Market left dazed and confused after Fed comments surrounding the removal of its US$85 bln/month bond buying programme

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The following is a summary of the key events impacting fixed income markets over the past week.

The market waited with baited breath as Fed Chairman, Ben Bernanke, looked to set the record straight in a recent speech about the Fed’s plans to remove its stimulus. The market had been left dazed and confused after a number of Fed comments surrounding the tapering/removal of its US$85bn/month bond buying programme.

Clarity sees things return to normal

After disclosing a road map for the possible tapering/removal of its bond buying programme on 19 June, the yield on the benchmark US 10 year treasury note soared from 2.18% to 2.74% in a couple of weeks. The Fed were clearly not expecting such a reaction and has set about trying to clarify its position and as the market absorbs these messages, equities were back on their way higher and US bonds fell back to 2.58%.

Highly accommodative policy is needed

Although the data continues to be positive, the Fed will be data driven and at least some tapering is now priced into the market. This was nowhere more evident than in the auction of US$32bn of three year notes last week which were sold at the highest yield in over two years, however the demand remained strong.

New Zealand is holding on in the back seat

As we continue to highlight, the New Zealand market has moved along with the US market with the long-end of the swap curve falling -21bp over last week and the 10 year New Zealand Government Bond (NZGB) falling -13bp. Locally there are a couple of factors bubbling away in the background.

News of the macro-prudential tools are expected before too long with some suggesting that the Reserve Bank of New Zealand (RBNZ) could be ready to implement loan-to-value restrictions in August.

Also on local minds is the Q2 inflation data due out on Tuesday. Forecasts are for inflation to be even lower than last quarter with 0.3% expected. This would keep annual inflation below the RBNZ’s medium target band of 1-3%. For the record the RBNZ itself expects an annual inflation rate of 0.8%.

Credit markets well bid

Not surprising was the bid tone seen in the credit markets over last week with equity markets returning to positive territory.

In Australia and the US credit markets were -4bp tighter with European markets -2bp tighter.

In New Zealand we saw some reversal of the recent sell-off with the yield on the ANZ Investment Grade Bond Index falling -19bp.

We are half way through July and already we have seen debt issues from ASB and Westpac in New Zealand and Westpac and ANZ in Australia so far this month.

Investors have had plenty of options with securities offered in the fixed and floating space along with capital securities in the form of tier two and tier one type debt instruments in Australia.

The latest statistics on the foreign ownership of NZGB from the RBNZ show a slight decline from 69.1% in May to 68.2% as at 30 June 2013. This is no surprise given our weakening dollar presenting an opportunity for local fund managers versus offshore sovereign.

Banks on both sides of the Tasman are busy issuing  both debt and capital securities

With the recent ANZ additional tier one issue and the launch of the Westpac tier two security, we are now beginning to understand the pricing of capital securities post 1 January 2013 when Basel III was implemented.

In New Zealand senior bank issues are coming thick and fast, however aside from Kiwibank no New Zealand registered bank has yet to issue a tier one or tier two under the Basel III banking standards.

Given New Zealand’s ‘big four’ banks are  Australia’s ‘big four’ banks, the inevitable pricing comparisons are relevant (technicalities of issuing such instruments in New Zealand aside)

Last week Westpac (Australia) became the first of the ‘big four’ to issue a loss absorbing tier two capital security. The pricing on the instrument is expected to be between 230bp to 245bp over the 90 day bank bill rate.

ANZ (Australia) recently allocated A$1bn under its additional tier one offer at a margin of 340bp over the six month bank bill rate. So if we start from the lowest ranking securities, the ordinary equity, the cost of equity as defined by the equity risk premium is ~800bp for one of the ‘big four’ banks.

We then move one notch higher into the additional tier one (hybrid) space where as we have just witnessed ANZ compensate investors with a 340bp margin.

Up another notch and investors receive 230bp to 245bp for tier two and then we arrive at the senior level where current pricing in both Australia and New Zealand is ~100bp to 110bp (5yr).

Tier one investors not really being rewarded

The question needs to be asked, are investors being rewarded for the risk now that we have securities that can be converted to equity if the Australian Prudential Regulation Authority (APRA) deem the bank to be non-viable (i.e. needs financial assistance from security holders).

Tier two holders are invested in a security that acts much more like a bond with compulsory coupons, five year maturity (likely) whereas tier one investors are faced with discretionary dividends, perpetuity and possible conversion.

We would argue that investors taking on this type of equity risk, with a fixed upside should be rewarded with a margin somewhere closer to the cost of equity.

Whilst one could argue that the credit worthiness of any of the ‘big four’ banks is not an issue and that APRA are fully aware of the consequences should it trigger non-viability, investors must be compensated for the potential risks.

It is unlikely that New Zealand investors will see this type of security from one of the big four banks until they have sorted out a tax issue with the Australian tax department and APRA regarding issuing conversion type securities versus write-down/off securities.

Corporate / Credit news

ANZ (Australia) said it had allocated A$1bn under its new Additional tier one issue. The margin was set at 3.40% over the Australian six month bank bill rate.

ASB launched a dual tranche floating and fixed rate senior bond issue. ASB are seeking a minimum NZ$100m at an indicative margin of 1.10% to 1.15%. The offer closes Tuesday 16 July.

Christchurch City Council had its credit rating lowered by one notch from AA- to A+ due to the loss of its consenting process and management. The BBB+ credit rating of Christchurch International Airport remained unaffected by the downgrade.

Fonterra reset the coupon on its perpetual capital notes (FCGHA) from 4.21% to 4.33%.

Genesis Energy (GPLFA) set the coupon rate on its modified capital bond. GPLFA will pay a coupon of 6.19% up until the first reset date of 15 July 2018. GPLFA will begin trading again on 15 July 2013. Genesis Energy purchased NZ$76,191,000 bonds and resold NZ$1,191,000 to eligible bondholders. NZ$75m of GPLFA are now held as treasury stock with NZ$200m on issue.

Westpac (WBC) raised NZ$385m via a three year floating rate note at a margin 75bp.The unlisted bonds will be issued on 8 August.

Westpac (WBC) in Australia launched its first Basel III compliant tier two issue. WBC are seeking to raise A$750m (more or less) at an indicative margin of 2.30% - 2.45%. The tier two issue is open to WBC’s existing holders of WBCPA, of which there is A$1bn on issue. The security will be listed on the ASX under the code WBCHB and has a maturity date of 22 August 2023, however WBC does have the option to call after five years.

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