Tuesday 18 February 2014 by FIIG Research Legacy

From the Trading Desk (18/02/14)

Yield direction and volatility

Australian employment figures were again weaker than anticipated (3,700 loss vs expectations of a 15,000 gain) and the unemployment rate rose to 6.0%. Yields fell 5-6 basis points (bps) last week following the disappointing employment figures, to close the week at 3.71% and 4.47% respectively.  Commonwealth government bond yields also fell 3-4bps to finish the week at 3.41% and 4.11% respectively.

This is the first time the unemployment rate has touched 6% since 2003 (see Figure 1 below), and the trend certainly suggests we have not seen the top yet. It is hard to imagine interest rates rising until this trend reverses; indeed it seems more likely that the next move would be lower. Juxtaposing this with recent concerns over inflation indicates the RBA will be caught between the proverbial rock and hard place in setting monetary policy this year. With low nominal interest rates being reinforced by lack of employment growth and inflation being stoked by those same low rates, our view continues to be that a combination of medium-term fixed coupon bonds and longer-term inflation-linked assets is the ideal mix of assets for a fixed income portfolio.

Figure 1

Will Qantas receive government support and what is the short-term risk vs reward?

The newswires have been inundated over the past week with rhetoric over possible government support for Qantas and the shape that support would take. The options tabled at the moment are removal of the foreign ownership restrictions imposed by the Qantas Sale Act or introducing some form of guarantee for Qantas debt. While there is divergent opinion on what measures should be taken, there is agreement within the government and the opposition that some form of support is warranted, and any measures would be positive for the April 2020 bond. The more likely outcome would be a debt guarantee, as a change in the Qantas Sale Act would come up against heavy resistance from the opposition. It is currently looking like the trigger for any action will be around Qantas’ 27 February corporate results announcement, but the bonds will undoubtedly trade actively in anticipation of this event.

The Qantas April 2020 line traded 18 bps tighter over the course of last week and has continued strengthening this week. Looking at a chart of the market activity before and after the recent ratings downgrades provides a fairly clear picture of the short term upside and downside for holders of this bond. As evidenced in Figure 2 below, the credit margin widened to 325bps in a knee-jerk reaction following the downgrades (partially due to forced selling by institutions with strict mandates), then settled around 270-290bps. This is arguably what investors could expect should the government do absolutely nothing to support Qantas. Looking back prior to the event, the bond was trading at margins of 200-220bps. Using those as short-term worst and best case scenarios, the risk-reward ratio bond is between 1:2 and 1:4, making the current margin attractive even after having contracted from the wide levels seen over the past two months.

Longer term upside should also be considered, which is twofold. At a 260bp margin the bond is currently yielding close to 6.60%, a factor of the maturity falling in the steepest part of the yield curve. Furthermore, if the Australian government introduces a guarantee of Qantas debt, the margin has the capacity to contract much further.

Figure 2

New G8 floating rate note

FIIG is proud to be sole lead manager for a new $50m floating rate note issue from G8 Education Limited. The notes hold a four year maturity, and are callable by the issuer at two years from issue at 103% of par and at three years from issue at 101.5% of par. The notes will pay quarterly coupons of 390bps over 90-day BBSW. The offer is available to wholesale investors only.

This is a welcome addition to a diminishing supply of attractive floating rate notes in the Australian market and is thus being extremely well received by investors. The offer was only open briefly before investor interest consumed the $50m on offer, and is now closed. Secondary market trading is expected to commence on 3rd March.

As shown in Figure 3 below, the spread offered represents compellingly attractive relative value. It is clear that G8 issued at a margin attractive enough to guarantee a positive outcome, and this anomaly is almost certain to correct itself over time (more likely sooner rather than later). To date, all of the FIIG led corporate issues have performed well since they were issued, as indicated in Figure 4 below.

Source: FIIG Securities

Figure 3

Source: FIIG Securities

Figure 4

New Direct Bond – Newcrest Finance

FIIG last week added the Senior Guaranteed Fixed Rate Notes issued by Newcrest Finance Pty Limited in US Dollars to the DirectBonds list. This bond is available to wholesale clients only and has a final legal maturity in October 2022.  It is available in US$10,000 minimum parcel sizes and pays a semi-annual coupon of 4.20% p.a. Headquartered in Melbourne, Australia, Newcrest is among the top 20 companies listed on the Australian Stock Exchange.  Newcrest owns and operates a portfolio of predominantly low cost, long life mines and a strong pipeline of brownfield and greenfield exploration projects.

Other credit margins and trading activity

The trading margin on the Silver Chef September 2018 issue widened 5 bps after it was released to market last week that the current CEO, Charles Gregory, was stepping down while the company’s founder and current chairman, Allan English, will take on the role of executive chairman while the company finds a new CEO.

The Sydney Airport 2020 and 2030 capital indexed bonds (CIB) once again provided the majority of activity in the inflation linked space with both issues recording $4m in turnover. Activity was prompted by continued access to excellent supply of both the 2020 and 2030’s. FIIG is currently well placed to fill client purchase orders with indicative current offer levels provided below:

  • Sydney Airport Nov 2020: 6.40%
  • Sydney Airport Nov 2030: 7.15%

Trading among index annuity bonds (IAB) was quiet last week. Availability of a small parcel of the JEM (Southbank) June 2035’s prompted modest activity, but supply was swallowed quickly due to pent-up demand in the typically difficult to source name. Alternatively, FIIG currently has good access to the JEM NSW Schools November 2035 IAB at an indicative offer of 6.35%.

The Bendigo Adelaide Bank Jan 2019 floating rate note (FRN) spent another week close to the top of FIIG’s most traded issue list as continuing strong demand was met with ample supply. Total turnover of $4m was recorded for the week across 37 trades. FIIG can currently fill client purchase orders at an indicative trading margin of +230 basis points.

In the Tier 1 space, the Swiss Re May 2017 FRN enjoyed high turnover due to attractive bids from the institutional market.


Offer levels are indicative as at 18 February 2014 and subject to change based on demand and market movements.

Yields for floating rate notes are estimated as the sum of the swap rate to maturity / call and the trading margin.

Yields for capital indexed bonds and index annuity bonds are estimated as the real yield plus a 2.50% inflation assumption.