raised through LGFA.
Hawkesby said the RBNZ was keeping a “close eye” on financial markets to make sure they were functioning well.
“Increasing the size or adding additional asset classes to the programme is a decision for the Monetary Policy Committee, based on an economic assessment,” Hawkesby said.
Australia has already done it
The Reserve Bank of Australia in March bought A$2b in local government bonds as part of its own QE programme. RBA Governor Phillip Lowe said the purchases would “help facilitate the smooth functioning of Australia’s bond market.”
LGFA Chief Executive Officer Mark Butcher said the decision would be the RBNZ’s call to make, but highlighted three factors that might play into any such decision by RBNZ.
The first was the way market confidence had caused a wide gap in the bid-offer spreads on a relatively low-risk bond.
Bid-offer spreads are the gap between the highest price an investor is willing to pay for an asset and the lowest price a seller is willing to sell it for.
Where an asset is “liquid” and can be easily sold the bid-ask spread will be tighter. When it is illiquid it’ll be wider. Typically local government bonds through LGFA would be easily converted to cash because they are relatively low-risk.
“There is supposedly more liquidity in LGFA bonds, but obviously we’ve seen less liquidity recently. We’ve seen wider bid-offer spreads,” Butcher said.
“The big capital markets have got a short-term issue with confidence in settlement,” he said.
Butcher said there had also been a “general crowding out of the capital markets by the New Zealand Government due to its issuance intentions”.
“The final thing to consider would be the LGFA and its role on behalf of the local government sector.”
Auckland wants Reserve Bank buying
Auckland Council, which is the biggest council borrower in New Zealand and effectively sets the base line for the Local Government Financing Agency’s credit rating and interest rates, said it would support Reserve Bank buying.
Group Treasurer of Auckland Council John Bishop said: “We would be supportive of a move that resulted in the RBNZ buying LFGA and local government bonds. This would increase the demand for local government bonds as well as increase liquidity.”
“At the moment the debt capital markets are volatile and challenging with many investors remaining on the side lines. In saying that however, debt capital markets conditions have improved over the last week,” he said.
Fund managers, economists want clarity
Head of Fixed Interest at Kiwi Invest Diana Gordon backed up Butcher’s claims that liquidity on LGFA bonds had dried up post-Covid.
“[LGFA bonds are] about as pristine as it gets, and that’s not trading particularly with any liquidity, which means I don’t know what the price is,” Gordon said.
“If I don’t know the price, it’s going to be hard for me to go in and buy for that,” she said in Thursday’s ‘Bernard and Jarrod Zoom out for lunch’.
“So how much more difficult is it for me to then go in and buy some of these slightly less pristine credits?”
Kiwibank Chief Economist Jarrod Kerr said the Reserve Bank had done what was needed for the Government bond curve.
“But as Diana has pointed out, the curves above that are struggling. So come in, buy LGFA, it’s not hard. It’s semi-government. We are going to be asking a lot of our councils through this recession to to help out and maybe ramp up their infrastructure spending. So you need to open the door for for them to issue. LGFA, Auckland Council. even buy a little bit of a Housing New Zealand,” Kerr said.
“The central bank has said that they are going to be the provider of liquidity. And to do that, they can come in and offer the price that Diana is looking for. And that’s all you need. And all of a sudden you’ve got a market with liquidity and things are functioning again,” he said.
“They won’t have to buy a lot because there’s not a lot of debt out there. We’re not talking about another $30 billion. We’re probably talking five billion.”
ANZ Economist and senior strategist David Croy said in a weekly newsletter that he believed RBNZ would eventually have to extend their LSAP to local government debt.
“The RBNZ’s LSAP programme is not currently targeting local authority debt, SOEs and utilities, but it could in time,” Croy said.
“In our view, extending it to very large high-grade issuers, or implementing some other relief package, makes sense.”
Local Government Minister Nanaia Mahuta said she hadn’t discussed the idea of the RBNZ buying local government bonds, but said a support package for local Government was being discussed.
“There’ll be a lot of considerations around how the whole of Government might be a part of alleviating the pressure for councils,” Mahuta said.
Headroom
Liquidity aside, New Zealand’s councils are in a relatively good position to borrow more according to data furnished by LGFA during an investor call.
Councils that borrow through LGFA are bound by debt covenants that limit their net debt to 250 percent of revenue. Across all councils that figure had fallen from 111.8 percent in 2013 to 68.8 percent in 2019.
Even the most indebted councils have room to borrow more without breaching debt caps. LGFA said the highest net debt to revenue ratio across all its councils was 180.3 percent.
Senior manager credit and client relations at LGFA Andrew Michl said councils were in a better position to borrow than they had been in the past.
“We’re fortunate that at the time Covid-19 has come along councils do actually have some headroom under their covenants to absorb any short-term impact,” Michl said.
