Interest Rates

[Toyota Lexcen]

And/or solid dividend stocks like the banks and TLS.
It certainly looks like TLS spiked today after news of the cut.

I didn't expect a cut today. After holding for 17 months I thought the RBA was showing some capacity for thinking independently of other central banks.

As much as I like to see my TLS shares go up I am sorely disappointed that the RBA chooses now to follow the same interest rate policies that have failed in USA, Japan and Europe.
And I feel terribly sorry for retirees trying to make ends meet on their interest income.

great post, with the recent change in oil/petrol prices they could of waited a month or 2 as pretty much everybody gets a benefit from lower fuel costs, $50-60/month saving on fuel is same as about the saving on a 300k mortgage with IR cut

the bigger hit for the average aussie is going to be the exchange rate, and the push by the RBA to lower it, many retailers have delayed price increases but they are slowly coming through on goods

 

[Value Collector]

I don't think lenders (banks) who are simply sitting on a pile of government guaranteed cash and are protected by loan insurances (premium paid by the lender) deserve returns much higher than inflation.

The banks capital is at risk, they will absorb losses before the depositiors do.

Banks are also offering a service to depositors, keeping their money safe and insured. Better than under the mattress .

Also the banks are the ones working finding borrowers, managing accounts etc, chasing loans etc. not sitting back watching midday movies.

 

[qldfrog]

The banks capital is at risk, they will absorb losses before the depositiors do.

Banks are also offering a service to depositors, keeping their money safe and insured. Better than under the mattress .

Also the banks are the ones working finding borrowers, managing accounts etc, chasing loans etc. not sitting back watching midday movies.

then obviously the banks shareholders who are watching midday TV should not be rewarded either?

 

[Value Collector]

then obviously the banks shareholders who are watching midday TV should not be rewarded either?

Their capital is at risk, they own an operating business, not a government guaranteed senior deposit.

If the depositor chooses to take a bit more risk, and buy a bank hybrid security, they will get a better return.

 

[qldfrog]

Their capital is at risk, they own an operating business, not a government guaranteed senior deposit.

If the depositor chooses to take a bit more risk, and buy a bank hybrid security, they will get a better return.

"they" meaning the banks???
or "they" meaning the bank shareholders?
Very different from the owner of bank hybrid securities which is taking a lot of risk (the risk the banks do not want to take)
I owned hybrids, I am an active shareholder but I found your initial comment quite offensive for people having term deposits as their key source of income,
if you are a retiree( which I doubt, but I am not one either) there is definitively a place for TD to ensure against a GFC like event.

It is pretty hard to agree on your point of banks taking risks when you do try to take a loan.their only risk is that their insurance will fold.Even if RE collapses, the onus is on the borrower, not the lender, we are not in the US (well some states) where you can default and walk away

I have some trouble to see your image of bank/telstra shareholders as entrepreneurs living on the edge. that 's all.
Wait for the winging when the banks collapse if that ever happen, and I bet you my taxes will be used to help them out as per history.
Rates being low indeed are not favoring all australian, this favors reckless investment and absence of saving which is not that good for the long term in a country.
So a very different point of view from yours
There are more cuts ahead and sadly I believe this rate cut was ill chosen and will come to bite us by inflating even more the RE bubble
but hey I sold my IP yesterday most probably thanks to that rate cut so why should I even care for my country.
And my portfolio got a nice jump both on the asx and for my O/S USD shares so very good outcome...for me.

 

[Value Collector]

"they" meaning the banks???
or "they" meaning the bank shareholders?
Very different from the owner of bank hybrid securities which is taking a lot of risk (the risk the banks do not want to take)
I owned hybrids, I am an active shareholder but I found your initial comment quite offensive for people having term deposits as their key source of income,
if you are a retiree( which I doubt, but I am not one either) there is definitively a place for TD to ensure against a GFC like event.

