Co-authored by Tom Guest and Jon Sheridan
Both bonds are ten year fixed rate but offer exceptional relative value of circa 4.6% per annum in a low interest rate environment. The note considers the merits of long dated fixed rate investments and includes a relative value assessment – including our preferred floating rate options
Over the last week, we added two new DirectBonds to our list.
They are from Middle Eastern banks, Emirates NBD and Qatar National Bank. We’re quite excited about the bonds as they are highly rated and offer yields to maturity around 4.6% per annum. We think the yield given risk is excellent and that there is scope for yield compression and price appreciation in coming days.
The bonds themselves are ten year fixed rate, against our recurrent theme of shortening duration, but the quality of the bonds and the fact the yield curve has already built in US Fed interest rate rises of 100bps gives us comfort.
If the Fed fails to increase by 100bps and indeed benchmark 10 year treasuries do not rise much further, these bonds offer an outstanding premium.
The new DirectBonds
The two new issuers are both brand new to the Aussie dollar market. They are both from the Middle East and highly rated financial institutions.
|Rating ||Maturity ||Coupon ||Coupon type ||Structure ||Min. investment || |
|A3 (A- S&P equivalent) ||9 February 2028 ||4.75% ||Fixed ||Senior unsecured ||AUD10,000 ||Factsheet here |
Emirates NBD is one of the largest banking groups in the Middle East and officially listed on the Dubai Financial Market in October 2007. That year, the merger between Emirates Bank International and the National Bank of Dubai (NBD) formed a bank capable of delivering enhanced value across corporate, retail, private, Islamic and investment banking throughout the region.
As at 31 December 2017, the group’s total assets were equivalent to approximately US$128bn.
Qatar National Bank (QNB Finance)
|Rating ||Maturity ||Coupon ||Coupon type ||Structure ||Min. investment || |
|Aa3 / A (Moody's / S&P) ||1 February 2028 ||4.90% ||Fixed ||Senior unsecured ||AUD10,000 ||Factsheet here |
QNB Finance is a wholly owned subsidiary of Qatar National Bank S.A.Q. (QNB). Established in 1964, QNB was the country’s first Qatari owned commercial bank and is now the largest commercial bank in Qatar for which financial statements are published. It is also the largest bank in the Middle East and North Africa region, with a strong focus on the Gulf Cooperation Council countries.
QNB Finance is 50% owned by the Qatari government with the other 50% being publicly listed on the Qatar Stock Exchange. The bank offers a broad suite of financial products and services to its customers, with business divisions focused on corporate banking, retail banking, international banking, asset and wealth management services and treasury. Through these business divisions, QNB caters to the needs of individual (including high net worth), corporate, institutional, government and government related clients, both domestically and internationally.
In 2017, QNB had approximately US$3.6bn profit and US$223bn of total assets. The bank is listed with a current market capital of circa US$35bn.
Note: Emirates DNB and Qatar National Bank bonds are available to wholesale investors only.
Why are these DirectBonds a good investment opportunity?
1. Very good relative value - both bonds trade around 4.60% pa yield to maturity
As new issuers to the Aussie dollar market, both institutions paid a fairly significant new issue premium to ensure they had excess interest. Other bonds with similar ratings and maturities trade much tighter, around 0.70%. For example, looking at QNB and while Moody’s rate it two notches higher at Aa3, if we take the more conservative rating of single A from S&P, a glance at comparable issuers is enough to gain a great deal of comfort in the low level risk of this investment – see Table 1.
Comparable issuer ratings
|S&P rating ||Issuer |
|A+ ||Rabobank |
|A ||Qatar National Bank |
|A- ||Stockland |
|BBB+ ||Aurizon |
|BBB ||Downer Group |
|BB+ ||Bluescope |
Relative value of QNB
While a yield of 4.60% per annum is well short of the returns you can expect with high yield bonds, you are being extremely well paid for the risk you are taking with the longer dated QNB. See Table 2 that highlights its relative value.
