Credit spreads generally continued to tighten in August, although Australian physical spreads were mainly flat over the month. For the synthetic indices, the US CDX Index tightened by 7.4 bps, the European iTraxx tightened by 5.4 bps and the Australian iTraxx tightened by 6.2 bps. Corporate and assetbacked debt issuance (excluding supranational/sovereign/ agency) reached AUD 10.8 billion this month compared with AUD 9.4 billion in July.

In the mining sector, Rio Tinto reported 1H14 results up 21% on the year and ahead of consensus. BHP Billton’s annual results showed underlying an increase in net profit after tax (NPAT) of 23.2% on the year, missing market expectations. The results were underpinned by record production volumes despite falling commodity prices and strong productivity enhancements that help strip out costs. Continuing trends among the miners are the reduction of capital expenditure programmes and cost cutting. BHP also announced that it will restructure the company and demerge its non-core assets.

For the food retailing sector, both Wesfarmers and Woolworths reported strong NPAT results, with Wesfarmers up 18.9% on the year and Woolworths up 8.5% on the year. Coles and Bunnings remained the growth drivers for Wesfarmers , while Target and Resources remained weak. The sale of the insurance business led to a full year dividend of AUD 1.90 per share and an additional AUD 1.1 billion return of excess capital. Woolworths saw further customer growth and strong cost performance. Operational efficiencies remain a focus but fourth quarter comparable store sales at supermarkets slipped back behind Coles.

Telstra reported solid annual results with income up 6.1% on the year. Across the product lines, mobiles continued to improve while fixed voice remained on a negative trend. Sydney Airport reported a strong result, with strong total passenger growth continuing historical trends. International passenger growth was stronger than domestic, mainly from Asia. Transurban had strong results, up 12.2% and ahead of consensus. The two largest roads in the portfolio, Citylink and M2 both delivered in line with expectations, while the outperformance came from M2 connection roads, the Lane Cove Tunnel and M7 Westlink.

Bendigo and Adelaide Bank saw strong cash earnings, up 9.9% on the year and beating market expectations. Credit quality was sound with lower arrears across most segments and stabilising Queensland cattle property values. Commonwealth Bank of Australia (CBA) reported strong results with NPAT up 16%, with all divisions growing.

For the Australian real estate investment trusts (A-REIT), GPT Group reported 1H14 results down 6.4% compared with 1H13. Retail was still reasonably subdued, offset by strong occupancy rates. Office remains challenged and logistics and industrials were modest. Stockland reported FY14 underlying profits up 12.2% on the year, mostly due to residential. Mirvac reported operating profit up 16% on the year with development activities accounting for most of the growth and the investment portfolio benefiting from the GE Capital portfolio acquisition. CFS Retail reported NPAT up 35.6% on the year with growth driven by property income growth and positive property revaluations. During the year, CFS Retail completed the internalisation of management which has seen AUM grow to AUD 14.9 billion.

Standard & Poor’s (S&P) downgraded Fonterra by one notch to A with a Stable outlook due to Fonterra’s risk appetite being higher than the prior rating expectation. This occurred due to a NZD 615 million joint venture with Beingmate to help meet Chinese demand for infant formula by taking a 20% stake, causing a reliance on dividends from equity holdings rather than direct control over cash flows. Fonterra will also spend NZD 555 million on expanding and optimising its processing capabilities on the back of weak global dairy prices.

Financial issuance this month included Wells Fargo, Member’s Equity Bank, UBS, National Australia Bank (NAB), Bank of America, Sumitomo Mitsui Banking Corporation, Scentre and Goldman Sachs. In the securitisation market, Medallion Trust 2014-2 issued AUD 4 billion.

Credit Outlook

Physical credit spreads have consolidated their levels, with the search for yield continuing, although global uncertainty in Ukraine and the Middle East is a potential negative. Despite having tightened over the last year, spreads still seem more likely to narrow than widen due to demand. We do not anticipate significant widening although the current heightened geopolitical concerns may provide some outward pressure on spreads.

An oversupply of senior debt from the Financial sector seems to be less of a threat than previously and markets appear more sanguine about regulatory risk. Our view, therefore, is that high quality corporate paper is now priced fairly against Bank issues due to continued spread tightening and high demand. Financials are, however, more likely to be volatile until regulatory issues are finalised and, in particular, there are more definite resolution processes for failing banks. Given their strong credit profiles, major Australian banks remain attractive issuers and should be relatively stable in the longer term although their higher liquidity can result in more volatility in the shorter term if investors try to trim their credit exposure.

Supply continues to be a key issue for the Australian market, especially outside the financial sector. Despite record levels of lower rated corporate paper, the corporate market remains supply-hungry and allocations to new deals are often being severely scaled. Future supply of new issuers is uncertain given many investment-grade issuers tend to be lowly geared and so require less debt. In addition, many Australian issuers are still drawn offshore or to the bank market.