It is pretty hard to agree on your point of banks taking risks when you do try to take a loan.their only risk is that their insurance will fold.Even if RE collapses, the onus is on the borrower, not the lender, we are not in the US (well some states) where you can default and walk away

I have some trouble to see your image of bank/telstra shareholders as entrepreneurs living on the edge. that 's all.
Wait for the winging when the banks collapse if that ever happen, and I bet you my taxes will be used to help them out as per history.
Rates being low indeed are not favoring all australian, this favors reckless investment and absence of saving which is not that good for the long term in a country.
So a very different point of view from yours
There are more cuts ahead and sadly I believe this rate cut was ill chosen and will come to bite us by inflating even more the RE bubble
but hey I sold my IP yesterday most probably thanks to that rate cut so why should I even care for my country.
And my portfolio got a nice jump both on the asx and for my O/S USD shares so very good outcome...for me.

"They" being the shareholders, have their capital at risk, because they own the banks capital, so any deterioration in the banks capital position will affect them.

Why should a person who's capital is sitting in a basically risk free, extremely senior position, thats guaranteed by the government, be entitled to high returns?

Yes Term deposits have a place in a portfolio, but that part of your portfolio (in my opinion), is only really entitled to earn enough to keep pace with inflation.

In the banks capital structure, there is many layers, and depositors sit at the very top, their money is basically at call, insured, and buffered by the banks capital and the government guarantee. if depositors want to earn a higher rate, then need to have money at risk, in other parts of the capital structure.

The banking system is basically providing a service to the depositor, keeping their money safe from theft and providing some protection from inflation, that's pretty much all they should expect.

 

[pixel]

The 10% drop of interest rate may be welcome news for people who live "on plastic", but it's a 10% pay cut for self-funded retirees - unless they're actively managing their dividend-paying investments.

In that context, I've come across a couple of shares with imminent ex-div, for which the Franking Credits lift the yield above 6% at present values. Assuming their share price remains steady, or at least regains the dividend within a few weeks - as has happened in the past - it could be a useful play.

Two stocks I'm looking at are OZG and WIC.

any comments?

Slightly off-topic but does anyone have an opinion about these specific stocks?

 

[Julia]

"they" meaning the banks???
or "they" meaning the bank shareholders?
Very different from the owner of bank hybrid securities which is taking a lot of risk (the risk the banks do not want to take)
I owned hybrids, I am an active shareholder but I found your initial comment quite offensive for people having term deposits as their key source of income,
if you are a retiree( which I doubt, but I am not one either) there is definitively a place for TD to ensure against a GFC like event.

Agree. And after the GFC many people are so fearful that they will simply not risk what savings they have left.

Rates being low indeed are not favoring all australian, this favors reckless investment and absence of saving which is not that good for the long term in a country.
So a very different point of view from yours
There are more cuts ahead and sadly I believe this rate cut was ill chosen and will come to bite us by inflating even more the RE bubble

Yes, only a third of the population have mortgages.
But I expect part of the cut justification is rising unemployment, ie the hope that it will drive business investment.

In the banks capital structure, there is many layers, and depositors sit at the very top, their money is basically at call, insured, and buffered by the banks capital and the government guarantee. if depositors want to earn a higher rate, then need to have money at risk, in other parts of the capital structure.

Their money is not at call in that if you break a TD you will lose most of the interest. When deposit rates are this low it makes more sense to put what you don't want in the market into an online at call a/c.

VC, you're young and smart. It's a very different position for very old people who are just not up to more actively investing their funds. Or, for that matter, the significant proportion of the population who are trying to save for a house deposit and unwilling to risk the volatility of the share market.

If there were a greater level of trust in financial advice, more people would access more options, but we all know how highly this industry is regarded overall these days.
(no offence intended to all responsible FPs, etc.)

 

[Value Collector]

Agree. And after the GFC many people are so fearful that they will simply not risk what savings they have left.

I am fine with that, my point is just that if you hold your capital in a cash deposit, you have an extremely safe very senior position, where the bank has to lose 100% of it's capital before you lose, your also government guaranteed, so as long as your earning enough interest to cover the inflation rate, your getting about what you disserve, your cash is safe from theft and somewhat protected from inflation.

I mean bond holders who's money is actually at risk ahead of depositors, and will lose 100% before a depositor loses a cent and are not government guaranteed, only earn a few percentage points more than the depositors as it is, and the various other loans and hybrids etc who will lose 100% before the bond holders lose only earn a few percentage points more than them.

