Statement on Monetary Policy – February 2009
Domestic Financial Markets
Interest rates and equity prices
Money and bond yields
The pressures in the Australian money market that intensified in September last year following the demise of Lehman Brothers in the United States, described in the last Statement, have abated somewhat over the past three months. Short- and long-term interest rates have fallen markedly over this period in response to the deteriorating global economic outlook and renewed concerns about the health of the financial sector. However, spreads on short-term interest rates relative to the expected cash rate, while falling from their October peaks, have generally remained elevated (Graph 57).
Movements in short-term rates have been driven by the major easing in monetary policy that has occurred, along with expectations of further easings over the first half of 2009. The 100 basis point cuts to the cash rate in both December and February reduced the cash rate to a multi-decade low of 3.25 per cent. Bank bill yields have declined to historical lows with the 3-month rate falling below 3¼ per cent, from over 7 per cent at the start of the current easing cycle in September last year.
Liquidity in the bill market has shown some signs of improvement over recent weeks. The bank bill spread to OIS has fallen back to around 50 basis points, compared with over 80 basis points in December. Nevertheless, spreads still remain above the average posted in the current crisis period, reflecting investors’ concerns about the risks of a deteriorating economic outlook on the strength of banks’ balance sheets.
Government bond yields are also sharply lower since the last Statement. The declines were driven largely by developments in offshore markets, with 10-year yields falling below 4.0 per cent, to their lowest levels since the 1950s (Graph 58). Again in line with offshore developments, the 10-year yield has since risen a little, to around 4.3 per cent, to be around 100 basis points lower than at the time of the last Statement. Shorter yields have fallen by slightly more, reflecting the heightened expectations of monetary easing.
In December, there was a marked widening in spreads between yields on semi-government and supranational bonds and Commonwealth Government securities (CGS) (Graph 59). This largely coincided with the substantial issuance of bank bonds which have an explicit guarantee by the Commonwealth and initially traded at a higher yield. Investors appear to consider these guaranteed bonds as a similar class of securities to semi-government debt, and so their yields have converged, with semi-government debt repricing to a similar (although still slightly lower) yield as the guaranteed issues. Semi spreads increased from around 60 basis points to a peak of 140 basis points in mid December, although spreads have since narrowed around 50 basis points. In contrast, spreads on guaranteed bank bonds fell by more. Notwithstanding the widening in semi spreads, given the large fall in CGS yields, yields on state government debt have still fallen to multi-year lows (Graph 60).
The Reserve Bank has accommodated quite large shifts in Exchange Settlement (ES) balances in its domestic market operations to minimise any disruption to the cash market (Graph 61). ES balances rose temporarily to a high of over $16 billion in mid December, primarily as a result of transactions associated with financial market consolidation. Balances remained high through the end of year, but as year-end pressures abated, ES balances have settled back to around $3 billion. The Bank has also been able to wind back its term deposit facility as money market and funding pressures have abated, with term deposits declining from a peak of $18½ billion in late December to around $5 billion currently. Notwithstanding the large movements in ES balances, the cash rate has remained at the target. In November, the Bank also further expanded the pool of collateral that is eligible for its operations to include all AAA-rated or P-1 rated securities, with the exception of highly structured products.
Volatility of the Australian share market has eased somewhat since the last Statement, with absolute daily movements now averaging 1½ per cent, down from nearly 3 per cent in October (Graph 62). This is around the average since the onset of the credit crisis, and still well above the long-run historical average.
The ASX 200 is up 3 per cent in net terms since mid November, broadly in line with share markets overseas (Graph 63). The Australian share market remains around 50 per cent below its November 2007 peak and is at the same level as in May 2004. Resource stocks have risen by 22 per cent since mid November after falling heavily over the previous few months, while financial stocks have declined by around 4 per cent, weighed down by the even larger falls in the share prices of banks overseas. The share prices of other companies in the index are broadly unchanged over the past couple of months (Graph 64).
