Opinion: Why corporate bond issuers, including Fonterra, paid too much

By Roger J Kerr The rush from retail investors to Hoover-up any corporate bond issue with a "7%" as the coupon interest rate is understandable in the circumstances of bank deposit interest rates heading below 3%. However the frenzy of activity in new issues coming to the market is raising some interesting questions about the management of debt in some of our major companies. Q1: Why does corporate New Zealand suddenly need to raise a whole lot of debt through the corporate bond market when there are no major investment projects or takeover activity occurring? The answer is of course that most are re-financing existing bank debt, they want longer debt terms than what the banks are offering and they want to diversify funding sources away from an over-reliance on banks. It is all a bit after the horse has bolted in my book. Why weren't these borrowers accessing the long-term US Private Placement debt market when issue spreads where less than 100 basis points just a few years ago? They are now paying 300 points above swaps for shorter terms. Their board directors should be asking the serious question around funding risk management, not me.

Q2: Fonterra receiving bids for $800m on a $300m retail bond issue tells you something about mis-pricing an issue. The borrowers are paying far too much, based on some dodgy advice from organising brokers/banks about demand levels in the retail market. The retail investors would have taken 6.75% in my view on the Fonterra bonds and the borrower would still get its money. Borrowers should be more cautious about who they use to organise such bond issues. The banks only have one motivation, which is to get their own loan exposure levels down on the corporate bond issuer. Therefore it is natural the banks will advise the issuer to offer a high interest rate to ensure the issue is a raging success. If I was Fonterra I would not be too happy at the massive over-subscriptions, it is certainly not a raging success. It tells me that the pricing was far too generous to the investors. Even though they have had their share of adverse publicity recently and some aspects of the bond offer where not as tidy as they should have been, Fonterra is a far stronger credit than what this bond issue implies. To compare Fonterra's credit quality (in terms of income/cashflow certainty) to be near to that of failed finance companies is utter rubbish in my opinion (as some financial media commentators have done). Q3: With massive investor demand for quality fixed interest securities at this time, why does Auckland City Council feel the need to have their retail issue underwritten by two banks? ------------ *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