Australia Market Commentary
The Australian bond market (as measured by the Bloomberg AusBond Composite 0+ Yr Index) was up 1.82% over the month. The yield curve flattened as the spread between long-term and short-term bond yields narrowed. 3-year government bond yields ended the month down 26 basis points (bps) to 1.37% while 10-year government bond yields were down 37 bps to 1.73%. Short-term bank bill rates ended the month lower. The 1-month rate was down 3bps to 1.81%, the 3-month rate was down 9 bps to 1.78% while the 6-month rate was down 16 bps to 1.84%. The Australian dollar remained unchanged to close the month at USD 0.71.
The cash rate remains unchanged at 1.50%. The Reserve Bank of Australia (RBA) has recently changed its tone, with a speech from Governor Lowe in February indicating that the probabilities of either a rate cut or hike appear evenly balanced.
The latest domestic economic data releases were mixed in March. Q4 GDP disappointed for the second consecutive quarter, with a weak 0.2% gain for the quarter and 2.3% for the year. Residential building approvals for January bounced back, recording a 2.5% increase. Year-on-year approvals remain in the doldrums at -28.6%. Employment rose modestly in February, adding 4,600 positions, after a very strong January. The unemployment rate nudged lower to 4.9%. The NAB Business Conditions eased 3 points to +4 in February, while business confidence fell 2 points to +2. Retail sales were up 0.1% in January, an improvement on December’s fall.
Australia Market Outlook
Global growth has desynchronised with one of the lead indicators for economic growth, the Purchasing Managers Index, showing contraction in over 40% of countries across the globe. We remain cautious about the global trade environment and shifting central bank policy settings. The US Federal Reserve has turned more dovish, appearing to drop their bias to hiking rates. Meanwhile, the US instigated trade war has subsided to a degree.
While the Australian economy has completed 26 years of uninterrupted expansion, there are some risks on the horizon. Over the past six months the consumer has struggled despite a strong business and employment outlook. Corporate profits are robust and business confidence remains positive, however historically low retail sales and poor consumer confidence driven by very low wages growth moderates the outlook for growth. Furthermore, the weaker housing market is starting to bite with falling house prices, lower building approvals and lower mortgage approvals filtering through to the broader economy.
We expect the RBA will need to cut rates in 2019, as the decline in house prices will slowly feed through to the real economy. Given weaker GDP growth and the soft inflation backdrop the RBA will likely have little justification to move cash rates higher in the near term. The RBA has recently changed its tone, with a speech from Governor Lowe in February indicating that the probabilities of either a rate cut or hike appear evenly balanced. Market participants are also starting to come around to this view, with some pushing back their expectations for rate hikes, while others are calling for cuts this year.
Credit Commentary
Sentiment for credit in March remained reasonably positive, although spread contraction was less than February with slight spread contractions across both physical and synthetic markets. Australian physical spreads were about 3 bps tighter while synthetic indices all rallied slightly with the Australian iTraxx 2.5 bps tighter and, in offshore markets, the US CDX 3.5 bps and European iTraxx 1.5 bps tighter. (All three indices rolled contracts on 20th March and the spread movements are adjusted for the rolls.)
S&P downgraded AMP Ltd and its subsidiaries, stating the move “reflects the weakened stand-alone credit strengths of AMP Life Ltd and the support it provides to the group credit profile.” The downgrade was by one notch taking the parent company AMP Ltd from A to A-. S&P also kept AMP on credit watch negative. S&P remarked that the rating change “reflects our view of uncertainty regarding the future quality of AMP after AMP Life is divested to Resolution Life Australia Ltd” and that “AMP’s group credit profile, post-divestment of AMP Life, is likely to be one or more notches lower than the current level.”
In offshore rating news, Moody’s upgraded Bank of America Corp’s issuer credit rating by one notch to A2 and the short term rating to P-1. The Operating Company Bank of America’s ratings were also raised one notch to Aa2/Stable. Moody’s upgraded Anglo American by one notch to Baa2. The following day, S&P upgraded the company one notch to BBB. In New Zealand, Fitch placed Fonterra’s A credit rating on negative outlook following its profit downgrade last month.
In banking news, CBA announced it has suspended preparations for the demerger of its wealth management and mortgage broking businesses in order to implement the recommendations of the Royal Commission. CBA stated, however, it remains committed to its strategy of ultimately exiting its wealth management and mortgage broking businesses. Following the fall-out from the Banking Commission, Westpac announced that it will exit personal advice by salaried and aligned planners by September. ANZ completed its AUD 3 billion share buy-back. ANZ’s common equity tier one ratio (CET1) as at December was 11.3%. Its capital position is expected to strengthen when the sale of its Australian Life Insurance business to Zurich is completed (currently scheduled for May). Suncorp announced a special dividend of 8c per share following the sale of its Australian Life Business and reiterated plans to return about AUD 600 million to shareholders.