The ASX 200 declined by around 40 per cent over 2008, the largest calendar year fall for the Australian share market on record but broadly in line with declines in share markets overseas. All sectors of the Australian share market recorded sharp declines over the year: financials fell the most (by nearly 50 per cent), while non-financial companies were down 37 per cent. Historical experience indicates that, following large falls, it can take between three and six years for the share market to recoup losses (Graph 65).
ASIC has extended its ban on covered short-selling of financial companies – where an investor takes a short position and has arrangements already in place for the delivery of securities, typically by borrowing them – to 6 March 2009 from 27 January 2009. Covered short-selling of non-financial companies has been permitted by ASIC since 19 November 2008. The ban on naked short-selling of all stocks will continue indefinitely.
Analysts have sharply revised down their forecasts for resource companies’ earnings due to sharp falls in commodity prices over the second half of 2008 and expectations that economic growth will slow over the next couple of years. Nonetheless, resource companies’ earnings are forecast to increase by 20 per cent for 2008/09 (less than one-third of the forecast growth rate a few months ago), and to then fall 10 per cent the following year. Analysts also revised down their forecast earnings for financial companies, which are now expected to be around 10 per cent below their level in 2007/08 for the next two years. Overall, analysts expect earnings to be flat for ASX 200 companies for both 2008/09 and 2009/10. However, the dispersion of analysts’ forecasts is at historically high levels, reflecting the uncertain outlook. Most companies will report their profit results for the first half of the 2008/09 financial year later this month.
Reflecting the significant downward revision to forecast earnings, the forward P/E ratio – based on expected earnings for the coming year – increased sharply since the last Statement (Graph 66). The trailing P/E ratio – based on earnings for the past year – fell slightly. Nonetheless, both the forward and trailing P/E ratios remain well below their long-run historical averages. P/E ratios for the three broad sectors of the Australian share market also remain well below their long-run averages.
Net equity raisings by listed companies totalled a record $27 billion in the December quarter 2008. Of this, $21 billion was raised by financial institutions, mainly due to substantial raisings by banks to strengthen balance sheets, repurchase hybrid securities and fund merger and acquisition (M&A) activity. The bulk was raised through placements at discounts of around 10 per cent to market prices. This indicates that Australian banks continue to have good access to equity funding, particularly compared to financial institutions abroad. Equity raisings by non-financial companies were a little above average in the December quarter, with funds tending to be used to pay down debt and fund investment (including M&A activity). A number of non-financial companies have also announced equity raisings in recent weeks. Buy-backs remain subdued, reflecting companies ’ preference to retain cash to strengthen their balance sheets given the uncertain outlook. IPOs also remained weak amid ongoing volatility in financial markets.
M&A activity remained solid in the December quarter, with $24 billion of new deals announced by listed Australian entities; a further $1/2 billion of deals were announced in January. Overall, $106 billion of M&A deals were announced by listed companies in 2008, about half the level for 2007, but around the average of the past five years.
The ongoing turbulence in capital markets continues to affect the cost and composition of financial intermediaries’ funding. Over 2008, the share of banks’ funding that was sourced from deposits rose by 3 percentage points to 40 per cent, with the five largest banks and smaller Australian banks recording particularly strong growth (Graph 67). This offset a 2 percentage point decrease in the share of funding from securitisation, where there has been little new issuance since the onset of the crisis.
Deposits continued to grow strongly in the December quarter, increasing at an annualised rate of 23 per cent. This reflected ongoing demand for low-risk assets from households and non-financial corporates, the introduction of the Government guarantee, and robust competition for deposit funding from financial institutions.
The average rate offered by the five largest banks on $10,000 term deposits decreased by 110 basis points over the three months to end January, much less than the 240 basis point decline in the 90-day bank bill rate, which is a pricing benchmark for these deposits (Graph 68). The regional banks’ and foreign banks’ rates on $10,000 term deposits have fallen by an average of 165 basis points and 188 basis points respectively. On average, the five largest banks’ rates on $250,000 term deposits have fallen by less than the rates offered by the foreign banks, but by more than the rates offered by the regional banks.
