Term Deposits. Figure 1. Term Deposit Spread over Relevant BBSW: November v October. 3 Month Spread. Background on Term Deposits

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1 Deposit Review November 2016 Term Deposits Jack Pobjoy Credit Analyst (+61) jack.pobjoy@bondadviser.com.au While global interest rate volatility continues, term deposit (TD s) rate spreads have continued to compress (albeit at a slower rate) throughout November (Figure 1). Inflation, US monetary policy and a Trump-driven growth agenda continue to be driving factors but these forces have impacted longer term interest rates. Short term rates are generally a function of the underlying RBA cash rate and as the growing consensus is for the RBA to remain on hold, we expect TD rates and spreads will be increasingly determined by the individual funding profiles of banks. Figure 1. Term Deposit over Relevant BBSW: November v October 0.80% 0.60% 0.40% 0.20% -0.40% 1 Month 3 Month 6 Month 1 Year 3 Year Average 'Special' Change in November October Source: BondAdviser, RBA Background on Term Deposits Deposits offer investors a range of benefits over other types of investments: The diverse offering in Australia allows for investment flexibility. Depositors are able to choose their investment term and deposit type. This allows the investors to effectively express their view on interest rates. Deposits offer certainty of returns. The type of deposit and level of base rate on the transaction date remains unchanged during the duration of the investment. This allows the investor to avoid market volatility. For amounts up to $250,000, deposits are guaranteed by the federal government. As a result, credit risk is minimal. Key negatives to term deposits include: 1 Bond Adviser Pty Ltd Interest Rate Risk the risk that a TD purchased and subsequently locked in is lower than the future market interest rate on offer. Liquidity risk TDs can only be liquidated early with the issuing institution (i.e. there is no open market) and will usually result in a reduction in the effective interest rate for the term. This typically involves 31 days notice. TDs offer no capital upside as seen in other fixed income products such as bonds and hybrids.

2 Dec-1999 Jul-2000 Feb-2001 Sep-2001 Apr-2002 Nov-2002 Jun-2003 Jan-2004 Aug-2004 Mar-2005 Oct-2005 May-2006 Dec-2006 Jul-2007 Feb-2008 Sep-2008 Apr-2009 Nov-2009 Jun-2010 Jan-2011 Aug-2011 Mar-2012 Oct-2012 May-2013 Dec-2013 Jul-2014 Feb-2015 Sep-2015 Apr-2016 Nov-2016 Monthly Review: Term Deposits Does Trump Mean Anything for Term Deposits? Over the past month, there has been a lot of discussion around Trump s impact on interest rates which has driven a significant sell-off in global bond markets. In short, this has been a function of the expectation that the Trump administration s pro-growth agenda is inflationary. This in turn, has resulted in a surge in the 10-Year US Treasury yield and the Australian 10-Year Government Yield has followed suit. Following the domestic yield curve steepening, CBA, Westpac, NAB and a number of smaller lenders have increased interest rates on mortgage products in recent weeks but what does this mean for savers? Historically, long term interest rates have been driven by economic expectations while short term interest rates have been a function of monetary policy (Figure 2). The cash rate target set by the RBA is used as benchmark for bank wholesale funding and this drives other short-term funding costs including deposit funding. While Australian banks have adjusted TD rates out of cycle (against the RBA cash rate) more recently, the trend remains the cash rate is the most significant factor in setting TD rates. Figure 2. RBA Cash Rate vs Term Deposit Rates 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% Source: AFMA, BondAdviser 3 Month 6 Month 1 Year Cash Rate While the increased interest rates on mortgage products will improve the earnings outlook for banks, we believe there will be no inclination to increase TD rates materially until the RBA decides to increase the cash rate. Given the current economic outlook and considerable amount of household debt in Australia, we do not expect this to occur anytime soon. However, one of the major inputs of Australian monetary policy in 2016 has been inflation which may rise in line with the US. It is unlikely the Trump presidency will result in any upward pressure on Australian TD rates but it has definitely helped define the interest rate floor. The recent rally in commodity prices partially driven by Trump s potential pro-growth policies has depressurised the case for further rate cuts by the RBA and with another US rate hike on the horizon in December, the global economy may be at an inflection point. As we have seen throughout 2016, recent rate cuts by the RBA (and globally) have had little impact on desired economic outcomes and as demonstrated by Trump, a fiscal response could be more appropriate. All of these factors add to the case that we may have reached the bottom of the interest rate cycle and for this reason, TD rates may have also bottomed. As a result, we believe the individual funding requirements of each bank will be the primary driver in determining TD rates in Bond Adviser Pty Ltd

