New Zealand

Author: | Published: 10 Oct 2001
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The New Zealand structured finance market reflects the status of its overall capital markets. Although the market is sophisticated in global terms, it does lack depth and volume. Structured finance activity continues to be characterized by one-off transactions for borrowers outside of the public arena. Only a few notable public structured finance transactions have completed during 2000-2001.

Although true structured deals have been limited in the capital markets, they continue to provide a reliable and competitive source of funding for many corporates, with a marked increase in the volume of corporate bond issuance in recent years. In particular, the debt management policy of New Zealand governments since 1984 – which has involved sourcing all domestic borrowing requirements in the domestic market – has increased the opportunities for issuers by providing liquid benchmarks for pricing.

Despite the small size of the market, securitization has become accepted as a source of funding, and issues of residential mortgaged-backed securities, in particular, are well established with signs of growing activity in this market. Other active areas have been the issue of exchangeable equity instruments to overcome structural inefficiencies in the Australasian taxation systems, and the use of repo-type instruments to provide tax-efficient funding for US residents. This article provides a brief summary of activity in the securitization market, together with a review of two structured finance techniques used in New Zealand.

SECURITIZATION

Under New Zealand law, there are few impediments to the securitization of a wide range of assets. Despite the small size of the domestic market, it appears that there is excess capacity in the market for quality asset-backed issues. Issues to date have been well supported and, as unsatisfied demand continues to exist, it is likely the growth trend in this market will continue as both investors and originators familiarize themselves with the benefits afforded by these structures.

There are eight issuers of asset-backed commercial paper instruments in New Zealand whose combined issuance last year totalled NZ$316 million and whose total outstandings amount to almost NZ$1.2 billion. An ever-diversifying range of assets are being proposed for securitization, with the most common instruments involving auto-backed receivables, store card receivables, trade receivables and, increasingly, residential mortgage-backed securities.

There have been over six issues of mortgage-backed bonds in New Zealand in the past three years. Examples in 2000 included the launch of a NZ$150 million residential mortgage-backed securities programme by AMS New Zealand Limited (originated by Australian Mortgage Securities Limited, an Australian subsidiary of ABN AMRO Bank NV). In addition, a special purpose vehicle originated by Sovereign Home Mortgage Limited issued a three tranche NZ$150 million mortgage-backed securities programme.

The bias towards residential mortgage-backed instruments reflects the stability of the residential mortgage industry in New Zealand. New Zealanders have the world's highest per capita rate of home ownership and very low mortgage delinquency rates. Other attractive characteristics include New Zealand's relatively low levels of unemployment and non-fluctuating property values. Given these features of the market, it is likely that any substantial growth in the volume of issues by securitization vehicles will be driven by residential mortgage-backed programmes.

TAX TRIANGULATION

As New Zealand's capital markets are very small in global terms, New Zealand issuers often need to access the Australian markets. In the equity markets it has become increasingly common for larger New Zealand corporates to migrate to Australia and maintain only a secondary listing in New Zealand. Similar trends are likely to emerge in the debt markets. For different reasons, it can be attractive for Australian corporates to raise capital in New Zealand. Often this simply reflects the fact that a large number of their existing shareholders will be based in New Zealand.

A key difficulty facing issuers in the combined Australian and New Zealand markets (known as the "Trans-Tasman" market by virtue of the sea that separates the two nations) is the tax inefficiencies created by the different laws of each country. This issue of "tax triangulation" has attracted considerable attention from both lawmakers and issuers in recent times.

The triangular tax issue affects Australian companies with New Zealand shareholders and either a branch or subsidiary that earns income and pays tax in New Zealand. The imputation credits that would be generated by the tax paid in New Zealand cannot be used by the New Zealand shareholders (because they do not hold shares in a New Zealand company) nor by the Australian shareholders (because it is not an Australian tax). This results in the Australian company's New Zealand shareholders being taxed twice on the same income. The equivalent problem arises for Australian shareholders in New Zealand companies operating in Australia.

From a New Zealand perspective, the inability to transfer tax credits to dividends makes it more difficult for New Zealand companies to attract Australian shareholders, which is a major obstacle to growth given the small domestic investor market. This problem has become more widespread in recent years as increased numbers of New Zealand companies have established substantial trans-Tasman operations or have relocated their head offices to Australia. The trend is likely to gain more momentum in the light of Australia's recent decision to lower its company tax rate to 30%, which has further dampened New Zealand's comparative advantage, as companies in this jurisdiction are taxed at 33%.

Issuer response

One issuer to successfully overcome this problem is Westpac Banking Corporation (Westpac), an Australian bank with a market capitalization of approximately A$18.5 billion and the sixth largest company listed on the Australian Stock Exchange. In 1996, Westpac merged with Trust Bank, one of New Zealand's largest banks, to form WestpacTrust which is a significant part of the Westpac group.

