Tuesday 01 October 2013 by Legacy

Fixed income market update

Australian iTraxx

The Australian iTraxx Credit Default Swap (CDS) index tracks the performance of Australian corporates and is an indicator of credit risk for investment grade entities.  The lower the spread, the lower the perception of credit risk.  The charts below show performance over one month and one year.  The iTraxx rolled on the 20th from series 19 to series 20 opening 12.5bps wider given the change in constituents.

Bond market in review

The Australia iTraxx index rolled from Series 19 to Series 20. The new index will include Crown Ltd and Telecom New Zealand. Optus and Tabcorp, currently in Series 19 will not be included in Series 20. The Series 20 will still have an average rating of A-, in line the Series 19.

During the month credit markets were focused on the record US$49bn bond deal from Verizon. The deal is bigger than the three previous record deals combined: Apple's US$17bn deal in April, AbbVie's US$14.7bn last November and Roche Holdings' US$13.5bn transaction in 2009. In addition, Verizon also now holds the record for the largest three-year, five-year, seven-year, 10-year, 20-year and 30-year fixed rate tranches.

The Fed decided to leave the current pace of QE unchanged at US$85bn/month and also left its 6.5% unemployment rate and 2% inflation thresholds unchanged. Bernanke’s press conference was dovish. He commented that the FOMC may not hike rates until unemployment fell far below 6.5% and that the decision to delay a taper was a precautionary step to confirm evidence of the economic outlook.  The Chairman also said that tapering may begin later this year, depending on the data, and that there is no fixed calendar. The Fed marked down its estimates of 2013 and 2014 growth while unemployment estimates were little changed. The median forecast for the year-end 2015 fed funds rate remained at 1.0% and the new estimate for 2016 is 2.0%, in line with market expectations.  Fundamentally the Fed’s lingering dovish stance should provide further support to credit markets

APRA published an assessment of Australian banks’ industry risks and loan serviceability standards in housing lending. The conclusions overall were positive and APRA has indicated that it will continue to monitor lending standards closely. Lending standards has contributed to strong housing loan performance historically. Currently low interest rates are supporting loan growth but household debt is already relatively high. The review "...confirmed that the ADIs surveyed had (sound) policies and procedures for evaluating loan serviceability that were subject to board oversight. At the same time, the review identified areas where serviceability practices can be improved…A strong focus on debt serviceability is critical in a low interest rate environment...”.

S&P/ASX 200 Accumulation Index v UBS Composite Bond Index

The UBS Composite Bond Index is designed to measure the performance of the Australian bond market.  The Bond Index consists of approximately 300 fixed interest securities issued by the Commonwealth Government, the State Government and semi government authorities as well as investment grade corporate issuers. This index provides a good representation of the movements in value and interest rates of this asset class.

The equities market has bounced back from the last two months’ declines, with the S&P/ASX200 Accumulation Index finishing July up +5.20%. This strong performance is further reflected in the gain of +23.83% which the equities market has returned over the last twelve months. The solid performance of equities over the month has seen that market pull ahead of fixed income on a long term returns basis, as evidenced in the above chart with an 8.94% return compared to 8.86% for the UBS Composite Index.

Credit spreads

The below chart and graph shows credit spreads (over the applicable swap curve) for each of the S&P investment grade rating band based on a five year maturity. Over the last month, risk asset spreads continue to contract.

Significant ratings changes over the month
Bank of Queensland: S&P upgraded BoQ, reflecting the expectation that the bank will maintain a risk-adjusted capital ratio above 15% over the medium-to-long term through implementing capital management initiatives.

Genworth Holdings: The ratings were affirmed and its outlook was revised to stable from negative. S&P said the rating action reflects continued favourable strategic execution and improved earnings at Genworth. The ratings on Genworth Australia have so far been unaffected. S&P previously said it would revise the outlook to stable if Genworth Australia executes its partial sale within 2013. On the latter, the AFR reported that the company has met with fund managers regarding the potential partial IPO (30-40% stake) but there is still disagreement on valuation.

Western Australia: S&P downgraded WA’s rating stating that while the Fiscal Action Plan announced in WA's fiscal 2014 budget improves the state's path, there is likely to be slippage, reflecting S&P’s view of limited political will, as evidenced by revision of several budget revenue and expenditure measures. As a result, WA's credit metrics are likely to remain more consistent with the lower rating over the medium term. The outlook is stable and reflects the view that the government will implement enough of its fiscal action plan to ensure its cash operating balance remains positive.

Mirvac: S&P upgraded the rating given their view that the group’s strengthened financial risk profile and commitment to maintaining a better financial risk profile through the property cycle.