Aussie Mining Meltdown Can't Kill Investor Hunger for State Debt

  • States have $3.9 billion to raise this fiscal year: Westpac
  • Sovereign yields near record low make states more attractive

Australia’s states are luring investors to their bonds as supply dwindles amid improved fiscal discipline from the strongest provincial borrowers, while the Federal government’s issuance program balloons.

Westpac Banking Corp. says the scarcity of state bonds, known as semi-government debt, is likely to be an important driver. They estimate regional authorities have only A$5.4 billion ($3.9 billion) more to borrow in the financial year ending June 30, with around three-quarters of that coming from iron-ore hub Western Australia. The national government needs to borrow A$31.2 billion via bond sales by June 30, according to data from the Australian Office of Financial Management.

While Prime Minister Malcolm Turnbull’s Commonwealth government is struggling to keep budget deficits in check as a collapse in global commodity prices hurts revenue, the states of New South Wales and Victoria are reaping the benefits of a house-price boom while using asset sales to trim borrowings. As federal bond yields approach record lows, investors are also favoring the mining-dependent states of Queensland and Western Australia, which offer bigger premiums given their weaker finances and lower credit ratings.

QuickTake Iron Ore Wars

“We think it’s attractive to be overweight semis relative to the Commonwealth Treasuries,” said James Alexander, who helps oversee about A$12 billion as head of fixed income in Australia at Nikko Asset Management. “The budget positions of most of the states are pretty strong. Clearly there’s some pressures on resources states in Queensland and Western Australia, but I think even with those pressures they’re still OK.”

Australia’s most populous state New South Wales said in a December review that significantly stronger revenue would drive its forecast budget surplus this fiscal year to A$3.4 billion, about A$876 million more than previously estimated. It said net debt would decline to A$1.8 billion on June 30, a reduction of A$8.1 billion compared with the prior estimate, it said.

Western Australia, on the other hand, is struggling to absorb the impact of a rout in metal and energy prices that has curtailed government incomes. Moody’s Investors Service downgraded the state’s credit score to Aa2 earlier this month, two rungs below top-rated New South Wales and Victoria, citing increasing risks the debt burden would exceed government estimates.

Under Pressure

The sovereign is under some of the same pressures. 

Treasurer Scott Morrison said in December his government’s underlying cash deficit through June would be 6.6 percent wider than previously forecast, requiring A$12.5 billion more in debt sales and taking the year’s funding task to A$90.5 billion.

All else being equal, an increase in the federal government’s borrowing needs tends to add upward pressure to its bond yields, according to Nikko’s Alexander.

That hasn’t been apparent so far this year as turmoil in financial markets drove investors into safe assets like government bonds as they pull money out of tumbling equities, commodities and corporate debt. The positive yield offered by Australian securities has made them particularly appealing in an environment where more than a quarter of sovereign debt globally yields less than zero.

The Bloomberg AusBond Treasury index has climbed 2.2 percent since Dec. 31, outpacing the 1.6 percent gain on state bonds and the 1 percent return for corporate debt. Australia’s benchmark S&P/ASX 200 index of stocks has dropped 6 percent.

‘Very Precious’

Toshifumi Sugimoto, chief investment officer at Capital Asset Management in Tokyo, says he’s buying both sovereign debt and highly rated semi-government bonds such as those issued by New South Wales and Queensland.

“These bonds will be very precious” as yields fall, he said.

Australia’s benchmark 10-year bond yield was at 2.53 percent as of 3 p.m. in Sydney on Thursday, having fallen on Feb. 12 to within 10 basis points of a record-low 2.25 percent. New South Wales’s AAA rated May 2026 bond offered a premium of 26 basis points over sovereign paper, while Western Australia’s July 2025 security was at a spread of 63 basis points, according to data compiled by Bloomberg.

Liquid Assets

Low sovereign yields may spur investors to prefer state bonds, particularly banks that are required to hold highly-rated notes as part of their regulator-mandated liquidity buffer. In Australia, that debt must take the form of either Commonwealth or state-issued securities.

For state bonds, “there’s an absolute scarcity, which means there’s little primary debt issuance, but there’s also relative scarcity given the high-quality liquidity buffers that the banks need to maintain,” said Damien McColough, head of fixed-income research at Westpac in Sydney. Over the medium-term, Queensland and Western Australia “have the most room to perform significantly to bond and swap,” he said.

A growing financial sector means banks need to add to their high-quality liquid assets as well as reinvest any maturities, he said. In addition, the increasing pool of state and sovereign bonds combined means that the Australian Prudential Regulation Authority and Reserve Bank of Australia will expect lenders to hold more of this debt and depend less on the Committed Liquidity Facility that the central bank provides as an alternative to make up shortfalls.

“The HQLA percentage will grow but it’s growing because of government debt,” said McColough. “The banks will be forced to buy those bonds but it makes the semis the gold.”

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