Yield direction and volatility
Yields drifted higher last week as investors waited for the annual Jackson Hole meeting later in the week, where global central bankers led by Federal Reserve Chair Janet Yellen said further improvement was needed in the labour market before an interest rate increase. Yields remained stable after the news, with the focus of the meeting placed on jobs as Yellen acknowledged there is still “significant” underuse of the workforce.
The 5 year and 10 year benchmark swap rates closed 6-10 basis points (bps) higher over the week, finishing at 3.28% and 3.83% respectively. The 5 year and 10 year Commonwealth government yields were both up 13 bps each for the week, closing at 2.94% and 3.48%.
This week US GDP figures are due to be released on Friday and there are no significant releases expected domestically.
Media speculates that Adani is planning to put Abbot Point Terminal up for sale
The media is currently speculating that Adani intends to put the Abbot Point coal terminal up for sale. While there has been no official comment from Adani on the topic, a sale of this asset could have interesting implications for the recently issued 2020 fixed coupon bond, which many of our clients hold.
The bond is backed by the terminal and a sale of the asset would carry the debt with it. That would not only remove Adani from the picture, but could also trigger a change of control event. In the case that a change of control should result in a credit rating downgrade, investors would be faced with two options.
- There is an embedded “put” option at a price of $101, which means that investors would have the option to return the bonds to the issuer at that price in this scenario. While the bonds are currently offered at a higher price ($101.75), this can be considered a “backstop” or worst case scenario for investors in the case the change of control is detrimental to the risk profile of the credit.
- There are also step-up provisions in the bond that, should it suffer a downgrade (by either or both agencies), the coupon steps up between 75 and 200 basis points. Investors may choose the step-up benefit over the put in this case.
There is also the distinct possibility that a change of control results in an improvement to the credit profile of the bond. As one of the highest yielding investment grade bonds on offer currently, this could result in significant outperformance of the bond.
It is the view of this analyst that investors who hold the Adani Abbot Point 2020 fixed coupon bond should view this potential event as a positive development.
Other credit margins and trading activity
A wider variety of index annuity bonds (IAB) on offer gave inflation linked trading a shot in the arm last week. Many of our favourite IAB issues saw decent activity, including the JEM NSW Schools 2031s and 2035s, which have not been seen in volume since May and June respectively. Given the scarcity of these two issues, supply was spoken for almost immediately by pent up demand. Other IABs traded were the MPC Dec 2033s and the Civic Nexus Sept 2032, both of which are still available.
The Sydney Airport Nov 2020 and 2030 issues again dominated capital index bond (CIB) trading as the space is currently suffering from a lack of supply. The 2030 bond remains available, while supply of the 2020s is just barely keeping up with demand.
The Bendigo Adelaide January 2019 lower tier 2 (LT2) floating rate note (FRN) became our most traded security last week as an attractive bid level from the institutional market saw some holders chose to take profit in a bond that has rallied hard since issue. FIIG’s view is that the Bendigo Adelaide issue is fully priced and offers little upside at current levels. FIIG is well positioned to execute client sell orders at an indicative trading margin of +226.
Qantas’s array of fixed rate issues continue to trade well as some of our highest yielding securities on offer. Wholesale only bonds, the May 2022 and June 2021 issues, are in excellent supply from the street and provide an attractive switch target for holders of the lower yielding April 2020’s. The price of the 2020s has been buoyed by retail demand. Indicative offer yields on the Qantas AUD issues are below:
- Qantas April 2020: 6.70%
- Qantas June 2021: 7.02%
- Qantas May 2022: 7.09%
Qantas is expected to announce FY14 results tomorrow (28 August).
Market levels are indicative as at 26 August 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.
Basis points (bps)
The basis point is commonly used for calculating changes in interest rates, equity indices and the yield of a fixed income security. The relationship between percentage changes and basis points can be summarised as follows:
Bank bill swap rate (BBSW)
A compilation and average of market rates supplied by domestic banks in regard to the specific maturities of bank bills. BBSW is calculated at ten o’clock every morning and compiled by AFMA.
The purpose of BBSW is to provide independent and transparent reference rates for the pricing and revaluation of Australian dollar derivatives and securities.
The date prior to maturity on which a callable bond may be redeemed by the issuer. If the issuer determines there is a benefit to refinancing the issue, the bond may be redeemed on the call date, at par, or at a small premium to par depending on the terms of the call option.