Long term treasury bond yields continued their downward trajectory last week following weaker-than-expected US labour force data and heightened geopolitical risk. However, a series of British terror attacks prior to the UK election next month and reports of missile tests in North Korea have failed to deter global equity markets which remain buoyant. The RBA is widely tipped to leave the cash rate on hold tomorrow, with GDP data (released Wednesday) being the next test for the domestic market. Consensus estimates indicate the economy expanded 0.3% during the March quarter and 1.6% year-on-year. Subdued wage growth and subsequently, weak consumer spending is expected to weigh on the result. Other economic data has also been unsupportive with new capital expenditure contracting 9.3% for the March quarter and building approvals sliding 17.2% last week. In the US, the non-farm payroll (jobs) report on Friday removed the last shred of uncertainty surrounding a June rate hike by the Federal Reserve. The unemployment rate dipped to a 16-year low of 4.3%, but the addition of 138,000 jobs was well below expectations and average hourly wage growth remains benign at 2.5%. This has left the timing of further rate increases in 2017 as unclear and has raised the question is the US economy is operating at full employment or is economic activity slowing?

Chart 1: Bloomberg AUSBond Composite Index (Monthly) Chart 2: Bonds vs Equities 2016/2017 (Monthly) Chart 3: Term Deposit Review – April

APRA Mortgage Risk Weights In the first of many announcements we expect over the coming months in relation to mortgage risk weights, ANZ last week revealed it expects to adopt its new model for residential mortgages in June 2017. This follows APRA’s completion of a review into the bank’s mortgage capital model which was initially announced in August 2016. The new model incorporates an average mortgage risk weight of 28.5% based on ANZ’s balance sheet as at 31 March 2017 (up from 24%) which equates to a 0.26% decrease in the bank’s Common Equity Tier 1 (CET1) capital ratio to 9.82%. Management indicated no additional capital management initiatives will be required as a result of the new model but further adjustments to capital adequacy are expected with APRA’s ‘unquestionably strong’ definition announcement later this year.

RBA Repo Eligibility In response to Standard and Poor’s decision to downgrade 23 banks operating in Australia, the Reserve Bank of Australia (RBA) last week reduced the minimum credit rating for repo-eligible securities issued by Authorised Deposit-Taking Institutions (ADIs). As a result, institutions such as Members Equity and Credit Union Australia are now re-eligible but interestingly, new names now fall under the RBA’s criteria (which weren’t eligible even before the downgrade). The most notable of these is Macquarie Group but also included are smaller ADIs such as Auswide Bank and QT Mutual. While this action will support the liquidity profiles of smaller participants in the Australian banking system, the cost of funding will inevitably widen for downgraded financial institutions. Given the new RBA repo criteria does not distinguish between counterparties within the ‘BBB’ rating band, banks that were downgraded into this pool (from the ‘A’ band) will be the hardest hit by the adjustment. This includes Bank of Queensland, Bendigo & Adelaide Bank and Rural Bank which will now be charged an additional 0.06% – 0.12% in margin (the additional repo collateral required by the RBA) instead of 0.03% – 0.05% under the previous framework.

Tabcorp / Tatts Merger After a lengthy assessment, Tabcorp (ASX: TAH) and Tatts (ASX: TTS) are expected to receive a final ruling on their proposed merger by the 13th of June 2017. However, on Friday the Australian Competition and Consumer Commission (ACCC) called on the Australia Competition Tribunal to block the transaction citing concern around competition for media rights and wagering. Although the merged entity will have slightly weaker credit metrics, we continue to believe the move will be credit positive due to increased cash flow and earnings stability and await the final decision to conduct a more detailed analysis. Nonetheless, if the merger proceeds it is likely to be subject to many conditions.

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