The average rate on financial intermediaries’ at-call deposits – including online savings, cash management and bonus saver accounts – fell by 156 basis points over the three months to end January, a little less than the decline in the cash rate over this period.
Since the introduction of the Australian Government Guarantee Scheme, banks have been able to more readily access wholesale funding markets. Australian banks issued a record $58 billion of bonds since the last Statement (Graph 69). Almost all of these were issued under the Guarantee Scheme and accordingly rated AAA. Around 70 per cent of the bonds were issued offshore, mostly in the US private placement market. The major banks accounted for around three-quarters of issuance since November. Following the strong issuance, the banks appear to be well placed to meet forthcoming maturities and fund their lending activities.
Investor demand for the guaranteed bonds has been strong, with some recent issues oversubscribed and spreads narrowing 65–80 basis points, since the first issues in early December. The major banks have recently issued 3- and 5-year guaranteed bonds domestically at spreads of 130 and 140 basis points over CGS, respectively (Graph 70). Taking into account the 70 basis point fee for the Government guarantee, spreads on guaranteed bonds are around 35 basis points lower than non-guaranteed bonds for the majors. While spreads on the major banks’ non-guaranteed bonds remain elevated, yields have declined with the fall in CGS rates to 4.7 per cent – similar to levels last seen in mid 2003 and around 400 basis points below the peak in June 2008.
The Government guarantee has enabled banks to issue bonds for larger amounts and at longer maturities than non-guaranteed bonds issued during the credit crisis. The average issue size of guaranteed bonds is around $460 million, significantly larger than recently-issued non-guaranteed bonds ($205 million) and the pre-crisis average ($130 million). The average term to maturity of guaranteed bonds is around 4 years, compared with 3½ years for recent non-guaranteed bonds and 5 years prior to the onset of the credit crisis (Graph 71). The large issuance at longer terms has reduced the share of banks’debt that is short term in recent weeks.
Total guaranteed liabilities of all deposit-taking institutions under the Guarantee Scheme for Large Deposits and Wholesale Funding is around $95 billion. This comprises $18 billion of large deposits (which amounts to 2 per cent of total deposits), $20 billion of short-term debt and $57 billion of long-term debt.
Rating agencies have recently made changes to the ratings and outlooks of several Australian financial institutions. St. George and BankWest (both previously A+) had their ratings upgraded to those of Westpac and CBA (both AA), respectively, after the acquisitions received regulatory approval. Suncorp was downgraded (to A from A+), reflecting Standard & Poor’s view that the importance of the bank within the group had fallen. The large Australian banks continue to be viewed favourably by rating agencies: the four majors are rated among the highest in the world (Graph 72).
Securitisation markets remain dislocated, with the bulk of residential mortgage-backed securities (RMBS) issued since the last Statement purchased by the Australian Office of Financial Management (AOFM); one small securitisation backed by auto loans was also issued. Four RMBS, totalling $2.6 billion, were issued during November and December, of which $2 billion was purchased by the AOFM as part of the Government’s $8 billion injection into the market. As with previous RMBS issues, investor demand was concentrated amongst the shorter-dated senior tranches. There were no public issues of asset-backed debt in January.
The low investor demand appears to be related to the overhang of supply in the secondary RMBS market which has seen AAA spreads to BBSW increase sharply from around 240 basis points in November to over 450 basis points. Domestic spreads have followed overseas spreads higher, with investors reluctant to participate in structured markets and some RMBS sales by fund managers in anticipation of redemptions. In contrast, the two RMBS issued in December priced at an average spread of 135 basis points, around the same level as deals issued in November. RMBS issuance remains uneconomic for most issuers at these spreads.
