Australian Debt & Hybrid Securities Research

Transcription

1 Australian Debt & Hybrid Securities Research Monthly Review January 2014 Nicholas Yaxley Credit Analyst

2 Contents News and Outlook 1 Government Bond & Money Markets Credit Markets Deposits & Official Cash Rate Economic Data Technical International Markets Recommendation Changes Since Last Month New Issues, Maturities and Resets Chart Pack 3 Appendix A Security Recommendations as at 23/01/ Appendix B Exchange Traded Australian Government Bonds ( etb ) 9 Appendix C Exchange-traded Treasury Indexed Bonds ( etib ) 10 Glossary 11

3 1 News and Outlook Nicholas Yaxley Credit Analyst Government Bond & Money Markets Australian government bond yields moved around during the month of January as expectations for global growth became increasingly uncertain. There was a broad-based flight to safety early in the month making government bond yields dip, but in a surprising CPI data release, expectations quickly changed with the domestic 10-year government bond yield jumping back up to 4.19%. The front end of the yield curve remained fairly steady, primarily as a result of employment numbers which took a sharp dive in December. As this data release was worse than expected, it has anchored any expectations of rate rises for We forecast the front end of the curve to continue this trend during in coming months but yields on 10-year Australian government bonds will be increasingly volatile if economic data out of the U.S. (and China to a degree) deviates from positive trend set in Credit Markets Broader credit markets were flat over the month as markets digested recent economic data and waited on further news surrounding the U.S. stimulus withdrawl. Benchmark credit indices drifted along with no real direction, but equity markets gave a more cautious undertone as economic data releases were weaker than expected. Listed interest-rate securities outperformed the broader market, with spreads contracting in bank capital securities (see Figure 5). This is driven by investor demand rather than any fundamental factors and we expect credit spreads to come under pressure on bank capital over coming months as issues begin to tap the retail primary market. Credit quality is starting to show signs of weakness across the corporate sector in Australia, primarily as a result of weak headline sales and unsustainable dividend payment policies. This was evident in announcements by Qantas Airways and QBE Insurance (we acknowledge these are not issuers in the retail market). Qantas was downgraded by the rating agencies as a result of structural challenges with competition and poor operating results. On the other hand, the QBE Insurance profit downgrade was as result of a significant writedown of goodwill associated with its recent U.S. acquisitions. These companies were not alone in witnessing weak sales figures as smaller retailers took some pain in what was anticipated as a bumper Christmas season. The financial sector was also busy during the month as it absorbed information from the Australian Prudential Regulation Authority, or APRA, on domestic systemically important banks, or D-SIBs, requiring those banks to hold an extra 1% in common equity tier-1 capital above Basel III levels from 1 January Also included in the report was APRA s expectation that key subsidiaries of the D-SIBs would be supported, in terms of covering losses and aiding liquidity, in order to avoid any impression the D-SIBs were unable to afford such support, which could question the safety of the system as a whole. The announcement was not a surprise with all four major banks already meeting or exceeding APRA's higher capital requirement and, in our opinion, are in a very strong position to comply with the new requirement by the 2016 implementation date. Deposits & Official Cash Rate Deposits have held steady during the month, with banks remaining focused on funding new loans through retail deposts. From an investor's perspective, deposits remain attractive relative to their long-term average. However, yields are linked to the offical cash rate and as the swap curve continues to steepen, we believe there are better opportunities for investors in relative low-risk investments. Economic Data On 22 January 2014, the Australian Bureau of Statistics released fourth-quarter CPI data which was significantly ahead of consensus. The fourth quarter is normally a softer quarter, so to see the seasonally adjusted CPI (trimmed mean) rising 0.9% (2.6% year on year) against an expectation of 0.6% (2.3% year on year) is positive as it brings the trend back above the midpoint of the RBA s target band. We note that 2H12 CPI rates were influenced by the introduction of the carbon price but we believe this has little influence on the data for There were some signs that the weaker Australian dollar is starting to shine through in fuel prices, equipment and tourism. Our base case assuption for monetary policy is that the RBA will remain on hold for the forseeable future until there is clear evidence the labour markets are stable, productivity has improved and/or inflation moves towards the edge of the target band of 2% to 3%. As stated current accommodative monetary stance is beginning to flow through to the real economy but at the same time we struggle to see real growth (that is inflation adjusted) within the economy until late 2014/early 2015.

