Statement on Monetary Policy – November 2009
Domestic Financial Markets
Money markets and bond yields
The Reserve Bank Board increased its target
for the overnight cash rate by 25 basis points
in both October and November, to 3.50 per cent.
The strength of recent economic data has seen
further increases in the cash rate priced into
money market yields. Reflecting these developments,
since the previous Statement, 3-month
and 6-month bank bill rates have increased by
over 60 basis points
Spreads between bill rates and the OIS curve have
remained well below the crisis averages. This is indicative
of the continued improvement in domestic financial
conditions, which has seen the Bank normalise
its dealings in its market operations
(see ‘Box E: Normalisation of Domestic Market Dealing Operations’).
The expectation of a higher near-term cash rate has seen the yield curve flatten with the spread between 3-month and 10-year Commonwealth Government securities (CGS) narrowing by around 60 basis points (Graph 56). Although the yield on 10-year CGS has fallen slightly since the last Statement, the spread to US Treasuries has increased by 20 basis points. The widening in the spread appears to predominantly reflect the fact that the policy rate is expected to remain at very low levels in the United States for some time to come.
The issuance of CGS has slowed, after picking up substantially in the first half of the year. Total CGS outstanding has increased by $4½ billion since the last Statement to $110 billion. In October the Australian Office of Financial Management (AOFM) resumed issuance of longer-dated inflation-linked debt. The $4 billion bond, maturing in 2025, was the AOFM’s first issuance of inflation-linked debt since 2003 and followed the NSW Government’s successful index-linked raising. Rather than using a tender process, the AOFM opted to sell the debt via a syndicate, a method of debt distribution which has also been favoured by the state government authorities in recent times.
Following a marked change during 2008 and early 2009, the composition of financial intermediaries’ funding has changed only a little in recent months. Competition for deposits remains strong, with the share of banks’ funding from this source rising slightly to 43 per cent over the September quarter, having risen by 6 percentage points since December 2007 (Graph 57). The shares of banks’ funding that come from long-term capital market debt and equity have also increased slightly over the September quarter as banks continued to manage their balance sheets conservatively. Banks’ use of domestic short-term capital market debt declined further; by end September 2009 it accounted for 13 per cent of total funding liabilities, down from over 20 per cent in late 2007.
Over the past two years, there has been a significant shift in banks’ pricing of deposits, with the average rate on major banks’ outstanding transaction, at-call and term deposits now broadly in line with the cash rate, after being about 120 basis points below the cash rate up until March 2008 (Graph 58).
The change in pricing has been largest for term deposits. The average rate offered on the major banks’ term deposit ‘specials’, the most relevant rate for term deposit pricing, has risen by 72 basis points since end July to 5.43 per cent, and is up about 175 basis points since early 2009. Banks’ overall cost of term deposits remains high relative to the cash rate, as they continue to target longer-dated term deposits and the yield curve is currently quite steep. The major banks’ 3- and 5-year ‘special’ term deposit rates are currently only 0–20 basis points lower than the yields on their bonds of equivalent maturity (Graph 59). The smaller Australian banks’ average ‘special’ term deposit rates have risen by 55 basis points since end July, and are currently in line with the rates offered by the major banks.
By end October, the average rate on the major banks’ at-call deposits (including online savings, bonus saver and cash management accounts) had increased by 16 basis points since end July to 2.60 per cent, slightly less than the increase in the cash rate. This left the average rate on at-call deposits 65 basis points below the cash rate, compared with 100 basis points in mid 2007. At the time this Statement was finalised, the November increase in the cash rate had only just started to flow through to deposit rates.
Bond issuance since the last Statement totalled around $55 billion across a diverse range of markets. Around two-thirds of these bonds were issued offshore, a little below the historical average. Australian banks have issued an increasing amount of unguaranteed bonds in recent months as investor appetite for bank credit has returned (Graph 60). In the December quarter to date, around 80 per cent of bonds issued have been unguaranteed, the highest share since the Government guarantee was introduced last October.