The high spreads on RMBS do not appear to reflect investor concerns about the quality of collateral. Although losses on RMBS (after the proceeds from property sales) picked up in the September quarter – the latest data available – they remain low as a share of securities outstanding (5 basis points for prime and 65 basis points for non-conforming on an annual basis). Investors in rated tranches of prime Australian RMBS have never borne a loss, with losses mostly covered by lenders’ mortgage insurance. Almost all the losses on non-conforming Australian RMBS have also been covered by credit enhancements (mostly the profits of the securitisation vehicle) rather than investors.
Conditions in the asset-backed commercial paper (ABCP) market have become more difficult since the last Statement, with many programs having difficulty rolling over paper and turning to their liquidity provider for support. The value of ABCP outstanding (onshore and offshore) continues to fall, and at October 2008 – the latest comprehensive data available – was 39 per cent below the peak in July 2007 (Graph 73); preliminary data suggest that ABCP outstanding onshore has fallen a further 18 per cent since then. The fall in the stock of ABCP outstanding has been broad-based across programs. Spreads on ABCP remain elevated, at around 65 basis points above BBSW. Around one-quarter of Australian ABCP was downgraded by one notch in late December, to A-1. This reflected the downgrades of ABN AMRO and the Royal Bank of Scotland, both of whom provide credit and liquidity support to the affected ABCP programs.
At the time this Statement was finalised, the February cut in the cash rate had only just started to flow through to borrowing rates. Nonetheless, interest rates on household loans have fallen substantially since the monetary policy easing cycle commenced in September last year (Table 10). Financial institutions have passed on the bulk of the cash rate reductions to their prime variable-rate housing loans, and this, coupled with the prevalence of variable-rate housing loans in Australia, has resulted in much greater pass-through of recent policy rate reductions to the average outstanding housing loan rate than in other countries (refer to ‘Box B: An International Comparison of Pass-through of Policy Rate Changes to Housing Loan Rates’).
Variable lending rates for prime full-doc housing loans fell by an average of 275 basis points in the five months to end January. The pass-through of cash rate reductions to variable housing loan rates in this easing cycle has been only slightly less than that seen in previous cycles.
The five largest banks’ average 3-year fixed housing loan rate has declined by 360 basis points since its peak, roughly in line with the decrease in the bank swap rate, off which these loans are priced. At 5.83 per cent, the 3-year fixed housing loan rate is at its lowest level in several decades. Nonetheless, borrower expectations of further declines in the cash rate (and hence variable housing loan rates) have seen the share of owner-occupier loan approvals at fixed rates continue to fall. In November, only 2½ per cent of owner-occupier loan approvals were at fixed rates; the lowest share in at least 17 years, and markedly lower than the decade average of around 12 per cent.
Overall, we estimate that the average interest rate on all outstanding housing loans had declined by 200 basis points by the end of January, to 6¾ per cent. This is around 95 basis points below its post‑1993 average (Graph 74).
There was greater pass-through of the December cash rate cut to personal lending rates than there was for earlier reductions. Over the easing cycle, financial institutions’ variable rates on low-rate credit cards and unsecured personal loans have fallen by 30–80 basis points. Rates on standard credit cards and margin loans have declined by 125–165 basis points.
Reflecting the decline in borrowing costs, the value of housing loan approvals appears to have picked up following a sharp decline in the first half of 2008. In the three months to November, housing loan approvals were higher than in July and August, although still around 25 per cent below their peak in mid 2007. This reflects a pick-up in housing loan approvals by the five largest banks, partly offset by relatively weak approvals by smaller lenders. As a result, the five largest banks’ share of gross owner-occupier loan approvals has risen by 14 percentage points since June 2008, to over 80 per cent (Graph 75).
Indications of a levelling out in loan approvals are in line with the steady housing credit growth in recent months and consistent with improved housing affordability. Over the December quarter, housing credit growth averaged 0.5 per cent per month, which is little changed from its average pace over the previous six months.