The equity holders of the bank, who's capital is at risk, and who's position is junior to depositors, bondholders, and every other stake holder involved will lose 100%, before any of the others lose, they are the last to be attributed a profit and the first to generate a loss, their capital can fluctuate wildly, and at the moment they will earn about a 5%- 7% dividend.

So for a depositor to feel entitled to the same rate of return as what an equity holder expects seems silly to me.

 

[DeepState]

Something to consider. The chart below shows the real yield on the 10 yr benchmark Australian Treasury 3% indexed bond. This figure was 0.29%pa as at today's COB:



Market implied 10 year inflation expectations are pretty much 2% per annum.

Hence, for a 30% tax rate, you are expecting to destroy real wealth by around 0.4% per annum after tax for investing in this thing. Remember, this is the best hedge against inflation surprise...which is enemy #1 for someone saving for a future life without personal exertion income as a main support - apart from not actually having enough savings. Nominal bonds are not the best hedge available. In other words, you have got to have more money actually in the market today than you expect to spend in nominal terms in the future.

Saving is supposed to be rewarded by increased real consumption at some future date. Today, it costs you to save. In order for this to make sense you need to refer to explanations like:
- everything else I could hold is bloody expensive and this is the lesser stupidity;
- there is a material risk of deflation despite the central expectation for inflation at about 2%pa; or
- I can't spend everything I own on restaurant dinners today because I simply can't eat that much. As a result, I have to invest in something to store my wealth for a future date even if I will be consuming less in real terms in future for the privilege of lending to the government.

Apparently, when you work it all out, we are also in full bore QE in real terms. Possibly more so than Japanese or European sovereign bond holders.

 

[Value Collector]

Something to consider. The chart below shows the real yield on the 10 yr benchmark Australian Treasury 3% indexed bond. This figure was 0.29%pa as at today's COB:

View attachment 61461

Market implied 10 year inflation expectations are pretty much 2% per annum.

Hence, for a 30% tax rate, you are expecting to destroy real wealth by around 0.4% per annum after tax for investing in this thing. Remember, this is the best hedge against inflation surprise...which is enemy #1 for someone saving for a future life without personal exertion income as a main support - apart from not actually having enough savings. Nominal bonds are not the best hedge available. In other words, you have got to have more money actually in the market today than you expect to spend in nominal terms in the future.

Saving is supposed to be rewarded by increased real consumption at some future date. Today, it costs you to save. In order for this to make sense you need to refer to explanations like:
- everything else I could hold is bloody expensive and this is the lesser stupidity;
- there is a material risk of deflation despite the central expectation for inflation at about 2%pa; or
- I can't spend everything I own on restaurant dinners today because I simply can't eat that much. As a result, I have to invest in something to store my wealth for a future date even if I will be consuming less in real terms in future for the privilege of lending to the government.

Apparently, when you work it all out, we are also in full bore QE in real terms. Possibly more so than Japanese or European sovereign bond holders.

Cash is pretty much always a bad investment long term, and the longer the term the worse it is.

There are plenty of other assets that will produce higher cash flow, while also providing a natural hedge against inflation.

 

[Julia]

I am fine with that, my point is just that if you hold your capital in a cash deposit, you have an extremely safe very senior position, where the bank has to lose 100% of it's capital before you lose, your also government guaranteed, so as long as your earning enough interest to cover the inflation rate, your getting about what you disserve, your cash is safe from theft and somewhat protected from inflation.

So for a depositor to feel entitled to the same rate of return as what an equity holder expects seems silly to me.

I don't think anyone has suggested that anyone feels entitled to anything in particular.
I understand the point you're making.
Nevertheless, deposit rates are probably more indicative of money supply and demand than any measure of safety. eg rates were very high back in the 70s/80s ( I recall paying 22% on IP mortgage) and, compared to today, they were high about five years ago when the credit squeeze was on and the banks were sorely in need of money and prepared to pay 8%. I don't think that deposited money was any less safe at 8% than it is at 2.5% and still government guaranteed.