The increasing amount of unguaranteed bond issuance has been underpinned by the major banks for whom unguaranteed debt is now mostly cheaper than guaranteed debt. There are signs that other Australian-owned banks are also able to issue unguaranteed bonds, with one A-rated bank issuing an unguaranteed pound sterling bond offshore in October. Foreign-owned banks have issued relatively large volumes of guaranteed bonds (Graph 61).
Secondary market spreads on guaranteed and unguaranteed bonds issued by the major banks have risen by around 20 basis points since the last Statement, but remain well below the levels prevailing earlier in the year (Graph 62). Consequently, at the 3-year maturity, Government-guaranteed debt (including the cost of the guarantee fee) is currently trading at 130 basis points over CGS, compared with 120 basis points for unguaranteed debt. Overall, since the last Statement, yields on the major banks’ bonds have remained broadly unchanged.
Banks continue to look to lengthen the maturity of their bonds, with the average tenor issued in recent quarters at 4½ years. The increase largely reflects the ability of the major banks to issue unguaranteed bonds with longer maturities, including beyond the five-year limit of the Guarantee Scheme.
The relatively high share of banks’ bond issuance offshore in recent months has occurred despite cross-currency basis swap spreads remaining at elevated levels, adding to the cost of issuance when proceeds are swapped back into Australian dollars. Conversely, this elevated spread reduces the final cost of domestic Australian-dollar bond issues by non-resident entities – Kangaroo bonds – and so has contributed to the solid issuance which totalled $5½ billion in the September quarter (Graph 63). A further $3½ billion has been issued so far in the current quarter, including an issue by a non-AAA-rated institution. This is the first such issue since the onset of the financial crisis, and is a further sign that investor risk aversion is easing.
In addition to accessing a wide range of bond markets, Australian banks have had good access to other types of capital market funding. During the September quarter, banks raised $7½ billion of equity – the second largest quarterly amount on record – predominantly through the issuance of new shares to retail and institutional investors. Investor demand for the additional shares was very strong – underpinned by the modest discount to prevailing market prices at which shares could be purchased – with deals upsized or investor allocations scaled back. A couple of Australian banks have also recently issued hybrid securities, raising nearly $3 billion.
Conditions in Australian securitisation markets have improved considerably in recent months. For the first time in a year, there were successful issues of residential mortgage-backed securities (RMBS) without the support of the AOFM, as well as several non-RMBS securitisations. The two RMBS issued without AOFM support totalled $1.5 billion, with strong investor demand leading both deals to be oversubscribed and upsized. Since the last Statement, a further four deals amounting to $2.2 billion have been issued with the AOFM as a cornerstone investor purchasing $850 million. With the AOFM’s purchases of RMBS now amounting to $7½ billion of the $8 billion initially allocated, and securitisation volumes remaining low by pre-crisis standards, the Treasurer announced in mid October that the Government would allocate up to an additional $8 billion to RMBS to support competition in the mortgage market.
Reflecting a relatively low volume of issuance and the ongoing amortisation of principal (i.e. mortgage repayments), the value of Australian RMBS outstanding has continued to fall, to around $100 billion, more than 40 per cent below its peak in June 2007 (Graph 64). Australian RMBS outstanding offshore has declined by nearly 60 per cent, because there has been no offshore issuance, while paper outstanding onshore has fallen around 20 per cent. The AOFM’s holdings amount to around 7 per cent of all Australian RMBS outstanding, and 12 per cent of the domestic market.
The AAA-rated tranches of the prime RMBS issued over recent months that have involved the AOFM as a cornerstone investor have priced at 120–130 basis points above BBSW. Deals that did not involve AOFM support have been priced a little higher. The pick-up in investor demand for RMBS in recent months has been evident in a decline in secondary market spreads, which have fallen to be only a little above primary market spreads (Graph 65). The narrowing suggests that the market has worked through much of the overhang of supply in the secondary market created by the deleveraging of structured investment vehicles – these entities used to account for a significant share of the RMBS investor base.
With the decline in the stock of RMBS outstanding, the narrowing of secondary market spreads, and the first non-AOFM sponsored issuance, the outlook for further RMBS issuance has improved.
