This week: iTraxx bounces off resistance; Qantas volatile following a week of bruising events; Silver Chef now available to retail investors at 6.75%
Yield direction and volatility
Yields rose last week after stronger than expected US gross domestic product data was released, followed by a decrease in the US jobless claims and a strong employment result, further fuelling bets the US Federal Reserve will reduce stimulus. Markets reacted accordingly with the 5 and 10 year benchmark swap rates rising between 1 to 6 basis points (bps) to close the week at 3.86% and 4.71% respectively. Similarly there was an increase in yields on the 5 and 10 year Commonwealth government bonds, which crept 7bps and 14bps higher respectively to 3.64% and 4.43% by week’s end. Yields were also higher across the fixed rate lines in response to the news.
On average, corporate trading margins widened over the week, with the Australian iTraxx benchmark index rising 7bps from 100 to 107. This marks the fourth occasion this year that this index has tested the 100 level and failed. As evidenced in Figure 1 below, this level has repeatedly met with resistance since the middle of 2010.
Source: Bloomberg
Figure 1
Qantas
Unquestionably the biggest mover of the week was Qantas. Following a disappointing earnings announcement, the issuer was subsequently downgraded to sub investment grade by Standard and Poor’s. Over the course of the week, the equity fell 13% (and a further 7% on Monday) and the yield on the April 2020 fixed coupon bond rose at least 100bps as market makers speculated on the implications of the events. This issue was heavily traded early in the week, with $6.5m in turnover, but has been limited since then as investors assess the significance of the two events.
At the time of writing, it is still a bit difficult to say when or where this will settle. Trades are going through at yields between 7.00% to 7.50% and fluctuating hourly. I would encourage readers to refer to Gavin Madson’s article on Qantas in this issue and make your own assessment as to the value and risk in this issue. I will make a couple of comments from a trader’s perspective though.
Firstly, much of the volatility in this issue is occurring between market makers, not investors, and it seems to be driven at least in part by speculation of a mass exodus by investors with tight mandates (limits) on holding sub investment grade credit. Having been such an investor in a previous career, I would point out that these mandates rarely dictate that investments must be liquidated immediately and those funds can and do wait for calmer market conditions before acting.
Secondly, once a fixed income security falls below investment grade, it can be difficult to ascertain where fair value should be. There are only a handful of those bonds in our market (18 in total, as compared to over 5,000 in the US), as issuers here would rather not incur the expense of obtaining a credit rating unless that rating is going to be investment grade. There are, therefore, a much larger number of unrated bonds, but these offer a poor indication of fair value as the level of risk varies greatly between the relevant credits.
At the risk of pointing out the obvious, investors need to keep in mind that, unlike an equity investment, this bond will return to the investor $100 in April 2020, and will continue to pay interest in the interim, assuming the company survives. It is the probability of that survival that investors must consider when assessing the risk and return on the investment.
Credit margins and trading activity in other bonds
Large supply of the Sydney Airport 2020 and 2030 capital indexed bonds (CIBs) continued last week, prompting high volume turnover in both issues. The Sydney 2020s was the top traded bond for the period with $5.5m in turnover across 34 trades. Trading in the 2030 line was less pronounced with $2.5m traded. Supply is excellent in both lines with indicative offer yields of 6.85% for the 2020 and 7.25% for the 2030.
Trading among index annuity bonds (IABs) was subdued last week as attention was diverted towards the high yielding FIIG new issues. Plenty of offers remain in the IAB space with some of our favourites listed here:
- MPC Funding December 2033: 6.65%
- JEM NSW Schools November 2035: 6.60%
- Plenary Justice June 2030: 6.50%
Trading among FIIG new issues was active last week as the recently issued Payce fixed rate December 2018 began trading in the secondary market. There were active two-way markets in FIIG’s older issues with each trading in excess of $1m as many investors switched exposure into Payce, which is currently offered at a yield of 9.35%.
Elsewhere in the mid-term fixed rate space, the DBNGP October 2019s and Stockland November 2020s continued to see demand from the clients in the retail sector at yields of 5.42% and 5.35% respectively.
New DirectBonds
The FIIG originated, Silver Chef Limited September 2018 line, previously available to wholesale investors only, was added to the retail DirectBonds list last week. This line pays a semi-annual, fixed rate coupon of 8.50% and has a legal maturity of September 2018. It can be traded in minimum parcel sizes of $10,000. Silver Chef is a rental equipment company that provides business critical equipment hire solutions to small-to-medium enterprises.
The indicative offer level on the Silver Chef bond is currently $106.98, or a yield of 6.75%. However, it must be noted that with only $30 million on issue, this can be a particularly difficult asset to source and investors wishing to participate may have to register interest and be patient.
Key Terms
iTraxx
The iTraxx is a proxy for credit spreads in Australia and allows professional investors to buy or sell protection against the risk of default of a set of the most liquid bonds in the market, therefore tightening reflects improvement in the market perception of risk.
Notes:
Offer levels are indicative as at 10 December 2013 but subject to change based on demand and market movements
Yields for floating rate notes are estimated as the swap rate to maturity / call plus the trading margin
Yields for capital indexed bonds and index annuity bonds are estimated as the real yield plus a 2.50% inflation assumption