4 2 Technical Technicals continue to be driven by the removal of quatitative easing by the Federal Open Market Committee during the next 9 to 12 months. As we have said before, this does not directly impact the listed interest-rate securities market but credit spreads are relative across the capital structure. If the market believes the broader economy is not strong enough to sustain QE tapering, interest-rate volatility will rise and credit markets will follow equities markets into negative returns. From a historical perspective, we remain in an artificially low-yield environment, but the year ahead is unlikley to be blemish free. Credit spreads in some sectors are back to precrisis levels and we feel that the corporate sector is likley to quickly put its balance sheet to work if there are any signs of economic turnaround. The return profile for interest-rate securites remains assymetric as benchmark rates are low and spreads are reaching historical levels. From a technical perspective we remain cautious of adding too much term or credit risk. International Markets U.S. treasury yields dropped to an 8-week low of 2.74% as the U.S. economic recovery started to show some signs of a slowdown (that is, U.S. employers hired 74,000 workers in December, the slowest advance since January 2011). This caused a rally in treasury securities (a drop in yields) as it raised questions about whether or not the U.S. Federal Reserve's tapering program might be slowed, or even halted. Our view is that the employment data was riddled with inconsistencies. We expect the employment data to be revised upward, or perhaps bigger gains are in store for the months ahead as some of the mystery jobs lost are found in later months. However, Morningstar's U.S. economist has recently highlighted several economic indicators that have him worried, including softer home prices, weaker existing home sales, and an above-average number of disappointments from fourth-quarter earnings reports. This may slow the recovery story but over the long term, we expect U.S. interest rates to normalise towards historical metrics. Three of the metrics we watch include the spread between current inflation and interest rates, inflation expectations, and the steepness of the treasury curve. Historically, the yield on 10-year treasury bonds has averaged 200 to 250 basis points above a rolling three-month inflation rate. Even with inflation at the unusually low rate of 1.2%, the yield on the 10-year treasury bonds could increase to between 3.20% and 3.70% to reach historical norms. Recommendation Changes Since Last Month 33On 21 January 2014, we initiated on AMP Subordinated Notes II (ASX Code: AMPHA). Although we remain comfortable with the credit profile of AMP Limited, the valuation is starting to look stretched. We initiate with a Hold recommendation. 33On 24 January 2014, we initiated on NAB Convertible Preference Shares II (ASX Code: NABPB). This security is almost a carbon copy of NABPA issued in March 2013, and hence we have used a very similar analysis framework. The security offers a slight term premium to comparable securites, but not enough to warrant a Buy recommendation. We initiate with a Hold recommendation. New Issues, Maturities and Resets 33Nil K

5 3 Chart Pack Figure 1: 90-Day Bank Bills vs Official Cash Rate Official Cash Rate 90 Day BBSW Aug-90 Feb-92 Aug-93 Feb-95 Aug-96 Feb-98 Rate (%) Aug-99 Feb-01 Aug-02 Feb-04 Aug-05 Feb-07 Aug-08 Feb-10 Aug-11 Feb-13 Source: Morningstar, Reserve Bank of Australia Figure 2: Interest Rate Futures Implied Cash Rate Implied Yield % 2.84% % 2.76% % 2.65% 2.70% % 2.59% 2.53% 2.53% % 2.50% 2.49% 2.48% 2.47% 2.45% 2.44% 2.43% 2.43% 2.43% 2.45% 2.48% % % % Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Source: ASX

6 4 Chart Pack Figure 3: Money Market Curve (Interest Rate Swaps) 28/01/ % 5.000% 4.000% 3.000% 2.000% 1.000% 0.000% 1M 2M 3M 4M 5M 6M 1Y 2Y 3Y 4Y 5Y 7Y 10Y 15Y Source: AFMA Figure 4: Term Deposit Average Special Rate (All Terms) Term Deposit Average Special Rate (All Terms) Term Deposit Average Rate (All Terms) Rate (%) Feb-02 Oct-02 Jun-03 Feb-04 Oct-04 Jun-05 Feb-06 Oct-06 Jun-07 Feb-08 Oct-08 Jun-09 Feb-10 Oct-10 Jun-11 Feb-12 Oct-12 Jun-13 Source: Reserve Bank of Australia