|Issuer ||Rating ||Maturity date ||Coupon ||Coupon type ||Structure ||Yield to worst |
|General Property Trust ||A ||24 August 2026 ||3.66% ||Fixed ||Senior debt ||3.92% |
|GPT Wholesale Office Fund No. 1 |
| A- || 22 February 2027 || 4.52% ||Fixed || Senior debt || 3.99% |
|Ausnet Services Holdings Pty Ltd ||A- ||16 August 2027 ||4.40% ||Fixed ||Senior debt |
|QNB Finance Ltd ||A ||1 February 2028 ||4.90% ||Fixed ||Senior debt |
Source: Bloomberg, FIIG Securities
Note: Prices accurate as at 20 February 2018 but subject to change
Furthermore, the QNB bond, which was issued this month, is expected to come more in line with comparable issuers once the bond settles into the secondary market and finds its natural level. So, moving quickly and making an early investment decision is in your interests. It’s also important to note that geopolitical risks associated with the region are taken into consideration by the ratings agencies when they assign their rating.
2. Rolling down the curve
This is a strategy that many bond managers use to capture excess absolute returns. Simply put, it is the increase in price expected when a longer dated bond, due to the passage of time, becomes a shorter dated bond yet retains the same coupon fixed at issue.
Using QNB as an example, it issued a shorter dated 2023, fixed rate bond at 4.15% pa at the same time as the 2028 maturity bond. As such, the market priced the five year extension to be worth 0.75 per cent per annum. All other things being equal, after five years when the 2028 bond is now a five year, not a 10 year bond, you would expect it to yield that same 4.15%. This equates to a capital price of $103.30.
If the Emirates bond is deemed to be equivalent, then that would price around $102.65.
3. Interest rate outlook and price potential
Why is this important if rates are rising? If the price is expected to rise as the bond rolls down the curve, but fall if benchmark rates rise, the rolling down the curve should offset some of the price fall driven by higher benchmark yields. The offset may not always be perfect, but then we can never predict exactly what is going to happen in markets either.
In any case, there is a divergence of opinion about the direction of AUD rates. To some extent, we have been dragged up by the steepening of the US yield curve – long end rates rising by more than the short end.
This might concern some investors where both bonds are high quality, long dated fixed coupon bonds – likely to experience downward price pressure in a rising interest rate environment. On the other hand, as discussed in Stephen Koukoulas’ article last week, we do not expect any meaningful rate rises for quite a while due to low inflation, low wage growth, low GDP, household debt, and the housing sector.
There is potential for current longer term interest rate expectations in Australia to soften, which would put upward pressure on high quality long dated fixed coupon bonds like QNB and Emirates.
For a while now, we have been advocates of:
- Taking core investment grade exposure in AUD that provides the basis for capital stability and income security
- In an underdeveloped market, pick up mispriced credit risk locally through AUD and high yield FIIG originations, and take additional high yield exposures in the US to pick up overall yield of the portfolio
- Take advantage of being AUD based - currency investors use the natural hedge of the AUD/USD rate if markets experience a severe “risk off” situation
This is definitely at the longer end of the investment grade spectrum, but with running yields well above 4.50 per cent, these bonds can form core holdings for income seeking investors as well as offering excellent downside protection should we see a “risk off” event.
To summarise, both DirectBonds from Emirates NBD and QNB Finance offer a high quality investment grade addition to balance high yield portfolios, provide very good relative value and potential price appreciation.
Best relative value in the floating rate note market
For those of you intent on keeping duration short, we continue to favour floating rate Residential Mortgage Backed Securities (RMBS). High institutional demand can make the securities difficult to access but we frequently receive parcels that are quickly snapped up by ready buyers.
NAB’s latest RMBS deal launched 5 February with the aim of raising $750m and was upsized to $2bn. Pricing gives an indication of what investors may achieve in the secondary market. Source: KangaNews
To add your name to the wait list for RMBS or to find out more information on the new DirectBonds, please contact your local dealer.
Note: RMBS are available to wholesale investors only
Tom Guest, Associate Director, Fixed Income Sales Tom is a Brisbane local who joined FIIG in 2014 as a dealer after stints as an analyst with Queensland Investment Corporation and before that, with Credit Suisse International in London.
Jonathon Sheridan, NSW/ACT State Manager
Jonathan is a fixed income specialist investing in and advising on markets for over 15 years, in private banking across all asset classes. He is a senior Director for FIIG's Private Client Sector.