Australian Market Commentary
The Australian bond market (as measured by the Bloomberg AusBond Composite 0+ Yr Index) returned -0.07% over the month. The yield curve steepened as 3-year government bond yields ended the month flat at 0.25% while 10-year government bond yields rose 13 basis points (bps) to 0.89%. Short-term bank bill rates ended the month lower. The 1-month rate was down 25 bps to 0.10%, the 3-month rate was down 27 bps to 0.10% while the 6-month rate was down 37 bps to 0.17%. The Australian dollar rose, closing the month at USD 0.65.
The Reserve Bank of Australia (RBA) held the cash rate steady in April, after taking strong action in March. The quantitative easing (QE) measures introduced in the prior month have begun to be implemented, so far seeing the RBA buy over AUD 50 billion in bonds. This has helped stabilise bond markets and brought a risk-on tone to certain segments of the spread markets throughout the month. When the RBA implemented the policy they stated that they would purchase government and semi-government bonds to ensure that the 3-year bond yield remained at around 0.25%. Their activity so far has achieved this objective, with 3 year bonds ending the month exactly on the target.
Domestic economic data releases were mixed in April, but all expectations are for much weaker data to come, as data points will soon capture the effects of the economic shutdown. Employment rose by 5,900 positions in March which exceeded expectations, but the ABS subsequently released data stating they had seen 6% of jobs lost in March. Inflation rose 0.5% quarter on quarter, taking the annual headline CPI to within the RBA’s 2–3% band, sitting at 2.2%. This reflects the impact of drought and bushfires and early effects of COVID-19, with food prices notably jumping to a 5-1/2 year high of 3.2%. However the recent decline in oil prices, rents and childcare points to very soft inflation outcomes in the near term. The NAB Survey of Business Conditions plummeted in March to -21, while business confidence fell to -65.6, which is the worst result on record. March retail sales were up 8.2%, led predominately by panic buying of food and other essential items. National CoreLogic dwelling prices continued to post gains, rising 0.3% in April. Overall this data simply confirms that the economy was looking strong before the COVID-19 crisis, but is expected to fall away quickly from here.
Australian Market Outlook
The ongoing dramatic changes globally, as COVID-19 has spread rapidly outside of China, has made estimating the full economic cost, at this stage, little better than guesswork. However, there is now little doubt that the world is heading into a recession given the various levels of industry and workplace shutdowns.
The Australian government has announced large stimulus measures to overcome the crisis, including a JobKeeper payment of AUD 1,500 a fortnight which is designed to keep people employed. Overall this should help mitigate the impact of the crisis, but the cost to the government will be staggering. Many countries across the globe will be running deficits of over 10% of GDP. The Australian government is no different and will need to fund large levels of debt issuance this year.
Within Australia, the shutdown of the economy to enforce social distancing is in full effect, with many businesses now closed. The retail and hospitality sector have taken the largest hit, with many restaurants now having been closed for two months. The stresses on small business will be large and the economic outcome is currently very uncertain. We do not yet even have a signal for when the economy will be fully reopened again, making any forecast little more than guess work.
The RBA’s QE has been designed to make financing conditions easier and to give banks an incentive to make sure the money gets to where it is needed most. Thus far, we have seen two of the major banks report the number of people facing hardship, which currently shows about 150,000 households seeking help. The RBA’s quick actions to make funding cheaper should help the banks alleviate some of this pain, but profitability across the economy is set to be weak.
Credit Commentary
Credit markets in April reversed some of the losses of March. However, the physical market in Australia, outside of major bank securities, lagged other markets both in spread movements and issuance. Domestic physical spreads tightened about 10 bps to government bonds by the end of month, mainly due to a strong contraction of major banks spreads, most specifically in the three to five year maturity area. Both domestically and offshore, synthetic markets credit spreads narrowed substantially: the US CDX by 34 bps, the European iTraxx by 31 bps and the Australian iTraxx by 54bps.