7 5 Chart Pack Figure 5: Bank Capital Securities Trading Margins (change on month) as at 26 January 2014 Average WCTPA WBCPD WBCPC WBCPB WBCHB WBCHA PCAPA NABPA NABHB CBAPC CBAPA BOQPD BENPD BENPC BENPB ANZPD ANZPC ANZPB ANZPA ANZHA -0.92% -0.09% -0.38% -0.20% -0.41% -0.06% -0.25% -0.35% -0.09% -0.18% -0.34% -0.10% -0.15% -0.19% -0.04% -0.15% -0.15% 0.03% 0.06% 0.53% 1.60% -1.50% -1.00% -0.50% 0.00% 0.50% 1.00% 1.50% 2.00% Source: Morningstar Figure 6: Floating Rate Securities Trading Margins (change on month) as at 26 January 2014 Average WOWHC TTSHA TPAPA TAHHB SVWPA SUNPD SUNPC RHCPA PRYHA ORGHA MYBG MXUPA MQGPA IANG IAGPC GMPPA CWNHA CTXHA CNGHA AYUHA AQHHA AGKHA AAZPB % % % % % % % % % % % % % % % % % % % 0.060% 0.080% 0.090% 0.250% 0.410% Source: Morningstar % % % % % 0.000% 0.200% 0.400% 0.600%

8 6 Chart Pack Figure 7: Australian Bank Capital Components Total Capital Tier 1 Capital 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Source: APRA Figure 8: Market Issuance by Issuer Risk Bucket $30bn $25bn $20bn $15bn $10bn $5bn $0bn Source: Morningstar Lower Medium Upper Medium High Extreme

9 7 Chart Pack Figure 9: New Issuer Monitor Corporate Financial Insurance Millions Qtr1 Qtr2 Qtr3 Qtr4 Qtr1 Qtr2 Qtr3 Qtr Source: Morningstar Figure 10: Credit Spreads on Non-Financial Corporates Spread to Swap (5Y) Spread to Swap (10Y) 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Jan-05 Jun-05 Nov-05 Apr-06 Sep-06 Feb-07 Jul-07 Dec-07 May-08 Oct-08 Mar-09 Aug-09 Jan-10 Jun-10 Nov-10 Apr-11 Sep-11 Feb-12 Jul-12 Dec-12 May-13 Oct-13 Source: RBA

10 8 Appendix A: Security Recommendations as at 23/01/14 Issue Size Years To Trading Running Yield Yield to Reset Dist Code Recommendation Price (AUD) Issuer (AUD m) Maturity Margin inc Fr ex Fr inc Fr ex Fr (AUD) Ex Date AGKHA Hold AGK % 6.25% 6.25% 5.47% 5.47% /02/2014 AMPHA Hold AMP % 5.31% 5.31% 5.16% 5.16% /03/2014 ANZHA Accumulate ANZ % 5.29% 5.29% 4.49% 4.49% /03/2014 ANZPA Accumulate ANZ % 5.79% 4.06% 5.62% 3.78% /02/2014 ANZPB Accumulate ANZ % 5.18% 3.63% 4.76% 2.64% /02/2014 ANZPC Accumulate ANZ % 5.84% 4.09% 5.89% 3.90% /02/2014 ANZPD Hold ANZ % 6.07% 4.25% 5.94% 3.98% /02/2014 AQHHA Hold APA % 6.91% 6.91% 5.74% 5.74% /03/2014 CBAHA Hold CBA % 3.69% 3.69% 3.78% 3.78% /04/2014 CBAPA Accumulate CBA % 6.07% 4.25% 4.90% 3.07% /01/2014 CBAPC Hold CBA % 6.24% 4.37% 5.37% 3.39% /03/2014 CNGHA Accumulate CNG % 5.81% 5.81% 5.00% 5.00% /03/2014 CTXHA Hold CTX % 6.88% 6.88% 5.42% 5.42% /03/2014 CWNHA Hold CWN % 7.30% 7.30% 6.01% 6.01% /02/2014 GMPPA Hold GMG % 6.73% 6.73% 6.96% 6.96% /12/2013 IAGPC Hold IAG % 6.47% 4.53% 5.23% 3.09% /04/2014 IANG Hold IAG % 6.48% 4.54% 5.87% 3.82% /03/2014 MBLHB Accumulate MQG % 5.31% 5.31% /03/2014 MQGPA Hold MQG % 6.60% 4.62% 6.13% 4.04% /11/2013 NABHA Accumulate NAB % 5.22% 5.22% /01/2014 NABHB Accumulate NAB % 5.27% 5.27% 4.37% 4.37% /03/2014 NABPA Accumulate NAB % 5.91% 4.14% 5.84% 4.00% /02/2014 NABPB Hold NAB % 5.96% 4.17% 5.89% 4.04% /02/2014 ORGHA Hold ORG % 6.69% 6.69% 6.36% 6.36% /03/2014 PCAPA Accumulate CBA % 3.84% 2.69% 5.71% 4.51% /03/2014 RHCPA Hold RHC % 7.40% 5.18% /09/2013 SUNPC Hold SUN % 7.08% 4.96% 5.91% 3.65% /03/2014 SUNPD Hold SUN % 5.45% 5.45% 5.09% 5.09% /02/2014 SVWPA Hold SVW % 8.68% 6.07% /11/2013 TAHHA Accumulate TAH % 6.97% 6.97% 4.07% 4.07% /02/2014 TAHHB Hold TAH % 6.59% 6.59% 5.84% 5.84% /03/2014 TTSHA Hold TTS % 5.61% 5.61% 5.01% 5.01% /03/2014 WBCHA Accumulate WBC % 5.29% 5.29% 4.53% 4.53% /02/2014 WBCHB Hold WBC % 4.96% 4.96% 4.91% 4.91% /02/2014 WBCPB Accumulate WBC % 6.47% 4.53% 4.54% 2.34% /03/2014 WBCPD Hold WBC % 5.90% 4.13% 5.85% 4.04% /02/2014 WCTPA Accumulate WBC % 3.86% 2.70% 6.15% 5.01% /12/2013 WOWHC Hold WOW % 5.72% 5.72% 4.43% 4.43% /02/2014

