Term Deposits. Figure 1. Term Deposit Spread Over Relevant BBSW: May v April Month Spread. Background on Term Deposits

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1 Deposit Review May 2017 Term Deposits Jack Pobjoy Credit Analyst (+61) jack.pobjoy@bondadviser.com.au Harini Warrier Credit Analyst (+61) harini.warrier@bondadviser.com.au Longer term Term Deposit (TD) spreads increased materially for the second month in a row as the domestic benchmark swap curve shifted lower. This gradual move has been driven by a moderation in inflation expectations in light of the re-emergence of geopolitical risk. Reports of missile tests in North Korea, allegations of the Trump administration s ties with Russia and an upcoming UK election has resulted in growing caution from global investors. For this reason, interest rate volatility may persist but in our opinion, financial markets have seen the low point in inflation. As a result, we believe TD rates will need to increase for term deposit spreads to expand rather than being driven by further compression in the underlying benchmark curve. Figure 1. Term Deposit Over Relevant BBSW: May v April % - 1 Month 3 Month 6 Month 1 Year 3 Year Average 'Special' Change in May April 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 currently 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. Income from TDs is fully taxable at the investor s marginal tax rate (i.e. no franking).

2 Priority of Payments Monthly Review: Term Deposits The Federal Budget and TDs The 2017/18 Federal Budget was one of the major talking points during the month with the Government s new bank levy stealing the show. Proceeds from the levy are estimated to raise $1.5 - $1.6 billion each year (in which there has been scepticism) calculated as an annual rate of 0.06% on each banks liabilities. However, the levy only applies to certain liabilities and excludes retail deposits below the government guarantee threshold of $250,000 (incorporating a large proportion of TD funds). Under the new legalisation, the tax only applies to banks with liabilities of at least $100 billion which includes the Big 4 banks and Macquarie. So, what are the implications for TD rates? In our opinion, there are two potential scenarios. Either the banks could absorb the bank levy through reducing TD rates or competition for deposit funding could intensify among the major banks (and to a lesser extent, Macquarie) as they are excluded under the levy calculation. The latter will naturally imply a modest increase in TD offer rates. Figure 2. Simplified Bank Capital Structure Senior Secured Debt (i.e. Covered Bonds) Government Guaranteed Debt (<$250k Deposits) Other Deposits (>$250k Deposits) Senior Debt Subordinated Debt (Tier 2 Capital) Hybrids (Additional Tier 1 Capital) Ordinary Equity (Common Equity Tier 1 Capital) Excluded for new bank levy Excluded for new bank levy Source: BondAdviser While it is difficult to quantify the final impact of the bank levy in relation to the funding profiles of the majors, we believe term deposits will not be used as a primary lever. Instead it is likely the banks will reduce operational expenditure, decrease dividends or if they choose to pass the tax onto customers (unlikely given parliamentary pressure) it will most likely be in the form of increased mortgage rates rather than TD rate cuts. Historically, meaningful moves in term deposit rates have been driven by increases or decreases to the RBA cash rate and we see no reason why this will change any time soon. While there may be some volatility in TD rates as a result of a potential reshuffling in funding profiles, the next major adjustment will be determined by the RBA s monetary policy stance which currently remains neutral (cash rate left of hold for last 9 meetings). Figure 3. TD Rates Await the RBA s Next Move 2 Bond Adviser Pty Ltd 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% Cash Rate Average 'Special' Term Deposit Rate Source: RBA

3 Market Commentary TDs remain Steady As expected, Westpac s (WBC) medium term deposit rate retraced to 2.10% p.a. following the end of its limited p.a. 12-day offer at the beginning of May. Aside from this reversal, the TD market remained relatively steady with no changes to offer rates across short-term, medium-term and longterm tenors. With WBC s revision, average major bank TD rates now sit at 12-month lows. The question is, can they get any lower? Figure 4. Major Bank Average TD Rates 2.60% 2.40% 2.30% 2.20% 2.10% 1.90% Short-Term Medium-Term Long-Term Source: BondAdviser, Company Reports The RBA cash rate was left on hold for the 9 th consecutive meeting on the 6 th of June 2017, but futures markets are pricing in the possibility of further rate cuts later in the year. Nonetheless, the consensus is that rates will remain on hold for the remainder of the year and it seems counterintuitive for the RBA to undo APRA s recent efforts in curbing credit growth (i.e. cap on interest-only loans). Figure 5. Future Implied Probability of RBA Cash Rate Decisions 100% 80% 60% 40% 20% 0% 95.4% 92.0% 87.8% 86.6% 82.2% 81.4% 4.6% 8.0% 12.3% 13.5% 17.8% 18.6% Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Cut Hold Source: Bloomberg Comparing Term Deposit Rates Overall, ANZ has the lowest term deposit rates across all tenors and continues to offer negative spreads. However, we note ANZ has introduced Advance Notice Term deposits which are much closer to peer levels (short-term 2.10% p.a., medium term 2.10% p.a. and long term 2.40% p.a.). The primary difference between this product and the ANZ s standard term deposit is the investor must give ANZ 31 days notice if they wish to withdraw money prior to maturity. Out of the majors, NAB leads all categories. In terms of the regional banks, BOQ continues to offer an attractive premium to most major bank rates across all categories. 3 Bond Adviser Pty Ltd

4 Figure 6. Monthly Change in Short Term TD Rates Figure 7. Short Term TD Deposit Rates 2.05% 2.10% 2.05% 2.05% 2.25% 1.65% - Figure 8. Monthly Change in Medium Term TD Rates -0.05% -0.10% -0.15% % -0.30% -0.35% % - Figure 9. Medium Term TD Deposit Rates 2.10% 1.70% 2.20% 2.10% 2.45% 2.25% - Figure 10. Monthly Change in Long Term TD Rates Figure 11. Long Term TD Deposit Rates 2.35% 2.40% 2.35% 2.40% 2.45% 1.80% - Figure 12. Monthly Change in Online Saver Rates -0.02% -0.04% -0.06% -0.08% -0.10% -0.12% -0.14% -0.16% -0.15% -0.05% ANZ CBA NAB WBC Saver Variable Rate Bonus Interest Figure 12. Online Saver Rates 2.55% 2.55% 2.51% 1.90% 1.05% 1.20% 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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