On the regulatory side, the Australian Office of Financial Management (AOFM) released regular updates on the Structured Finance Support Fund (SFSF) with regards to eligibility of issuers to participate and the potential for the fund to enter into secondary market trades to assist investors to participate in the primary market. The AOFM has been consulting with the Australian Securitisation Forum (ASF) about the SFSF and in particular the creation of a “Forbearance SPV” which will assist in the management of liquidity in the light of mortgage payment deferrals.
The RBA’s Term Funding Facility (TFF) was operating in April, and will provide up to AUD 91.7 billion borrowing capacity for the banks, effectively limiting the likelihood of issuance from Australian banks.
ANZ announced that the Reserve Bank of New Zealand will not allow it to pay dividends or redeem capital notes at this time, resulting in it being unable to redeem NZD 500 million of securities with an optional exchange date of 25 May 2020. In contrast, Bank of Queensland (BOQ) received approval from APRA to call its capital notes on 26 May 2026. APRA’s approval is contingent on BOQ replacing the capital notes with a new Tier 1 instrument at the first available opportunity.
BOQ reported cash earnings of AUD 151 million, down 9.6% on the pcp, but only down 1.3% compared to 2H19. BOQ has deferred its decision on the payment of an interim dividend until the economic outlook is clearer and stress testing results have been discussed with APRA. An AUD 10 million provision for COVID-19 made in early February will need to be adjusted substantially higher. Bendigo & Adelaide Bank announced the withdrawal of its 2H20 financial outlook guidance.
Later in the month, major banks started their reporting. National Australia Bank (NAB) pulled forward its 1H20 reporting from 7 May to 29 April and announced an AUD 3.5 billion capital raising. NAB also announced a lowered dividend of 30 cents/share. NAB reported cash earnings, down 51.4% on the pcp and a sharp lift in impairment costs to AUD 1.6 billion. ANZ reported 1H20 cash earnings down 60% on the pcp and announced that it would defer its coupon. At the end of month a few days prior to the release of its 1H20 results, Westpac announced that it will take an AUD2.24 billion impairment charge for 1H20.
In ratings news, Australia’s AAA sovereign rating had its outlook revised to negative from stable by Standard & Poor’s (S&P). As a result, the major banks and government supported entities such as Air Services Australia were also moved to a negative outlook. Ratings on securitised products were not impacted.
Fitch downgraded the ratings of Australia’s major banks (ANZ, Commonwealth Bank, NAB, Westpac) to A+/Negative from AA and moved Suncorp to a negative outlook. Fitch also revised the outlooks of Auswide Bank Ltd, Bendigo & Adelaide Bank Ltd, Heritage Bank Ltd, IMB Ltd and Police Bank Ltd to negative from stable. Moody’s changed its outlook on the Australian banking system to negative but kept the major bank ratings at Aa3 stable.
Outside of Australia, Fitch was also very active on banks. In Europe it revised the outlooks on Credit Suisse Group AG (A), UBS Group AG (A+) and Royal Bank of Scotland to negative and placed ING, Barclays PLC and Svenska Handelsbanken (AA) on ratings watch negative. In Canada, Bank of Montreal, CIBC, Royal Bank of Canada, Bank of Nova Scotia, National Bank of Canada and Toronto-Dominion Bank had their outlooks revised to negative from stable. Bank of America (A+), Citigroup (A), JPMorgan (AA-), Goldman Sachs (A), Morgan Stanley (A) and Wells Fargo (A+) had their outlooks revised to negative from stable. S&P was also active, moving Barclays, Lloyds, RBS, BNP, Societe Generale, BPCE, Credit Agricole, Rabobank, ING Groep, Deutsche Bank and Santander to negative outlook. Swedbank AB was downgraded to Aa3 from Aa2 by Moody’s.
Virgin Australia Holdings Ltd was downgraded to D by both S&P and Fitch and to Caa3, negative watch by Moody’s after the company entered voluntary administration. Boral Ltd had the outlook of its Baa2 rating moved to negative by Moody’s. Woodside Petroleum had its outlook on its Baa1 rating revised to negative from stable by Moody’s. Fitch has revised the outlook of Transurban to negative from stable. S&P revised the outlooks on GPT Wholesale Shopping Centre Fund, QIC Shopping Centre Fund, Scentre Group and Vicinity Centres to negative and revised QIC Property Fund to stable from positive. Scentre Group and Vicinity Centres also had their rating outlooks revised to negative by Moody’s.