11 9 Appendix B: Exchange Traded Australian Government Bonds as at 28/01/14 ASX Code Price Coupon Ex-date Payment Date Running Yield YTM Maturity GSBK % 4-Jun Jun % 2.271% 15-Jun-14 GSBS % 9-Apr Apr % 2.248% 15-Oct-14 GSBG % 3-Arp Apr % 2.264% 15-Arp-15 GSBS % 9-Apr Apr % 2.43% 21-Oct-15 GSBK % 4-Jun Jun % 2.619% 15-Jun-16 GSBC % 5-Feb Feb % 2.775% 15-Feb-17 GSBM % 9-Jul Jul % 2.92% 21-Jul-17 GSBA % 9-Jul Jul % 3.06% 21-Jan-18 GSBS % 9-Apr Apr % 3.197% 21-Oct-18 GSBE % 5-Mar Mar % 3.251% 15-Mar-19 GSBG % 3-Apr May % 3.477% 15-Apr-20 GSBI % 5-May May % 3.662% 15-May-21 GSBM % 3-Jul Jul % 3.812% 15-Jul-22 GSBG % 9-Apr Apr % 3.905% 21-Apr-23 GSBG % 9-Apr Apr % 3.992% 21-Apr-24 GSBG % 9-Apr Apr % 4.103% 21-Apr-25 GSBG % 9-Apr Apr % 4.301% 21-Apr-27 GSBG % 9-Apr Apr % 4.398% 21-Apr-29 GSBG % 9-Apr Apr % 4.582% 21-Apr-33 Figure 11: Exchange Traded Government Bond Yield Curve 5.00% 4.50% 4.00% 3.50% 3.00% Yield to Maturity 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% Term to Maturity Source: ASX, Morningstar

12 10 Appendix C: Exchange-traded Treasury Indexed Bonds ( etib ) as at 28/01/14 ASX Code Price Coupon Ex-date Payment Date Running Yield YTM Maturity GSIO % 10-Feb Feb % 0.36% 20-Aug-15 GSIO % 10-Feb Feb % 1.147% 20-Aug-20 GSIO % 11-Feb Feb % 1.365% 21-Feb-22 GSIQ % 7-Mar Mar % 1.550% 20-Sep-25 GSIQ % 7-Mar Mar % 2.539% 20-Sep-30 GSIO % 11-Feb Feb % 1.997% 21-Aug-35 Figure 12: Exchange Traded Government Bond Real Yield Curve 3.00% 2.50% 2.00% Yield to Maturity 1.50% 1.00% 0.50% 0.00% Term to Maturity Source: ASX, Morningstar