Personal credit decreased further in the December quarter, as the fall in the share market has contributed to a very large decline in margin debt, and credit card lending has continued to slow (Graph 76). Margin lending has now fallen by around 50 per cent from its peak. The incidence of margin calls rose sharply in the December quarter, to a record 10 calls per day per 1,000 clients (Graph 77). The average for the 2008 calendar year was 4.9 calls per day per 1,000 clients, well above its annual average of 1.8 calls per day per 1,000 clients between 2000 and 2007. The increased frequency of margin calls in 2008 reflects both the extreme volatility in equity markets throughout the year, and the sustained declines in share prices, which have pushed up investors’ gearing levels.
Benchmark interest rates for business borrowing have also fallen since the last Statement, however these have at least in part been offset by increases in risk margins. Variable interest rates on large business loans – which are mostly priced off bank bills – are estimated to have fallen by 295 basis points in the five months to end January. Variable indicator rates for small business loans have declined by around 180 basis points. Business interest rates have declined over the past two months, as the marked fall in bank bill rates over the latter half of 2008 was more fully reflected in interest rates on outstanding large business loans, and as banks passed on most of the December cash rate reduction to their small business rates. Liaison indicates that some borrowers have recently experienced sizeable increases in risk margins.
The average of the major banks’ rates on new 3-year fixed small business loans has decreased by 370 basis points since its peak to 6.21 per cent, the lowest level in several decades. However, with rates on new fixed-rate loans having risen steadily until June 2008, the average rate on outstanding fixed-rate loans is still reasonably high by historical standards.
Overall, abstracting from recent changes in risk margins, we estimate that the average interest rate on all outstanding business loans has fallen by 230 basis points since the start of the easing cycle to 6.50 per cent; this is 135 basis points below its post-1993 average and just 15 basis points higher than the trough in rates in early 2002. This fall will in part have been offset by increases in margins.
Despite the fall in businesses’ borrowing costs, growth in total business debt has slowed sharply to an annualised rate of 1 per cent in the December quarter, after averaging about 8 per cent through most of 2008 (Graph 78). In the month of December business credit contracted by 1.1 per cent, reflecting a decline in foreign-currency-denominated lending. The slowdown has been broad-based across Australian banks, foreign-owned banks and capital market debt. It appears to reflect weaker demand from businesses, due to falls in profits and confidence, and a tightening in lending standards. Commercial loan approvals have continued to decline in recent months, suggesting that business credit growth is likely to remain subdued in the near term.
The slowdown in business credit growth in the December quarter was evident across large and small loans. It was also relatively broad-based across industry sectors. Over recent months there has been some speculation that many foreign-owned banks will withdraw from the Australian market and that this will create a significant funding shortfall for businesses. While there is a risk that some foreign lenders will scale back their Australian operations, particularly if offshore financial markets deteriorate further, at this stage there is little sign of this, with most of the large foreign-owned banks planning to maintain their lending activities in the Australian market.
There has been no corporate bond issuance since October 2008. Secondary market spreads on corporate bonds have increased by around 5 basis points since the last Statement, reaching a high of 450 basis points above CGS (Graph 79). However, due to the fall in CGS yields, corporate bond yields are currently around 7.2 per cent – 150 basis points lower than at the end of October 2008 and at levels last seen in August 2007.
The ratings of all of the monoline bond insurers that are active in the Australian market were downgraded further by at least one rating agency since the previous Statement. The downgraded monolines insure around $27 billion of domestic bonds, accounting for around 3 per cent of the Australian non-government bond market. While the ratings of credit-wrapped bonds differ across credit rating agencies, most are below their initial AAA rating, and are now rated Baa by Moody’s and AA to A by Standard & Poor’s.
Credit grew at an annualised rate of around 3 per cent over the December quarter, down from around 7 per cent over the June and September quarters. The slowdown has been broad-based across business and household credit (Table 11; Graph 80). The slowing in credit growth is consistent with other domestic demand indicators, as discussed in the ‘Domestic Economic Conditions’ chapter. Growth in broad money has increased in recent months, partly reflecting a pick-up in demand for currency and deposits.