Conditions in short-term securitisation markets have also improved. While asset-backed commercial paper (ABCP) outstanding has roughly halved since its peak in mid 2007, the pace of decline has eased in recent months. Indeed, in July – the latest comprehensive data available – modest declines in onshore outstandings were offset by an increase in offshore issues, partly reflecting the first pound sterling issuance in a year. Market participants report that they now have little difficulty rolling over paper, including at longer maturities. The improving conditions in the ABCP market have been reflected in declining spreads. Since their peak, spreads have fallen by around 15 basis points, to 50 basis points above BBSW, and are now around the same level as in February 2008.
Financial intermediaries have largely passed on the October and November cash rate increases to variable housing rates. Interest rates on new fixed-rate housing loans have also risen, reflecting the increases in capital market yields.
Variable interest rates on prime full-doc housing loans have largely risen in line with the cash rate since end July, with the major banks passing on the full 50 basis point increase, although many smaller lenders are yet to adjust their rates in response to the November increase (Table 8). The major banks’ interest rates on new 3-year and 5-year fixed-rate housing loans have increased by around 75–110 basis points since end July to average 7.60 per cent and 7.95 per cent respectively. With fixed rates currently around 2–2½ percentage points higher than variable rates, the share of owner-occupier loan approvals at fixed rates has drifted lower over recent months to 6 per cent, about half its decade average.
Overall, the average interest rate on all outstanding housing loans (variable and fixed) is estimated to have risen by 30 basis points since end July, to 6.10 per cent (Graph 66).
This is about 150 basis points below its post-1993 average, and close to the low earlier this decade when the cash rate was at its previous cyclical low.
After rising significantly over the year to June 2009, the value of housing loan approvals has levelled out in recent months (Graph 67). Demand from first-home buyers peaked in May, following a substantial rise over the first half of the year in response to the government incentives available to first-home buyers and lower interest rates. However, a pick-up in housing loan approvals to investors and other owner-occupiers has offset this decline in first-home buyer approvals.
The five largest banks’ share of gross owner-occupier loan approvals has stabilised at about 82 per cent over the past few months, up from 60 per cent just before the onset of the financial market turbulence in mid 2007 (Graph 68). The market shares of the smaller banks, credit unions and building societies and wholesale lenders have also been little changed over recent months.
Housing credit grew at a monthly average rate
of 0.7 per cent in the quarter, a similar pace
to that seen over the previous year, with the
higher level of new approvals largely offset
by higher repayments
(see the ‘Domestic Economic Conditions’ chapter; Table 9; and Graph 69). Owner-occupier housing credit continues to grow at a much faster pace than investor housing credit.
Financial institutions’ rates on variable personal loans have risen by an average of 20 basis points since end July, with the October increase in the cash rate largely being passed through, but lenders yet to adjust rates in response to the November increase. Average rates on unsecured personal loans, credit cards, home equity loans and margin loans have increased by 15–30 basis points.
The stock of personal credit, which is a small component of household credit, was unchanged during the September quarter. The stabilisation of personal credit in part reflects the levelling out in margin lending which had fallen sharply during 2008. Stronger equity markets meant that the incidence of margin calls declined to a low 1.0 calls per day per 1,000 clients in the September quarter (Graph 70). Borrowers’ gearing levels declined by 5 percentage points to a new historical low of 34 per cent as the value of their collateral rose by 17 per cent.
Interest rates on business lending have risen since end July, reflecting the increases in the cash rate and market rates.
The major banks passed through the October cash rate increase in full to their variable indicator rates on small businesses lending (Graph 71). To date, not all lenders have adjusted their rates in response to the November increase; overall pass-through has only been partial for those that have. Rates on new 1–5 year fixed-rate loans have risen by 40–125 basis points, a little more than the increases in capital market yields.
Variable interest rates on banks’ outstanding large business loans (those greater than $2 million) are estimated to have increased by an average of 35 basis points since end July. This reflects rising bank bill rates and a small increase in average risk margins as the outstanding loans are gradually repriced at the current higher spreads.
The average interest rate on all outstanding business lending (variable and fixed) is estimated to have increased by about 30 basis points since end July, to 6.05 per cent. This is about 170 basis points below its post-1993 average.
