Photographer: Patrick Hamilton/Bloomberg

Australia’s Most Indebted State Still Lures Bond Investors

Updated on
  • Queensland debt has delivered a 5.6% total return this year
  • Borrowing increasing, although less than previously estimated

Investors are snapping up Queensland government bonds even as Australia’s most indebted state increases its total borrowing and the tapering of the resources boom weighs on revenues.

The average yield premium the debt offers over federal government notes has fallen to 27 basis points as of Wednesday from 45 at the end of June 2015, Bloomberg AusBond index data show. The northeastern state’s securities have returned 5.6 percent so far this year, trailing only Victoria’s 5.9 percent among the country’s eight provincial issuers.

While the drop in commodity prices is crimping royalties and slowing revenue growth in one of the country’s largest mining and energy producing regions, the hunt by global bond buyers for extra yield has helped tighten credit spreads. And although last month’s state budget estimated total borrowing will rise to A$75.3 billion ($56.5 billion) in the current financial year, that’s less than the government had projected in earlier fiscal updates.

“In terms of the market, we will have overall less debt on offer than previously forecast,’’ Queensland Treasurer Curtis Pitt said in an interview in Sydney last week. “We expect they will see us not only as safe investment, but also seeing their investments over a longer period will pay dividends.’’

The government’s debt, including the liabilities of state-owned businesses, is projected to climb to A$78.9 billion by 2019-20 from an estimated A$72.7 billion at the end of last month, according to the most recent budget documents. Queensland Treasury Corp.’s A$7.3 billion borrowing program for 2016-17 is predicted to include about A$1.9 billion of new money and A$5.4 billion for refinancing of existing obligations.

Pitt said that while he’s cognizant of the total debt carried by Queensland, the administration’s actions are centered around reducing the money owed directly by the government, as opposed to the obligations of the state’s publicly-owned corporations. Having come to office in February 2015 as part of a Labor government that’s vowed not to sell off assets, he is instead ramping up gearing on businesses such as electricity networks and ports.

The treasurer is also drawing on A$4 billion of the state’s surplus funding for pension liabilities to keep so-called general government borrowing in check.

Shifting Debt

General government sector debt is expected to fall to A$38.4 billion by June 2019 from A$43.1 billion in June 2015, according to budget documents. In contrast, borrowing by state-owned firms is set to increase by about A$7.5 billion to A$39.6 billion over the same period.

The state is resorting to shifting debt as it faces lower-than-expected revenue and after a study by KPMG showed the public firms had room to load up on debt. Last financial year’s revenue hole -- stemming from lower mining royalties, taxes and federal support payments -- was estimated at the most recent budget to be A$1.2 billion larger than previously anticipated.

Queensland’s energy network businesses had a net debt to regulated asset base ratio of about 55 percent compared to an average of 80 percent for the industry, according to papers from Pitt’s first budget in 2015. The government said its aim was to take the measure to between 70 percent and 75 percent for the public firms, which would free up about A$3.5 billion in equity from the businesses.

Ratings Outlook

While Queensland is catching up with other states in leveraging its state-run corporations, it “can’t keep doing this forever because total state government debt is not shrinking,” said Damien McColough, head of fixed-income research at Westpac Banking Corp. in Sydney. “They will need to improve the revenue side of the balance and keep the expenses side under control.’’

Queensland carries a stable AA+ credit score at S&P Global Ratings, one step below the highest ranking. It has an equivalent rating of Aa1 at Moody’s Investors Service, albeit with a negative outlook, while Fitch Ratings puts it one level lower at AA.

Moody’s said last month that the deterioration in Queensland’s financial performance is “a credit negative,’’ while Fitch said the state’s net overall risk remains the same despite the plans to lower general government debt.

The Australian federal government, which has top credit scores at all three major agencies, had its outlook shifted to negative on Thursday by S&P. That move which mirrored for the country’s most highly rated regional borrowers: New South Wales, Victoria and the Australian Capital Territory.

“Fundamentals get trumped right now by demand for yield,’’ Westpac’s McColough said. “Our broad view on the state government sector is relatively positive and there’s not a lot of performance relative to bonds still left in the AAA space. So that will slowly but surely benefit Queensland and the other higher-yielding issuers.”