Following a relatively benign week in financial markets, broad market indices finished largely unchanged. Long term interest rates continue to trend sideways as investors look at data affecting inflation expectations. Capital markets are expected to remain fairly quiet this week as the financial year end approaches. For credit markets, trading margins continue to grind tighter against an accommodative technical environment. The market is looking at a significant maturity wall in both wholesale and listed markets over the next few months and given the current technical environment it is difficult to see a correction in valuations any time soon. Fundamentally, we see minimal stress across the credit spectrum but given trading margins are nearing cycle lows, we remain cautious of systemic shocks and remind investors the importance of fixed income investing is capital stability, not appreciation.

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

Moody’s Rating Action on Banks In line with recent rating action from Standard & Poor’s (S&P), Moody’s followed suit last week by announcing downgrades to the long-term senior unsecured issuer ratings of 12 Australian Authorised Deposit-taking Institutions (ADIs). However, unlike S&P, Moody’s cut the issuer ratings for the Major Banks by one notch (stable outlook) citing elevated risks in the household sector increases sensitivity of the banks’ credit profiles to an adverse shock. Consequently, the rating agency lowered its Macroeconomic Profile for Australia, Baseline Credit Assessments (BCAs) and Counterparty Risk Assessments (CRAs) for each downgraded institution but stressed in its view that a potential adverse shock is not the rating agency’s base-case scenario and rather a tail risk event. Other downgraded banks include Bendigo & Adelaide Bank, Members Equity Bank, Heritage Bank, Newcastle Permanent and Credit Union Australia. As a result, various subordinated debt and hybrid ratings were also lowered due to Moody’s revised BCAs (similar to S&P) but importantly, Moody’s actions did not lower any of these ADI’s ratings below their S&P equivalents. However, in comparison to S&P, Moody’s applied a more stringent case-by-case approach and as a result, affirmed its long-term ratings for 6 different Australia banks “reflecting the balance sheet buffers and resilience to potential shocks for these banks.” These include AMP Bank, Bank of Queensland, Suncorp-Metway, Macquarie Bank as well as foreign banks operating in Australia, Citigroup and HSBC. As a side note, Moody’s also placed Genworth Financial Mortgage Insurance on review for downgrade. This is a credit in which we have consistently had a negative view despite underlying security performance not strictly following fundamentals.

ASX-Listed Debt & Hybrid Market Last week there was ~$2.4 billion in redemptions in the ASX-Listed Debt & Hybrid market (ASX: NABHB, HBSHB and ANZHA) with Westpac also announcing (click here) it will redeem its $1.6 billion Subordinated Notes (ASX: WBCHA) in August 2017. As a result, reinvestment options for listed Tier 2 capital instruments are thin with only 4 securities remaining. Demand for these securities in the over-the-counter (OTC) wholesale market is robust and we can expect the listed Tier 2 market to contract further over the medium term as these existing securities roll off. On a positive note, Peet Limited (ASX: PPC) launched its third ASX-Listed security with its Series II simple corporate bonds (Prospective ASX Code: PPCHB). The bonds are structured as floating rate with a term of 5.25 years and the offer size has been set at $50 million. Interest will be paid on a quarterly basis based on a calculation equal to 90-Day BBSW plus an interest margin of 4.65% p.a. set through the bookbuild last week. Closing date for the broker firm offer is the 28th of June 2017 and the issue date is scheduled for the 5th of July 2017.

Tatts-Tabcorp Merger Following the initial announcement back in October 2016, the Australian Competition Tribunal (ACT) last week granted authorisation for the Tabcorp-Tatts (ASX: TAH, TTS) merger to proceed. The ACT’s decision is conditional on Tabcorp divesting Odyssey Gaming Services in which the group previously announced in April 2017 that this business will be sold to Australian National Hotels Pty Ltd. Despite pressure from the Australian Competition and Consumer Commission (ACCC), the ACT stated it is satisfied the transaction will result in significant public benefits. Tatts shareholders are expected to meet in August 2017 to consider the Scheme. The group outlined implementation is expected shortly thereafter subject to other relevant approvals. The Tatts Bonds (ASX: TTSHA) are subject to a Change of Control clause which will be triggered “if a person and their associates come to have a relevant interest in more than 50% of the shares of Tatts”. For this reason, bondholders may require (albeit no obligation) Tatts to redeem their bonds at face value (with accrued interest) if the merger proceeds later this year.

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