Companies’ internal funding (cash profits) has been resilient during the financial crisis, enabling companies to reduce their reliance on external funds (see ‘Australian Corporates’ Sources and Uses of Funds’, RBA Bulletin, October 2009). The stock of business net external funding increased modestly over the September quarter (Graph 72). A sharp fall in business credit was more than offset by strong equity raisings. In large part, the decline in business credit this year appears to reflect the repayment of bank loans by listed corporates, as they have sought to reduce their gearing significantly. Companies scaled back their use of debt during the financial crisis as interest margins increased and banks tightened their lending standards. While the strong equity raisings have been primarily undertaken to reduce gearing by paying down debt, some corporates have announced their intention to use the proceeds to fund acquisition and investment activity. Aggregate debt levels of listed companies are estimated to have fallen by around 20 per cent over 2009 so far, with the decline broad-based across sectors.
Over the September quarter, intermediated business credit contracted at an annualised rate of 9 per cent, with the weakness broadly based across industry sectors, and evident for banks and non-bank financial institutions. The contraction in business credit over recent quarters has been more pronounced for large businesses than for small businesses, likely reflecting large businesses having better access to new equity capital to pay down debt.
Approvals data suggest that the business sector still has reasonable access to intermediated funding. Commercial loan approvals have been broadly steady since the beginning of the year after falling significantly in 2008. There were $16 billion of syndicated loan approvals to Australian businesses in the September quarter, the largest in the past few quarters. Refinancing continues to be the predominant use of funds.
Equity raisings remain the dominant form of external finance. Equity raisings by already-listed corporates (i.e. excluding IPOs) in the September quarter amounted to a strong $20 billion, the second highest quarterly amount on record. While nearly half of this was raised by resource companies – partly driven by the Australian component of Rio Tinto’s equity raising ($4 billion) – issuance of equity by real estate and infrastructure and other companies was also solid (Graph 73). Equity raisings have remained strong in the December quarter. The bulk of equity has been raised through placements and rights issues to institutional investors (mostly fund managers), often followed by smaller issues to retail investors. Investor demand has been solid, with many issues oversubscribed, partly because investors could usually purchase the new shares at a modest (and in a few cases, large) discount to prevailing market prices. Equity raisings have historically been offered at a discount to market prices, with the discount typically higher if the raising is large relative to the company’s existing market capitalisation. These trends were also evident for equity raisings undertaken this year, though the average discount was a little larger than has been the case historically, at around 20 per cent.
Buybacks by already-listed companies remain subdued, with corporates preferring to retire debt or retain cash at this time. As market conditions have improved in recent months, there has been a pick-up in IPO activity, with the completion of the first two IPOs of size since July 2008 and other IPOs being prepared.
The equity raisings undertaken by listed corporates this year have had a large impact on their gearing. The aggregate gearing ratio – the ratio of the book value of debt to equity – is estimated to have declined by around 20 percentage points since end 2008, to be around the historical average of 65 per cent (Graph 74). The fall in leverage has been broadly based across sectors. Resource companies’ gearing has fallen almost 20 percentage points to around 40 per cent. The bulk of this reflects the unwinding of Rio Tinto’s prior increase in leverage from its takeover of Alcan. While more highly leveraged corporates, such as real estate and infrastructure companies, have recorded declines in gearing, these have been partly offset by asset writedowns. These companies’ gearing is still above pre-crisis levels, with many continuing to restructure their balance sheets, including the negotiation of asset sales and bank loan extensions. The gearing of other corporates – which include companies in the retail, manufacturing, telecommunications, information technology and healthcare sectors – has also fallen, to be around the lower end of its historical range.
Corporate bond issuance remained solid in the September quarter, with $5½ billion raised by nine corporates. A further $3½ billion has been raised in the December quarter so far. While issuance earlier in the year was limited to larger corporates with an established presence in capital markets, more recently, as investor risk aversion has started to ease, the range of borrowers has broadened with a number of medium-sized entities also issuing bonds. The increase in investor demand has also been evident in declining spreads on corporate bonds in secondary market trading. Secondary market spreads on domestically-issued BBB-rated corporate bonds have fallen to around 330 basis points – around 245 basis points below their peak in March, but still well above the pre-crisis average of less than 100 basis points.
