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. Over the last month, the Australian iTraxx widened primarily in response to developments in Cyprus, then contracted as the month progressed.

Bond market in review

In line with market expectations, the RBA left the cash rate unchanged at 3%, with local and international macro risks supporting the RBA’s decision to maintain an easing bias since the last rate cut in December. The RBA is still emphasising the possibility of a future rate cut (which is about 80% priced), however they did note that rate cuts are still working through the system. If you would like more information on the rates outlook, please see Stephen Nash’s article ‘Economic surprise, asset class performance, and the RBA outlook’ in this issue of The Wire.

Australia had some favourable data on retail trade and building approvals for February. The international trade deficit also surprised the market on the upside, falling to $0.2bn in February (January: $1.2bn). Private sector credit and job vacancies data however fell short of market expectations.

The Australian headline CPI grew by 0.4% in the first quarter, falling short of market expectations which centred on a rise of 0.7%. Annual growth now stands at 2.5%.

The RBA’s semi-annual review of financial system stability reflected a positive view of the Australian financial system on account of improved global financial conditions.

Offshore, the BoJ doubled its asset purchase program and extended its coverage to longer dated bonds in an attempt to reflate the economy, while the ECB and BoE both left their respective interest rates on hold as expected. The IMF downgraded its global growth forecasts for 2013.

A deal was reached regarding the Cypriot banking system. The new deal is far harsher on bond and equity holders and large depositors of the problem banks, but protects small depositors and avoids a nation-wide deposit tax. The second-largest bank, Laiki, will be split and the ‘good bank’ merged with the largest bank, Bank of Cyprus.

Credit spreads

The chart below illustrates the credit spread over the five year swap curve for each credit ratings band. Each band represents a composite credit spread of securities around that maturity. In other words this is an illustration of the average composite additional yield above swaps for different rated Australian corporate securities.

Spreads at 23 April 2013:

AAA: -50.25

AA: +97.26

A: +129.75

BBB: +213.84

Significant ratings/credit changes over the month

• S&P affirmed the UK's AAA rating but kept the outlook at negative. S&P said weaker growth could force the country's general government debt to rise, approaching 100% of gross domestic product, from its estimated current level of 85%. S&P said its affirmation reflects its view the government remains committed to implementing its fiscal program and has the ability and willingness to rapidly respond to economic challenges.
• S&P issued its revised criteria for assigning equity content to corporate entities, effectively tightening the eligibility of instruments being assigned "high" equity content. This lead to the reclassification of the equity credit from high (100% equity credit) to intermediate (50% equity credit) on the subordinated note issues from Origin Energy (ORGHA), Tabcorp (TAHHB) and AGL Energy (AGKHA).

While this event has received headlines and created some concern, it should not come as a major surprise. In November 2012, S&P announced a review of the assumptions and methodologies used to determine the equity credit content of certain hybrid instruments, with a focus on those with high equity content. We also note the August 2012 subordinated note issues from APA (AQHHA) and Crown (CWNHA) had similar features to 100% equity credit issues yet only received 50% equity credit.

Following the criteria change, S&P announced that the outlook on Tabcorp's BBB rating was changed to negative from stable, and that Santos' BBB+ rating had been placed on CreditWatch Negative from a previously stable outlook. There was no change to the S&P credit rating and outlook for both AGL Energy and Origin Energy, although we note Origin Energy’s credit rating was downgraded one notch in February 2013.

• S&P downgraded Newcrest Mining's rating to BBB from BBB+ after the company revised lower its production guidance to about 2 to 2.15m ounces, or 10% below previous guidance. The outlook is stable. The agency added that Newcrest's financial metrics will be weaker than forecast for the rating, and remaining at that levels for longer than previously expected.
• Fitch changed the outlook on Alcoa to negative. The rating of BBB- was affirmed. The negative outlook reflects the possibility that, given weakness in the aluminium market, EBITDA will fall short of expectations and high financial leverage will persist. Alcoa is rated BBB-/Stable by S&P and is on review for downgrade by Moody's (Baa3).

Facilitation desk top 5

The top 5 bonds are selected by the facilitation team in conjunction with FI sales and is not research. Selected bonds are those which:

• Are exhibiting strong relative value
• Have offers currently available in the short term
• Are covered by FIIG research

The Qantas 2020 FCBs and Swiss Re tier 1 FRNs are available to wholesale/sophisticated investors only

Projected yields for ILBs use an inflation assumption of 2.50%. Running yields on ILBs are based on the current indexed face value, and will accrete with inflation

Projected yields for FRNs are equal to the swap rate plus the trading margin

Pricing is indicative and subject to the availability of offers