13 11 Glossary BBSW Conversion Conversion Discount Conversion Number The Bank Bill Swap Rate (BBSW) is the average mid rate for Australian dollar bills of exchange accepted by an approved bank, having a tenor with a designated maturity that appears on an approved information vendor's service (e.g., Reuters Screen BBSW page). Under certain circumstances, the hybrid security may be converted into a number of ordinary shares of the underlying stock at a specified conversion number, subject to terms, conditions and corporate events, including conversion discount, conversion date and triggers. A discount in percentage applied to the underlying stock price into which the hybrid security may be converted. Also referred to as exchange discount. The number of ordinary shares of the underlying stock into which the hybrid security may be able to convert. For certain hybrid securities, there may be a minimum and/or a maximum conversion number applied. The conversion number is generally calculated based on a formula: Conversion Number = Face Value / [VWAP x (1 Conversion Discount)] Convexity Cumulative Dividend Yield Duration Exchange Face Value Gross Margin Market Rate Mandatory Conversion Net Reference Rate A measure for bonds used in conjunction with modified duration in order to measure how the bond's price will change as interest rates change. It is equal to the opposite of the second derivative of the bond's price relative to its yield, divided by its price. For example, since a non-callable bond's duration usually increases as interest rates decrease, its convexity is positive. Depending on the hybrid security, the dividend, distribution or coupon paid may or may not be cumulative. If the dividend, distribution or coupon is cumulative and if the issuer defers the payment of the dividend, distribution or coupon on any payment date, then additional dividend, distribution or coupon will accrue at the prevailing distribution rate. Expressed as a percentage, dividend yield is the company's annual dividend payments divided by its market cap, or the dividend per share divided by price per share. The change in the value of a fixed-income security that will result from a 1% change in interest rates. Duration is stated in years. For example, a five-year duration means the bond will decrease in value by 5% if interest rates rise 1% and will increase in value by 5% if interest rates fall 1%. Duration is a weighted measure of the length of time the bond will pay out. Exchange means the conversion, redemption, buy-back or cancellation of the hybrid security. The face value of the security is the issue price typically being AUD 100 per security. Yield expressed, inclusive of any available franking credits or tax-deferred benefits. Expressed as a percentage per annum, the margin offered by the hybrid security over a reference rate. The initial margin is typically determined by a bidding process within a prescribed margin range known as bookbuild. For certain hybrid securities, the margin may be increased (refer to Step-up) at a predetermined date. See Reference Rate. Some securities include a mandatory conversion condition, which forces conversion if the underlying stock price is above some threshold level and the issuer chooses not to redeem the security for face value. Yield expressed, exclusive of any available franking credits or tax-deferred benefits. Typically a floating reference rate (e.g., 90-day BBSW) used to reference the periodic coupon payment of a hybrid security. The reference rate is generally applied at the beginning of a distribution period for the upcoming distribution. Also referred to as the market rate.

14 12 Reset For certain hybrid securities, on a reset date, the issuer may reset certain terms including the next reset date, the dividend/ distribution rate, the conversion discount and the timing of frequency of dividend/distribution payments. Resets may mean significant change to the terms of the hybrid security and as a result investors may or may not accept such new terms. Further, the issuer may elect to redeem or to exchange the hybrid security. As such, Morningstar has a conservative approach to treating resets and considers it as a probable maturity. In tables and abbreviations, we use "Reset" to refer to any step-up, mandatory conversion, call or other pseudo-maturity event. Running Yield Step-up Tax Deferred Time to Maturity/Reset Trading Margin VWAP Volatility Yield to Reset/Maturity (YTR/ YTM) The hybrid's annual coupon payments expressed as a percentage of the market value of the security. For certain hybrid securities, the margin above the reference rate may be increased or stepped-up at a predetermined date upon the occurrence or non-occurrence of a certain event (e.g., non-conversion at a specified date). The distribution of certain hybrid securities may have a tax-deferred component (may be less than 100%), which allows the distributions to be tax deferred over a certain period. The tax-deferred distributions are not assessable to Australian income tax upon receipt for most investors, but instead reduce the cost base of the security for capital gains tax purposes and as a result defer tax until the disposal of the security. Securities offering a tax-deferred component may give rise to tax benefits. Changes to tax legislation may have the effect of reducing the tax-deferred component of distributions. Investors should seek professional taxation advice in relation to dealing in these securities and their individual situation. The time expressed in number of years from now to a reset date, conversion date, step-up date and/or maturity date, where on such date, either the terms of the security may change or the security may be repurchased, redeemed, exchanged or converted. In simple terms if an issuer already had securities on issue, they could expect any new securities with $100 face value to trade close to the trading margin. The Trading Margin of a security s is the effective margin at which s trades; it is the margin which a new security n with face value of AUD 100 would need so the sum of the discounted cash flows of n equal the discounted cash flows of s assuming redemption of both s and n at the pseudo-maturity date of s. The calculation is grossed up for franking where appropriate. The average of the daily volume weighted average sale price of ordinary shares sold on ASX during the relevant period subject to specific terms and adjustments of the relevant hybrid security offer. The degree to which the price of a security tends to fluctuate. The hybrid's internal rate of return to reset, step-up or other pseudo-maturity event.

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