 

[Value Collector]

I don't think anyone has suggested that anyone feels entitled to anything in particular.
.

One of the forum members said they were offended because I suggested that depositors didn't really disserve to earn more than the approximate rate of inflation on cash deposit, I took that to mean he thought they were entitled to more.

.

Nevertheless, deposit rates are probably more indicative of money supply and demand than any measure of safety. eg rates were very high back in the 70s/80s ( I recall paying 22% on IP mortgage) and, compared to today, they were high about five years ago when the credit squeeze was on and the banks were sorely in need of money and prepared to pay 8%. I don't think that deposited money was any less safe at 8% than it is at 2.5%

Money was more at risk of inflation during the 70's/80's, when you were paying 22%, the depositor was at risk of having his money halve in value within three years if he didn't get a high interest rate to compound his holdings.

and still government guaranteed

The government, and the banks capital protect your principle for loss on any given day, the interest rate protects it from being eroded by inflation. If inflation is 2%, a 2-3% coupon TD rate is fair.

If you don't think interest rates have anything to do with the safety of the deposit, try selling a 5% unsecured Bond, when an at call, government guaranteed, bank deposit account is paying 6% and it sits ahead of the bond in seniority. You won't beable to sell it, you will have to offer a higher rate to compensate the holder for the risk they are taking by accepting your bond.

 

[sydboy007]

For anyone interested in what's currently available in the corporate bond world

 

[sydboy007]

a good read for those who are finding it difficult to generate enough cash flow off cash and TDs. Probablly wont get the strong capital growth of the last 2.5-3 years but should generate a a decent cashflow with some inflation protection built in.

https://www.fiig.com.au/news-and-research/news-and-research/details/2015/05/05/comparing-the-relative-value-of-indexed-annuity-bonds?utm_source=threeware_enews&utm_medium=email&utm_campaign=The%20Wire%20-%206%20May%202015%20-%20Issue%20347

With real yields of between 2% to 3% on offer, inflation indexed annuity bonds (IABs) continue to represent a compelling investment proposition given the strong underlying credit quality.

This article provides a comparison of the relative value of (IABs as well as a short summary of the underlying business and risk of each one.

IABs fully amortise over the life of the bond, with payments comprising both a principal and an interest component which are indexed to CPI. As such, IABs offer a relatively high cash flow for a product that offers inflation protection.

As listed in the table below, FIIG has a number of IABs available across a variety of maturities. Each of the IABs are currently rated investment grade and were originally issued as a source of financing for various infrastructure public-private partnership (PPPs). Generally speaking, these PPP projects receive availability-based service payments from their respective government counterparty, based on the availability of completed buildings and the provision of services.

The availability payments are contractually pre-agreed for the full project term and are generally sufficient to cover operating expenses, service debt and pay a return to equity holders. The availability revenues have a CPI-linked component which is directly matched to the CPI-linked outgoings of the project, which include servicing of the IABs. The bonds are senior secured, and as such a high level of recovery is expected in the unlikely event of default or project termination.

Despite the recent low reading for the CPI, we continue to see strong demand in the market for inflation protection. This was highlighted when the Australian government recently issued inflation linked bonds at negative real yields. Recent gains in crude oil prices and the depreciation in the Australian dollar underscore the importance of having a level of inflation protection incorporated into an overall investment portfolio. In an environment where Australian government inflation linked bonds are being issued at negative real yields, we believe the real yields of 2% to 3% on offer with these highly rated IABs continue to represent a compelling investment proposition. Each of the bonds listed below are available in initial investment parcels based on a $10,000 face value.



Source: FIIG Securities
Please note that bonds marked in red above are available to wholesale investors only.

Wholesale investors can request the above table and chart with credit rating details from their FIIG representative.

Below we provide a brief outline of each of the projects and commentary on the relative value of the IABs related to each of them.