3 Market Commentary CBA cuts again In November, CBA hit savers again with a fresh round of TD rate cuts. The bank s ~1-Year rate was reduced by a further 0.15% to 2.25% and now sits below the level it was at before the generous increase in August (Figure 3). Other tenors decreased also with ~6 month and ~3 month rates cut by and 0.05% respectively. On the other hand, CBA just last week increased its mortgage rate for fixed term owner occupier and investment loans by up to 0.65%. Throughout 2016 bank earnings have been hit by ongoing regulatory reforms, particularly regarding capital levels and liquidity. Given the recent surge in long term interest rates (following the US election), it is no surprise that CBA has taken the opportunity to improve its earnings margin. Given the Australian 10-Year treasury yield remains elevated relative to short term rates (which have remained stable), we believe upward pressure on mortgage rates outweighs downward pressure on term deposit rates. Due to recent rate hikes on mortgage products, banks now have increased breathing room in regards to earnings and for this reason, we do not expect any material further TD rate cuts. This is conditional on no further RBA cuts to the cash rate but given the growing consensus is that we have reached the bottom of the interest rate cycle, we remain confident that TD rates will remain at current levels going into Figure 3. CommBank Term Deposit Rates 2.75% 2.25% 1.75% Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Short Term Medium Term Long Term Source: Company Reports Comparing Term Deposit Rates Overall, ANZ has the lowest term deposit rates across all tenors and continues to offer negative spreads. However, we note that ANZ has introduced Advance Notice Term deposits which are much closer to peer levels (short-term p.a., medium term 2.20% p.a. and long term 2.55% p.a.). The primary difference between this product and the ANZ s standard term deposits is that the investor must give ANZ 31 days notice if they wish to withdraw money prior to maturity. NAB and WBC still lead the medium and long term categories respectively out of the majors (2.40% p.a. and p.a.). BOQ continues to offer an attractive premium to the majors across all categories (~0.20%). 3 Bond Adviser Pty Ltd

4 Figure 4. Monthly Change in Short Term TD Rates -0.06% -0.05% -0.08% -0.12% Figure 5. Short Term TD Deposit Rates 2.45% 2.05% 2.10% 2.10% 2.15% 1.65% - Figure 6. Monthly Change in Medium Term TD Rates -0.06% -0.08% -0.12% Figure 8. Monthly Change in Long Term TD Rates 0.08% 0.08% 0.06% 0.04% 0.02% -0.06% -0.05% Figure 7. Medium Term TD Deposit Rates 1.70% 2.10% 2.40% 2.20% 2.40% 2.60% - Figure 9. Long Term TD Deposit Rates 2.25% 2.40% 2.52% 2.60% 1.80% - Figure 10. Monthly Change in Online Saver Rates 0.15% 0.05% -0.05% -0.15% -0.25% -0.15% ANZ CBA NAB WBC Saver Variable Rate Bonus Interest Figure 11. Online Saver Rates 2.85% 2.71% 2.60% 1.90% 1.25% 1.20% 1.20% 1.25% ANZ CBA NAB WBC Saver Variable Rate Bonus Interest Source: BondAdviser, Company Reports Note: Short Term ~3 Months, Medium Term ~6 Months, Long Term ~12 Months. 4 Bond Adviser Pty Ltd

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