Bloomberg News

Daiwa Buys State Debt as Spreads Twice Average: Australia Credit

March 26, 2012

Daiwa SB Investments Ltd. (DSBI), the manager of the biggest Australian bond mutual fund, is buying the debt of Queensland and other states amid a shortage of AAA rated central government securities.

The extra yield the so-called semi-government notes offer over central government debt dropped 21 basis points, or 0.21 percentage point, this quarter to 84, still more than twice the average premium of 35 since 1997, according to Bank of America Merrill Lynch indexes. The equivalent spread for U.S. municipal debt shrank 11 basis points since Dec. 31 to 50, the data show.

Foreign holdings of Australian government bonds climbed to a record 84 percent last year, increasing the allure of local government debt for Japanese buyers seeking higher yields than those available at home, according to Tokyo-based Mitsubishi UFJ Asset Management Co. (13444) and Nissay Asset Management Corp. The Australian government has A$236 billion ($247 billion) of securities outstanding, compared with A$198 billion for local authorities, led by Queensland and New South Wales.

“Semi-government bonds are cheaper, but still offer value against” federal debt, said Yoshisada Ishide, who manages the $15.5 billion Daiwa SB Short-Term Australian Dollar Bond Open Fund, which has 52 percent of its assets in Australia. “Borrowing costs for states will continue to narrow relative to government debt.”

New South Wales and Victoria are rated AAA by Moody’s Investors Service and Standard & Poor’s. Incoming Queensland Premier Campbell Newman, who won election March 24 in a landslide victory over the ruling Labor Party, has pledged to restore his state’s AAA rating, which was lowered to AA+ by S&P in 2009.

The state of Victoria is benefiting from the influx of international buyers as it looks to refinance more than A$7 billion in debt that matures by the end of 2014.

Buying Victoria

Japanese investors comprised 60 percent of turnover in the state’s bonds by overseas buyers since July 1, according to Justin Lofting, general manager of treasury at funding arm Treasury Corp. of Victoria. That compares with 40 percent in the 12 months ended June 30, 2011. The state has completed 80 percent of its A$7.3 billion funding program this year, Lofting said in response to e-mailed queries.

The gap between the yield on New South Wales’ May 2020 security and comparable federal government notes narrowed to 76 basis points on March 22, the least since Dec. 8, according to data compiled by Bloomberg. The spread for Queensland’s February 2020 bond fell to 110 basis points on the same day, the lowest since Nov. 17.

Corporate Spreads

Elsewhere in Australian credit markets, the extra yield investors demand to hold corporate bonds instead of government securities was at 245 basis points on March 23, the smallest premium since Nov. 8, a Merrill Lynch index shows.

Benchmark 10-year federal notes advanced yesterday, pushing the yield down one basis point to 4.17 percent, or 193 basis points more than comparable U.S. Treasuries.

The gap between yields on the 10-year notes and similar- dated inflation-linked debt shows investors estimate annual consumer-price gains will average 2.75 percent over the next decade, up from estimates for a 2.44 percent pace at the end of 2011.

The cost to insure Australia’s debt against nonpayment using credit-default swaps was 70 basis points on March 23, according to figures from CMA, which is owned by CME Group Inc. and compiles prices in the privately negotiated market. That compared with 31 basis points for the U.S. and 74.5 for Germany.

Australia’s dollar, the world’s fifth-most traded currency, bought $1.0456 as of 3:51 p.m. yesterday in Sydney, after reaching $1.1081 on July 27, the strongest since it was freely floated in 1983.

Increased Holdings

The extra yield investors demand to buy the debt of local governments in the U.S. declined to 48 basis points on March 21, matching a four-month low. The premium to hold Canadian provincial and municipal bonds was at 70 basis points on March 23, unchanged from the end of 2011.

Daiwa’s Ishide said he continues to buy bonds from major Australian states and holds more semi-government debt than half a year ago. His fund is the biggest among the 1,749 that have a focus on a particular geographic region, Bloomberg data show. It has 15 percent of its assets allocated to municipal bonds, according to a report on the company’s website citing figures as of the end of February. It has returned 9.9 percent this year, beating 56 percent of its competitors.

Semi-government debt is set to hand investors a 0.4 percent loss this quarter, the first decline since 2010, a Merrill Lynch index tracking Australia’s six states and two territories shows. Sovereign bonds have dropped 1.5 percent since Dec. 31, poised for their biggest slide since the three months ended June 2009, compared with a 0.2 percent advance for an index of global government notes.

Record-Low Yields

Perceptions of credit stability in Australia, one of only 12 countries to hold a AAA rating from the three main credit assessors, prompted investor demand for the nation’s debt and drove down bond yields to records.

The 10-year (GACGB10) yield has risen 53 basis points since Feb. 1, when it matched a record low of 3.648 percent. The yield surpassed the Reserve Bank of Australia’s cash rate target on March 15 for the first time since August. Central bank officials held the key rate at 4.25 percent at a March 6 meeting after two consecutive quarter-percentage point rate cuts late last year.

RBA Governor Glenn Stevens said in a March 19 speech that a lower growth target for China, Australia’s biggest trading partner, will still allow one measure of the Asian nation’s gross domestic product to exceed the euro area in a few years and match the U.S. in a decade.

Federal Reserve Bank of St. Louis President James Bullard said March 23 U.S. monetary policy may be at a “turning point” and the Fed’s first interest-rate increase since the global financial crisis could come as soon as late 2013.

Fading Flight

“The flight to quality into sovereign debt is fading,” said Hideo Shimomura, chief fund investor at Mitsubishi UFJ Asset Management, which manages the equivalent of $72 billion in assets and is a unit of Japan’s biggest publicly traded bank. “What investors choose next is likely to be state bonds.”

Queensland, Australia’s biggest debtor state, has A$77.1 billion securities outstanding, after the Labor government spent A$54 billion to improve infrastructure. The opposition Liberal National Party ended 14 years of Labor rule in the resource-rich state that generates a fifth of Australia’s wealth, winning 78 out of 89 seats in Queensland’s parliament, according to the electoral commission.

‘No Choice’

New South Wales has raised around A$6.5 billion to date toward its required A$10.2 billion for the current year, Tim Hext, head of balance sheet and funding at the state’s Treasury Corporation, said in an e-mail yesterday.

“New South Wales’s AAA rating, high yields and the Australian dollar story are the main attraction for Japanese investors in the state’s local-currency bonds,” Hext said.

The state has A$53.5 billion in debt outstanding, Bloomberg data show.

“Japan’s big funds have no choice but to buy state bonds instead of sovereign debt,” said Shinji Kunibe, the chief portfolio manager for fixed-income investment in Tokyo at Nissay Asset Management, which oversees the equivalent of $65 billion in assets. “By investing in state bonds, you can get higher yields on securities that guarantee you similar creditworthiness to government debt.”

To contact the reporters on this story: Kristine Aquino in Singapore at kaquino1@bloomberg.net; Monami Yui in Tokyo at myui1@bloomberg.net

To contact the editor responsible for this story: Rocky Swift at rswift5@bloomberg.net


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