Praeco is a special purpose company that financed, designed, built and now maintains the Australian Defence Headquarters Joint Operations Command Facility under a PPP arrangement with the Commonwealth Government. Praeco is the only PPP project where the Commonwealth Government is the project counterparty, which is a relative advantage to the other IABs where the counterparty to the PPP is a state government. While the project’s credit is subject to refinancing risk, this relates to the nominal bullet bonds which have a call date one month prior to the maturity date on the IABs. We therefore expect the IABs will be fully repaid to maturity. We believe the Praeco IAB offers good relative value for investors seeking inflation protection with a shorter duration, noting the strength of the Australian Commonwealth government counterparty.

Wyuna Water is a special purpose company which has entered into an agreement with the Sydney Water Corporation to design, build, and operate two water filtration plants in Illawarra and Woronora in Sydney for 25 years until 2021. The payment obligations from the Sydney Water Corporation are guaranteed by the NSW state government. We understand the contract is likely to be extended a further 15 years until 2036 which would be a credit positive. There could be a potential rating upgrade for Wyuna rating when the contract extension is finalised and if there is evidence of an improved financial profile for the remaining term of the extended PPP contract. With the potential for a credit rating upgrade, we consider the Wyuna Water 2021 as good relative value for a shorter duration IAB.

MPC is the funding vehicle for the Melbourne Convention Centre PPP project. The IABs have a relatively high credit rating reflecting the benefit of a guarantee of scheduled principal and interest repayments on the bonds by insurer Assured Guaranty Municipal Corp. While the 2025 IAB looks fully priced, we see good relative value in the longer dated 2033 IAB given the relatively strong credit rating.

Plenary Justice SA is the special purpose company which entered into a PPP arrangement with the South Australian government in respect of the redevelopment of five police stations and four court houses in six different locations across South Australia. Plenary Justice acquired the freehold rights to all of the six sites which enhances the recoverability on the bonds in an unlikely default scenario. Unlike other PPP projects, the operating phase obligations have been retained in-house by Plenary Justice rather than subcontracted out to third-party service providers, which means Plenary Justice has higher exposure to volatility in operating costs than other PPP assets. We consider the 2030 IAB to be fully priced given the higher operational risk and relatively weaker South Australian government counterparty.

Civic Nexus is the financing vehicle for Civic Nexus Pty Ltd as trustee of the Civic Nexus Unit Trust (“Civic Nexus”), which entered into a PPP arrangement with the Southern Cross Station Authority to finance, design, build and maintain the Southern Cross Station (formerly known as Spencer Street Station), in Melbourne. Civic Nexus has the right to operate the Station for the balance of the project term, which expires in 2036. Major subcontractors are Honeywell Limited for facilities maintenance, Wilson Parking for security and parking, as well as other subcontractors including for cleaning. Unlike the other PPPs, Civic Nexus also earns a considerable portion of its revenue (around 30%) from commercial revenues including rental from retail properties, car parking, bus terminal rentals, locker hire, advertising and other sources. The Civic Nexus 2032 IAB appears fully priced at current levels.

Novacare is the special purpose vehicle which entered into a PPP arrangement with the NSW state government to redevelop the Newcastle Mater Hospital. Construction was fully completed in mid-2009. Operating phase responsibilities have been subcontracted to Medirest (Australia) Pty Ltd and Honeywell Limited, for the entire project term through to 2033. Novacare is offering good relative value at current levels.

RWH Finance is the financing vehicle for RW Health Partnership, a special purpose entity established to design, construct, operate and maintain the new Royal Women’s Hospital in Melbourne under a PPP arrangement with the Victorian state government. The hospital was completed in 2008 and comprises a 5 level car park, 9 floor hospital facility, 60 bed private hospital and private consulting suites. While this is the highest yielding IAB on offer, we note the refinancing risk prevalent in the structure relating to the nominal bullet bonds issued by RWH Finance (see New Direct Bond – Royal Women’s Hospital for further information). For investors who would prefer not to have exposure to refinancing risk, there are other IABs such as MPC 2033 and JEM NSW Schools 2031 which are currently offering comparatively good value for taking a lower credit risk.

JEM NSW Schools is the financing vehicle for Axiom Education NSW No. 2 Pty Ltd (“Axiom NSW”), which maintains facilities at 11 schools across NSW under a PPP agreement with the NSW state government which expires in 2035. Axiom NSW has subcontracted the bulk of its services obligations to Spotless. Axiom NSW benefits however from the absence of refinance risk in its capital structure. FIIG has both a 2031 and 2035 IAB available, with both offering good relative value.