Westpac established WestpacTrust Investments Limited (WTIL), a New Zealand subsidiary, which issued an equity instrument known as "NZ class shares". At the time, the public offer of up to $800 million NZ class shares was one of the largest in New Zealand stock market history. The instrument was devised to correct an imbalance whereby New Zealand investors held less than 2% of Westpac's ordinary shares, despite the fact that Westpac's New Zealand operations were of considerable importance to the group's overall earnings performance.

By offering New Zealand investors shares in a special purpose New Zealand-based vehicle, rather than a direct investment in Westpac, investors had the opportunity to hold a stake in the future performance of the Westpac Group through shares that "mirror" the Westpac ordinary shares. This mirroring was achieved by a variety of means:

  • special voting provisions attached to the NZ class shares gave NZ class shareholders influence in the polls called at meetings of Westpac shareholders;
  • the NZ class shares were exchangeable for Westpac ordinary shares in certain circumstances (such as a takeover of Westpac, the liquidation of WTIL or failure by WTIL to pay to NZ class shareholders a New Zealand dollar equivalent of the dividend on Westpac ordinary shares);
  • entitlement to dividends, if declared, would equal the New Zealand dollar equivalent of dividends paid on Westpac ordinary shares. As dividends paid to NZ class shareholders would be paid from a New Zealand company, they would be able to carry full imputation credits and so would be unaffected by the tax triangulation issue; and
  • the board of directors of WTIL stated its intention to mirror, where possible, bonus issues, share splits, consolidations and rights issues undertaken by Westpac in respect of Westpac ordinary shares.

For these reasons, it was anticipated that the price performance of the NZ class shares should track the movement of the New Zealand dollar equivalent of the price of Westpac ordinary shares, although in practice the tracking has been at a small discount to the Australian equivalent share (at present less than 5%).

Regulatory response

Although NZ class shares are unaffected by the tax triangulation issue, the transaction costs involved and the complexity of the deal mean it is unlikely to provide a solution for issuers other than those at the very top end of the market in terms of size. Finally, after more than a decade of debate, the revenue authorities in Australia and New Zealand have recently announced that they are working on a mechanism to reduce the triangular tax inefficiency. Any law change in this area will have implications for companies with trans-Tasman operations and shareholders in both jurisdictions.

The two options being considered are pro rata allocation (where franking and imputation credits would be attached to dividends in proportion to the residence of the shareholders of the country) and streaming (where imputation credits and franking credits could be streamed to shareholders resident in the country in which the credits arise). A third option – mutual recognition of imputation credits – is regarded as politically unacceptable as its consequences extend far beyond the tax problem, although it would eliminate the tax barrier to trans-Tasman investment. Officials favour the pro rata allocation approach and are preparing a consultation document, expected to be ready for publication towards the end of 2001.

REPO-TYPE INSTRUMENTS

Another financing technique that has been employed in recent times is the use of repurchase (or repo) instruments to provide tax-efficient funding for overseas investors, and principally US residents. These transactions commonly involve a US company (the US borrower) and a subsidiary of a New Zealand financier (the NZ financier).

Usually these repo transactions involve the sale to the NZ financier by the US borrower of ordinary shares and fixed rate preference shares in a New Zealand resident subsidiary of the US borrower (the NZ issuer), coupled with a structured buyback of the securities. As a consequence, the initial "sale" is not recognized for US purposes.

From a New Zealand perspective, the focus is on ensuring that the set-off procedures afforded by connected forward purchase arrangements result in only the net position being recorded in the consolidated balance sheet of the New Zealand financier. Repayment of the NZ financier's investment is typically achieved via a buyback obligation at redemption date.

Overall, the structure provides numerous potential benefits for the transaction parties. The US borrower achieves low-cost funding, while the related set-off arrangements have the effect of mitigating credit exposure and minimizing prudential requirements. From the perspective of the NZ financier, the transaction is expected to generate an attractive pre-tax marginal yield and accounting return for the financier's consolidated group.

CONCLUSION

Although the depth of the local markets will inevitably restrict large-scale domestic issues, it is expected that the New Zealand structured finance market will continue to grow at a steady rate as issuers seek more cost-effective funding. Already there are signs that project financing will emerge as a growth area as the appetite of central government for the funding of infrastructure projects diminishes.

Recent economic indicators support predictions of more robust financial sector activity in 2002. There has been a resurgence in overall economic activity since 2000, spearheaded by the export sector which is thriving on the back of a low exchange rate, strong trading partner growth, improved commodity prices and favourable climatic conditions for primary producers. Although the performance in many key domestic industries has remained lacklustre, current expectations are for domestic industry sluggishness to subside in 2002 and for the economy to post moderate growth over the next few years. This forecast augurs well for growth in the structured finance market in the wake of the past two years' successful transactions.


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