The ASX 200 has risen by around 5 per cent since the last Statement to be 45 per cent higher since the trough in early March and at its highest level since October last year (Table 10). Despite these gains, the ASX 200 remains around 35 per cent below its peak in November 2007.
Financials’ share prices have increased particularly sharply, to be up around 65 per cent from their trough earlier in the year. This has largely reflected solid increases in banks’ share prices, which have outperformed their global peers, reflecting their ongoing profitability and the soundness of the Australian financial system (Graph 75). Despite the gains in Australian banks’ share prices since the trough, they remain nearly 25 per cent below their peak in November 2007.
While profits announced by ASX 200 companies during the recent reporting season declined, they were a little better than expected. Underlying profits – which exclude significant items and asset revaluations/sales – for the second half of the 2009 financial year were around 20 per cent lower than the corresponding period last year. This brought the fall in profits for the entire 2009 financial year to around 20 per cent, the largest fall since the early 1990s. Headline profits fell by around 70 per cent in the half-year as a result of large asset writedowns by real estate and resource companies. Writedowns were particularly prevalent among real estate companies, which reported downward asset revaluations of around $7 billion. Dividend cuts continued as companies conserved cash. Around 60 per cent of reporting companies announced cuts to dividends in the second half, with companies that cut dividends in the first half more likely to announce cuts for the second half. More than one-third of companies cut dividends by more than 50 per cent.
The fall in aggregate underlying profit was due to resource companies, which reported a decline in profits of around 40 per cent compared with the corresponding period of 2008 due to falls in revenues from lower commodity prices and lower production volumes. Financials’ profits fell slightly, with falls in banks’ profits partly offset by increases in the underlying profits of insurance and real estate companies. Other companies’ profits increased by nearly 10 per cent, consistent with the comparative resilience of the domestic economy.
The major banks’ underlying, after-tax profit for the second half of the 2009 financial year was $6.9 billion, 11 per cent lower than in the second half of 2008 and 25 per cent below the peak in 2007 (Graph 76). The banks’ return on equity fell by 4 percentage points to 10 per cent, below the 19 per cent recorded in 2006 and 2007, as the banks raised additional shareholder equity to strengthen their balance sheets.
The banks’ Australian operations continued to perform well, with solid balance sheet growth and a 24 basis point rise in the net interest margin as higher lending spreads more than offset the increased cost of deposits. However, the banks’ overseas operations (mainly in the United Kingdom and New Zealand) recorded significantly lower profits.
The banks’ bad and doubtful debt expense (as a share of outstanding loans) rose by 0.3 percentage points to about 0.9 per cent. This largely reflected higher specific provisions for business loans in Australia and offshore. Net impaired assets as a percentage of lending assets more than doubled to 0.8 per cent.
The major banks reduced their half-year dividends per share by 23 per cent, to help further boost their very strong capital ratios.
Analysts have slightly revised up their forecasts of ASX 200 companies’ earnings over the past few months. Earnings are expected to fall by 2½ per cent in 2009/10, but to increase by over 20 per cent in 2010/11, in large part because of a pick-up in resource companies’ earnings of over 35 per cent as global economic growth picks up. Over the past couple of months there has been some moderation in the dispersion of analysts’ forecasts, suggesting that uncertainty about the outlook has declined compared with earlier in the year.
Reflecting the falls in profits recently reported by listed companies, the Australian trailing P/E ratio has increased by 4 percentage points since end August, to 23 – its highest level since the early 1990s. This ratio has now increased 13 percentage points since its February low, with over half of the rise reflecting the lower earnings figures. Trailing P/E ratios have historically risen around the end of recessions, as the market incorporates the expected improvement in earnings. Incorporating these expectations, the forward P/E ratio – which is based on earnings forecasts for the next 12 months – is currently at 16, a little above its long-run average.
The dividend yield of the Australian share market is unchanged since end September, and is slightly above its long-run average of 3.9 per cent. Since its January peak, the dividend yield has fallen 3½ percentage points, with around 40 per cent of this fall due to firms cutting dividends in order to retain cash.