JEM Southbank is the financing vehicle for Axiom Education Queensland Pty Ltd (“Axiom Qld”), which maintains facilities at the Southbank Institute of Technology, Brisbane under a PPP agreement with the Queensland state government. Axiom Qld provides facilities management services, which are to be provided for the balance of the PPP term, expiring in 2039. It has subcontracted the majority of its operations phase obligations to Spotless, a highly experienced PPP subcontractor. The project is subject to refinancing risk, with the nominal bullet bonds which mature in June 2018 needing to be refinanced. However, unlike Praeco and RWH, Moody’s considers JEM Southbank’s refinancing risk more manageable and as such has kept its rating on a stable outlook.

 

[pixel]

Media Release
Number 2015-11
Date 7 July 2015
Embargo For Immediate Release
Statement by Glenn Stevens, Governor: Monetary Policy Decision

At its meeting today, the Board decided to leave the cash rate unchanged at 2.0 per cent.

http://www.rba.gov.au/media-releases/2015/mr-15-11.html

 

[sinner]

Not many people are aware (thanks John Hussman!) that there is a strong relationship between short term government interest rates and total government debt.

Here is a scatterplot of RBA data, showing $b outstanding in Government securities vs the cash target rate. The data only goes back to mid 1990, so the relationship is not as clear as if you use US data from the Federal Reserve which goes back much further.



But, you get the drift! Government interest rates go with the Government balance sheet. This makes sense if you think about the accounting identity of Government + Household + Corporate sectors in a country.

So we can infer a move up to 4% rates would entail a 50% reduction in balance sheet. Rates above 6% have only been sighted when the Goverment balance sheet is barely in debt (generally implying the Household and Corporate sectors are doing well).

May be useful for those who are trying to figure out where rates will go. My 2c is that worries about rate hikes are overblown, since I think it is unlikely for Central Banks of the world to start trying to lighten their balance sheet without completely destroying the economy.

 

[sydboy007]

Not many people are aware (thanks John Hussman!) that there is a strong relationship between short term government interest rates and total government debt.

Here is a scatterplot of RBA data, showing $b outstanding in Government securities vs the cash target rate. The data only goes back to mid 1990, so the relationship is not as clear as if you use US data from the Federal Reserve which goes back much further.

View attachment 63313

But, you get the drift! Government interest rates go with the Government balance sheet. This makes sense if you think about the accounting identity of Government + Household + Corporate sectors in a country.

So we can infer a move up to 4% rates would entail a 50% reduction in balance sheet. Rates above 6% have only been sighted when the Goverment balance sheet is barely in debt (generally implying the Household and Corporate sectors are doing well).

May be useful for those who are trying to figure out where rates will go. My 2c is that worries about rate hikes are overblown, since I think it is unlikely for Central Banks of the world to start trying to lighten their balance sheet without completely destroying the economy.

the worry is we're at close to ZIRP for Australia.

hate to think what will happen if bank CDS go back to GFC levels. CBA is roughly the mid 60s at present but hit around 180 during the GFC and peaked around 210 in mid 2011.

The RBA had plenty of dry powder back then. Any tightening in global credit markets will be instantly felt as the banks will pass on the cost increase to borrowers. That might mean we start seeing a decent yield on TDs again, but doubt we'll get 5 year at 8% TDs like WBC offered.

prob best to get some corp bonds and accept that 5% is going to be a decent yield going forward in the new normal.

 

[sptrawler]

prob best to get some corp bonds and accept that 5% is going to be a decent yield going forward in the new normal.

I would think that is a fair call.IMO

 

[sinner]

the worry is we're at close to ZIRP for Australia.

There is still plenty of room to move downwards from 2%.


If you are familiar with the Japanese interest rate cycle, you will know that after the rate fell below 2% it never raised above it again, currently sitting at 0.5% I think.

Meanwhile JGBs provided decent returns in the move from 2% to 0.5% (yields down, price up) while everyone thought that the "top is in" for JGBs for like 20 years now.