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Weekly Highlights (5 May 2015)

Over the past week we have witnessed a steeping of the yield curve (change in long term rates expectations), the RBA keeping interest rate traders happy with a rate cut, APRA changing the capital rules for banks (good for debt and hybrid investors), major banks kicking of their half year reporting and a few interesting pricing benchmarks.

The yield curve  relevant to our investor base is the swap curve (not the government bond curve) and what the majority of interest rate products are priced from. The chart below shows the curve is starting to steepen at the long end (that is past 5 years). This is primarily a result of inflation expectations picking up again across the globe. Inflation measures in Europe and the US have risen to the highest levels since December. For Australian investors its the same old story – when the world sneezes we catch a cold. If  inflation expectations are up so are ours.

We released an article this week on the back of Waynes Byrnes (APRA) speech about implementing the FSI recommendations. This speech sent bank shares into a mini meltdown as the market broadly didn’t expect the timing of the new rules to be implemented so quickly. Our view is the changes to the capital requirements are credit positive for debt and hybrid investors. Check out the full article here.

chart

Now for what everyone has been waiting for ….the RBA announcement. This one is not one for the ages. The futures market was pricing in a 76% probability of a rate cut today so the RBA’s actions are far from astonishing.  The announcement read:

“the inflation outlook provided the opportunity for monetary policy to

be eased further”

because they want to…

“reinforce recent encouraging trends in

household demand”.

In our opinion they cut because they can and the economy is still fragile enough to warrant further stimulus and a lower AUD. We don’t need to go into the detail but its another hit to income investors as short term swap rates (BBSW) will reduce and floating rate notes will reset at a lower coupon.

Over the course of this week ANZ, MQG, NAB and WBC will all report half year results and we expect them to be broadly pretty dull. Given the results of ANZ and WBC in the past two days profitability will remain high (albeit below some expectations), asset quality continues to improve but there may be some uncertainty in regard to future capital settings. This uncertainty could result in increases in the capital targets for each bank.

In terms of new issues in the past week, we have identified a few which are relevant to our clients. Heritage Bank issued a 5 year floating rate notes at 3m BBSW +115bp while in New Zealand, Kiwibank (subsidiary of New Zealand Post, which is a 100% state-owned enterprise)  issued NZ$150m of a Tier 1 capital instrument at  3.65% over bank bills. The Heritage deal is offered at a ~0.4% premium to the major banks and although this is not a security we currently cover it looks reasonable value given the balance sheet risk.

In news that is important but did not make a lot of headlines,  Standard and Poors released its 2014 Annual Global Corporate Default  and Rating Transitions Data. While this might not sound important it is actually the best empirical data set of defaulted and / or deteriorating loans globally. This is just a summary of the major findings:
  • In 2014, 60 global corporate issuers defaulted (2013: 81) which was the lowest since 2011. These 60 defaulted issuers accounted for a total of $91.6 billion in debt, down from $97.3 billion in 2013.
  • Similar to 2013, this decline is a result of both a smaller number of defaults and an increase in the number of issuers in 2014 (up to 3,163 from 2,804 a year earlier).
  • The U.S.  accounted for the majority of defaults globally in 2014 (55%) but this is the lowest percentage in the past 34 years.
Overall, we would suggest that the the economic, political and business environment has been very favourable for global borrowers in 2014.While all of this data is not directly relevant to Australian issuers its gives investors confidence that we are at the low point in the default cycle and liquidity / refinancing risk is arguably as low as it was in 2007.