Opinion: Messages for NZ from the UK debt market

By Roger J Kerr I was last week at a Corporate Treasurer's conference in Manchester, England, a very dull grey city that epitomises the UK economy. There is no real industry left there; the Manchester and UK economy is nowadays all public and services sectors. The UK Government is right in the sticky stuff and if they were any other country, the IMF would be moving in to take control of their economic policies. The UK service sector is contracting badly as European clients cut back on their requirements. UK Chancellor, Alistair Darling's austere budget was based on a very optimistic GDP growth forecast for 2010. Two days later their GDP numbers came out for the March quarter at -1.7%, much worse than Treasury forecasts. The UK Treasury's GDP forecasting track-record makes our RBNZ and Treasury performance in this area look pretty good. The talk amongst the bankers, fund managers and corporate treasurers about bank lending contraction and alternative sources of funding all sounded very familiar to home. Just like here in NZ, the bankers see corporate credit margins moving even wider as the banks themselves struggle to fund. The big corporates who borrow under their own name are starting to see strong end-investor demand for their debt securities; therefore they see lower credit spreads (margins) going forward. The UK fund managers quite rightly want to lock in as much money as they can right now into record high corporate credit spreads for periods as long as they can get. UK companies are going to the market with corporate bond issues for 5 and 7 year terms and end up extending to 10 and 15 year terms as this is where the investor demand is. Their only problem is to find enough bank counterparties to do the swaps with. Some European banks have disappeared, the credit ratings of the UK clearers are not that flash and many are wary of trading with US investment banks. Some banking mates working for the Aussie banks in London suddenly find themselves courted by large UK corporates for this swaps business as the Australasian banks now stand as the highest credit rated around. There was concensus from the fund managers and corporate treasurers that corporate credit spreads will move down over coming months, despite the funding challenges the banks have. Globally, moneymarket and credit markets are slowly improving in liquidity and operation. There are some worries about further write-offs by banks of bad assets, but overall the worst does appear to be over in respect to the blow-out in credit spreads after the September 2008 Lehman's impact. Similar to NZ, the treasury management issues in the UK currently revolve around cash, liquidity, funding risk, bank lending margins and the corporate bond market. It seemed to me that many corporate treasurers had lost their focus on interest rate and FX risk management as the more immediate and urgent cash/funding issues took precedence. That is probably a mistake given the very low levels of the Pound exchange rate and UK interest rates. However any recovery in the UK economy is much further away than in New Zealand, therefore their treasurers will have plenty of time to address the financial market price risk issues at a later date. Here in New Zealand, corporate borrowers who have followed our advice since December/January should be well pleased with the overall weighted-average entry levels into long-dated fixed-rate swaps. There is still time to enter swaps to lift fixed rate percentages to their maximums, but such hedging programs would want to be completed by May/June. ---------------- * Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com