Dexus and Dexus Wholesale Property Fund have equally and jointly acquired the remaining 50% interest in Sydney’s MLC Centre from GPT Group for a total price of AUD 800 million on a yield below 5%. Both Dexus and Dexus Wholesale Property Fund currently hold 25% stakes. Later in the month, it emerged that Dexus was considering acquiring the 80 Collins Street (Melbourne) development from QIC for AUD 1.4 billion. The manner of funding such a deal could impact the credit: although Dexus could, in theory, undertake a fully debt funded purchase which would leave it with little headroom under its current A-/A3 ratings with S&P and Moody’s.
In other Australian issuer related news, Caltex provided a disappointing Total Fuel and Shop Margin of ~AUD 160-170 million in Q1, ~ AUD 35-45 million lower than pcp (prior corresponding period). Sydney Airport provided a relatively weak passenger traffic performance update for February, with total flows 1.5% lower than the pcp, pulled lower by domestic traffic, which was 2.7% lower. The ACCC announced it will release its decision on the proposed Vodafone Australia and TPG Telecom merger on the 9th May. Transurban announced that CityLink Concession Deed Amendments for the West Gate Tunnel Project have received the necessary parliamentary consents. The changes provide for a CityLink concession ending on the 13th January 2045. Wesfarmers announced an unsolicited conditional, non-binding and indicative proposal to buy Lynas Corp for AUD 1.5 billion (cash). In response, Lynas Corp stated it would not engage with Wesfarmers. APA Group announced that its proposed Dandenong Power Project has been shortlisted as part of the Federal Government’s Underwriting New Generation Investments scheme. Lendlease was reported to have hired banks for the potential sale of its Engineering and Services unit which is credit positive but offset by the fact that it is reviewing its capital structure “to reflect the anticipated shift in earnings mix and associated lower earnings volatility.” Rio Tinto is reported to have issued force majeure notices on iron ore shipments following disruptions to production and shipments following Cyclone Veronica and is also reported to be assessing damage sustained at its Cape Lambert port facility.
In securitisation news, Moody’s has commented in a report that it sees a moderate rise in Australian RMBS delinquencies, given house price falls and high household debt. The 30+ days’ arrears rate rose to 1.58% in December 2018 from 1.49% a quarter earlier.
Although down from February’s level, issuance in Australian credit markets was consistent with previous years at AUD 4.85 billion with about AUD 90 million across three non-financials (Incitec Pivot, ConnectEast and Stockland) and the remainder across six financials (Suncorp, Rabo, IAG, ICBC and Macquarie). Year-to-date issuance is slightly higher than previous years at close to AUD 20.6 billion. Securitised markets provided more supply with AUD 3.5 billion of new issuance across three RMBS issues (Columbus, Liberty and Resimac) and two ABS issues (Smart Trust and Flexigroup).
Credit Outlook
Domestic credit spreads remain substantially tighter than the post-financial-crisis wides of 2015. As such, there is room for further widening in an environment where global or economic uncertainty continues to apply pressure: however, underweighting credit at current spreads for any sustained period of time has become more expensive than at the beginning of last year.
Supply has begun to increase domestically after a slow start this year in terms of number of issuers. Domestic non-financial supply is often less abundant and is always uncertain given many Australian investment-grade issuers tend to be lowly geared and so require less debt. In addition, the bank loan market remains attractive for shorter maturities and offshore markets offer competitive pricing for sizable long-term debt issues. Many issuers have also taken advantage of low rates to refinance many of their maturities and the short-term corporate pipeline is thin.
Given the possibility of further weakness of spreads, caution needs to be applied especially when investing in lower-rated credits. Despite the differing performance in terms of ratings, high-yield spreads in the US still appear reasonably tight and in Europe are close to normal but vulnerable to further widening; as such, the extent of compensation for taking exposure to lower-rated credit is less compelling.
Domestic and offshore financials tend to be the most common issuers in the Australian market and can offer value. However, for offshore issuers the attraction is decreased aspects such as the increase in non-domestic issuing programmes and the complexity of the variations in treatment of TLAC (total loss-absorbing capital). Accordingly domestic major banks offer a simpler value proposition due to their liquidity and some of the smaller local approved deposit institutions (ADIs) provide a solid spread with conservative management. On the non-financial side, the lack of supply has resulted in many deals being expensive but stable sectors such as the utilities and quality REITS remain more attractive sectors. Securitised product remains another area of value given solid spreads and in many cases superior credit quality.
