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Wednesday 22 May 2024 by Thomas Sharp

FY24 Credit so far, and what's to come

FIIG’s in-house Research team recently published a report which covered the trends of various sectors over FY24 so far. The insightful and relevant updates can help readers to better understand what to expect from issuers over the remainder of FY24 and into FY25, and also to help position portfolios. Here we look through some highlights of the report.

Corporate Sector

Consumer demand has been held up over the past nine months or so by Australia’s low unemployment rate and a running down of savings. It makes sense then that businesses have reported solid operating conditions as per the NAB Business Survey. Looking at the last two months, the data for February showed a rebound in business conditions (blue in Figure 1) with all underlying measures of the metric higher. In fact, conditions recovered to sit above its long-run average after a few months of declines. There was also little change in the numbers for March. This it likely signified that businesses are in a good position to weather coming storms as consumers continued to spend over the back end of 2023 (eg. Black Friday in November) and into early 2024.

Despite this, business confidence (orange) has been fairly depressed. This has been driven by higher interest rates. Although most economists believe that Australia will avoid a hard landing, there has been and will likely continue to be a slowdown in consumer activity over the short term. All else being equal, this should result in weaker business conditions and ongoing low confidence over the next six months. Elevated inflation and ‘higher for longer’ interest rates will likely impact the financial performance of companies as it would affect revenues, interest costs, and profits.

Banks and Financials

Profitability at the major banks has begun to decline on account of decreasing net interest margins (NIM) and higher operating expenses. There was an increase in mortgage arrears, and while on a trend basis the results have been higher than previously, these rates are still well below long-term averages and not really a concern at this stage. Capitalisation remains very strong, with CET1 ratios well in excess of the ‘unquestionably strong’ minimum targets set by APRA for the major banks. The key event over the next month is the upcoming maturity of the TFF, which provided AUD187bn in funding to banks at the start of the pandemic. All funding must be repaid by June this year, so banks must replace the maturing TFF funds with other sorts of funding.

The trends in the non-bank financial institution (NBFI) sector largely mirror the major banks. The key difference is the scale of the impact; the major banks reported falls in NIM, but the impact on NBFIs was much larger. For example, CBA reported a 11bp decline in NIM, whereas Pepper Money saw a 20bp reduction. The same with profits: net profit after tax for CBA declined approximately 8%, but it was 42% for Liberty. One factor for this is the competitiveness in the residential mortgage market. Fewer mortgages are being written since borrowing costs are higher, lending requirements are stricter, and also due to regulation. This has affected the entire industry, but NBFIs in particular since the larger banks are price setters (i.e. they unofficially set the cost of lending). Although NBFIs have been able to offset the decline in residential volumes with other forms of banking such as business and auto lending, these are riskier because borrowers typically have lower credit quality.

Real Estate Investment Trusts (REITs)

The latest results from the Australian REIT sector showed signs of some challenges which are expected to continue for the next 12 months or so. Why do we expect this? It relates to the weakening in asset values from high interest rates, which in turn will affect financial performance. Further declines in asset values are likely as cap rates continue to widen / soften. As a result, most analysts are anticipating that the buffers under each company’s respective credit metrics will narrow. Combining all of this, it would not be farfetched to see the credit outlooks of some REITs turn negative, and some potential downgrades in credit ratings.

But the probability of widespread ratings downgrades across REITs seems limited, and the chance of these issuers falling into non-investment grade territory is quite remote. Moody’s recently wrote that rated Australian REITs are “expected to benefit from good asset quality, favourable lease structures (eg. rent escalation mechanisms), and solid, but reducing, balance sheet capacity.

Commodities and Resources

Commodity prices have been on a wild ride over the last few years, and FY24 so far has been no different. Gold has emerged as a safe haven for risk averse investors, oil prices have spiked at various stages then fallen just as quickly on the back of geopolitical developments, and coal and iron ore have fluctuated given China’s uncertain outlook.

The area that comes up regularly is the new and battery minerals segment (eg. nickel and lithium). Why is this the case? First, it is related to prices. A decline in nickel and lithium prices has raised some concerns about the viability of various projects and companies. This has put a number of battery mineral mines across Australia into loss-making territory. Second is related to supply and demand. There was a lot out there about demand dynamics tied to batteries and electric vehicles which for a long time were very positive. Recently however, we are seeing lower demand than anticipated because the take up of batteries and electric vehicles, and subsequent expansion plans of companies involved in their creation, has declined. At the same time, a large volume of nickel supply has hit the market from Indonesia, which are backed by Chinese producers. As you can imagine, a surplus in supply will drive prices down. S&P believes that this trend is unlikely to change in the short-term.


Airport assets have continued to benefit from a rebound in consumer travel. Currently, the outlook for airports seems strong with respective management commenting that demand remains robust. However, there have been some signs that domestic demand is plateauing. Returning capacity (i.e. supply) should help to alleviate some pressures on airfares, leading to a subsequent response in demand. But in the absence of another pandemic-like scenario, we believe the performance of airport entities will remain solid.

Rail and ports (and airports too) are impacted by the macroeconomic environment. A slowdown in Australia, or demand from third party customers, could impact financial performance. In the case of the two largest rail companies (Pacific National and Aurizon), many of their contracts would include inflation escalation and revenue protection mechanisms as described above. This means that rising costs can be passed through to customers. These contracts would likely also have exclusivity or volume commitments for a number of years.

Lower container volumes may impact each group, but it is important to consider who the end customer is. For Pacific National, a lot of its key counterparties are based in Australia and provide a wide range of services across the economy, some which are essential and others which would be more volatile. This diversity of operations should help during a downturn. Similarly for Aurizon, coal (its predominant activity) remains a key commodity for many Asian countries. While the energy transition is ramping up and expected to accelerate, coal powered stations are not expected to be immediately turned off due to the uncertainty associated with upgrading the grid.

The key to analyse credit risk in the regulated utility space is to think about future five year periods and what this may mean for revenues, capex, and expenses. The energy transition is the obvious thematic; large projects will be required to upgrade energy infrastructure and connect them to the energy grid, but there are various risks associated with this. From a credit perspective, this would likely come with a ramp up in revenue to offset increased capital spending in the next few years. We also note that these companies’ credit ratings are at the centre of their financial framework, so will do whatever it takes to maintain current ratings.


The results from the February reporting period were fairly decent, but as highlighted throughout this report, there are risks and considerations within each sector. The results in the upcoming August reporting season could indeed amplify these risks, particularly given the ‘higher for longer’ rate outlook that is expected.

On a pure risk basis, we believe that the banks, particularly the Major Banks, and infrastructure companies (mainly ones with spare capacity) are the most suitable sectors. Such infrastructure groups would include Transurban and the major airports (Brisbane, Sydney, etc.), although utilities such as AusNet, Ausgrid, Transgrid would still be appropriate given their regulated nature. We hold this view because the credit profiles of all these entities are very strong. Most infrastructure groups benefit from visible cash flows, and the major banks have robust capital positions which will help in a downturn scenario. There are some smaller banks which would be fitting such as Judo Bank. However all banks, as explained previously, are trading with low credit spreads which does make the return less appealing at present.