Term Deposits. Background on Term Deposits. Deposits offer investors a range of benefits over other types of investments:

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1 Deposit Review August 2017 Term Deposits Jack Pobjoy Credit Analyst (+61) jack.pobjoy@bondadviser.com.au Ethan Xing Credit Analyst (+61) ethan.xing@bondadviser.com.au Both short-term and long-term interest rates experienced minimal movements (relative to previous periods) over the month of August. Nonetheless, TD spreads over BBSW tightened (Figure 1) given TD rates remain static across almost all tenors. This again manifests the positive correlation between TD spreads and interest rate volatility. While domestic interest rates are of course subject to global forces, local monetary policies are still playing a key role in driving short-term interest rates. The RBA has maintained the record low cash rate () for 12 months consecutively since the rate was last cut in August The domestic housing market has shown growing signs of a slowdown as a result of banks tightening their lending policies. In the short term, the cash rate is highly likely to continue to remain on hold, although we note that there was some optimism on wage growth from the RBA governor in the latest meeting. Figure 1. Term Deposit Over Relevant BBSW: August v July % 0.60% 0.40% 0.30% 0.20% 0.10% -0.20% 1 Month 3 Months 6 Months 1 Year 3 Years Average 'Special' Change in August July Source: RBA, BondAdviser 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 Index Rebased Monthly Review: Term Deposits AusBond FRN v AusBond Bank Bill Term deposits are considered one of the safest investments as they provide certain return with minimal risks (up to $250,000 in ADIs guaranteed by the Government). However, in the low-yield environment in Australia, investors are favouring alternatives to TDs for higher returns and potential capital gains. These alternatives primarily include bonds, equities but also safer ones such as Cash ETFs and Floating Rate Bank Bond ETFs. Below, we use the AusBond Credit Floating Rate Note (FRN) Index (which broadly tracks Floating Rate Bank Bonds) and the AusBond Bank Bill Index (which tracks Cash instruments) as an example to demonstrate the different risk and return features. Figure 2. AusBond Credit FRN Index v AusBond Bank Bill Index AusBond Credit FRN Index AusBond Bank Bill index Source: Bloomberg, BondAdviser Figure 3. AusBond Credit FRN Index Metrics v AusBond Bank Bill Index Metrics AusBond Bank Bill Index AusBond Credit FRN Index Average Return 1.13% 1.27% Maximum Return 1.95% 3.06% Minimum Return 0.30% -0.44% Standard Deviation 0.40% 0.53% *Note: Quarterly Returns, Source: Bloomberg, BondAdviser 2 Bond Adviser Pty Ltd As Figure 2 shows, the AusBond Credit FRN Index has grown more overall than the AusBond Bank Bill Index since 1998, indicating a better performance in the long term. This is also reflected in Figure 3 with a quarterly average return of 1.27% (vs 1.13% for Bank Bill) and highest recorded return over the period was 3.06% (vs 1.95%). Nevertheless, the bond market is subject to higher credit risks relative to the shorter-term cash markets. The historical minimum return for the AusBond Credit FRN Index was is -0.44% whereas the worst return for AusBond Bank Bill Index over the same period was 0.30%. Cash markets also have experienced less volatility in the long run, represented by the lower standard deviation of 0.40%. Although both indices track some of the safest investment options available in Australia, there are still marginal differences in risk that cash investors should be aware of. As shown above, financial floating rate notes (the bulk of the AusBond Credit FRN Index) can exhibit negative returns during times of stress. Investors should always be aware of additional risks when considering cash-like alternatives with extra yield. In other words, there are often reasons why a certain instrument has a higher yield.

3 Market Commentary CBA Ease Long-Term TD TD rates offered by the majors across various horizons almost remained static in August. CBA s long-term rates have bounded between 2.25% and for the last couple months as seen in Figure 4. Its temporary long-term TD rate revealed the intent to remix its funding profile for compliance purposes (as discussed in Term Deposit Monthly - July 2017). However, the month of August saw CBA s long-term TD rate drift back by 0.30% to 2.20%, potentially suggesting its funding portfolio has been adjusted well in the previous period and the bank remains more content with its current deposit funding structure. In addition, CBA reported strong results for the financial year 2017 in August with a Net Stable Funding Ratio (NSFR) of 107%, well above the 100% requirement and also above a probable longterm target of 105%. Even though the bank s Liquidity Coverage Ratio (LCR) dropped by 6% to 129% relative to 135% in 1H17, this is still marginally higher than its likely long-term target of 125%. CBA s large 26.5% market share does indicate that the bank is more sensitive to macroeconomic changes than its peers. Based on that, decreasing long-term TD rates could also reflect less of an incentive to generate loans as rapidly and to further reduce credit exposures in home and business loans in the current environment. Figure 4. CBA Short-Term and Long-Term TD Rate 2.90% 2.70% 2.30% 2.10% 1.90% Short Term Long Term *Note: Short Term ~3 Months, Long Term ~12 Months. Source: BondAdviser, Company Reports Comparing Term Deposit Rates ANZ offers the lowest term deposit rates across all tenors, representing negative spreads in relation to BBSW in the medium and long-term categories. However, ANZ s Advance Notice term deposits, which requires 31 days notice if depositors wish to make a withdrawal prior to maturity are comparable with peers. NAB s short-term offering (2.10%) and long-term offering (2.40%) continues to lead the short and long-term categories whereas WBC s medium-term deposit () leads the medium-term category. The regional TD offerings appear more favourable with BOQ consistently offering more attractive returns than its major rivals across all categories. 3 Bond Adviser Pty Ltd

4 Figure 5. Monthly Change in Short Term TD Rates Figure 6. Short Term TD Deposit Rates 2.40% 2.10% 2.05% 2.05% 1.60% Figure 7. Monthly Change in Medium Term TD Rates Figure 9. Monthly Change in Long Term TD Rates -0.15% -0.20% -0.25% -0.30% -0.35% -0.30% Figure 8. Medium Term TD Deposit Rates 2.60% 2.05% 2.20% 2.25% 1.70% - Figure 10. Long Term TD Deposit Rates 2.60% 2.40% 2.35% 2.40% 2.20% 1.80% - Figure 11. Monthly Change in Online Saver Rates -0.02% -0.04% -0.06% -0.08% -0.12% ANZ CBA NAB WBC Figure 12. Online Saver Rates 2.55% 2.51% 1.90% 1.20% ANZ CBA NAB WBC Saver Variable Rate Bonus Interest 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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