TOTAL SA had its outlook revised to negative from stable by Moody’s. Daimler AG was downgraded to BBB+ from A- by Fitch with a stable outlook. Heathrow Funding Ltd had the outlook revised to negative from stable by Fitch.
In other ratings news, S&P released a report on the exposure of the Australian banking system to the COVID-19 crisis stating that dividend capacity is severely limited but the major banks have significant ability to absorb a large increase in bad debts, even in a severe downside scenario. Moody’s released a report highlighting increased risk in ABS due to payment deferrals and identifying SME ABS and RMBS obligors exposed to the worst-hit industries as posing the most risk while suggesting government support packages might defer the impact but not eliminate it.
In other news, the ACCC has approved the Asahi Group Holdings acquisition of AB InBev’s Carlton & United Breweries business. Transurban released its March 2020 update, with average daily traffic decreasing by 4.8%. Sydney, Adelaide, Perth and Auckland Airports all gave updates showing, as expected, severe declines in passenger numbers over the quarter with March being the nadir. Only cargo transport and intra-state transport (particularly to mining areas) were not substantially reduced. SCA Property is looking to raise AUD 200 million of equity to shore up its balance sheet through the current downturn as well as to enable it to be opportunistic in asset purchases. In their 3Q20 sales updates, GPT and Mirvac both released March 2020 updates emphasising their strong positions to manage the downturn. Both had already withdrawn their guidance for FY20. Woolworths recorded group sales up 10.7% from pcp, while Coles recorded a 12.9% increase in total sales revenues. Wesfarmers also recorded sales growth for Bunnings, Officeworks, Catch and Kmart, all of which benefitted from improved on-line sales. Target, however, continued to underperform.
US banks (Bank of America, JPM, Citi and Wells Fargo) and brokers (Goldman Sachs and Morgan Stanley) reported for the March quarter with the notable features being a sharp increase in credit costs and positive trading income. European banks (UBS, Credit Suisse, HSBC, Santander, Barclays and Deutsche Bank) reported similar trends, although Deutsche Bank surprised on the upside.
Issuance over April was limited to five covered bonds (four from Canadian banks and the other from Suncorp) and one refinancing of a Pepper I-Prime Trust for which no pricing information was given.
Credit Outlook
The term of and response to the virus remain the core determinants of the outlook. Even after a contraction of spreads in April, recent spread widening has resulted in credit appearing very attractively priced. However, in the current environment of uncertainty and nervousness, caution becomes the key requirement. Understanding of the different risks involved in individual credit issuers has become increasingly pertinent as the initial spread widening becomes increasingly refined depending upon the characteristics of the issuers.
Supply and demand in January and February were strong but disappeared in March and April and, going forward until markets settle, it would seem likely that supply—especially in the non-financial corporates—will be patchy and focused on high credit quality issues. Domestic non-financial supply is traditionally less abundant and is being tempted to offshore markets where government buying of credit has strengthened both demand and pricing of credit.
Any allocation to credit should be more weighted towards shorter dated credit which is less sensitive to spread movements, given that spreads are expected to stay wide and be challenged for the next months. Until markets settle, financials are expected to be the most common issuers in the Australian market and can offer value even in the current environment. However, for offshore issuers, caution must be applied both due to the long-running issue of the complexity of the variations in treatment of capital requirements with varying rules on TLAC (total loss-absorbing capacity) and due also to the different levels of impact of COVID-19 in the markets. Accordingly, domestic major banks offer a simpler value proposition due to their liquidity—although the TFF may limit their availability, while some of the smaller local ADIs provide a solid spread with conservative management. On the non-financial side, the retail A-REITs, airports and autos are the most obvious sectors to avoid but even the less immediately exposed issuers must be scrutinised very carefully for indirect impact from the expected economy downturn. Securitised product would appear to be a potential area of value, but even with these a thorough examination of structure and assets is necessary.
