Credit spreads continued to tighten in September, with domestic physical spreads tightening 1 basis point (bp) over the month. For the synthetic indices, the US CDX Index widened by 7.64 bps, the European iTraxx by 2.65 bps and the Australian iTraxx by 4.8 bps. Corporate and asset-backed debt issuance (excluding supranational/sovereign/agency) reached AUD 5.8 billion this month compared with AUD 10.8 billion in August.

In the Australian credit market, the relative lack of supply compared with demand continues to cause spreads to tighten in the physical market offsetting the risks of an unstable geopolitical environment. The month saw companies attempting to cost cut and increase efficiencies with Coles announcing plans to axe 600 jobs and to outsource its IT operations. This is in line with the company’s renewed efficiency drive aimed at freeing up funds to reinvest in reducing food and liquor prices. BHP Billiton also announced 700 job losses in its Queensland coal business as it strives to cut costs in the face of falling commodity prices and a high Australian dollar.

In the Australian real estate investment trust (A-REIT) sector, following the internalisation of management, CFS Retail announced a name change to Novion Property Group. GPT Group pulled out of the bid for AMP’s AUD 400 million Mount Ommaney Shopping Centre in Brisbane. Instead, in conjunction with GPT Wholesale Office Fund, it acquired 50% in CBW, which comprises two office towers and retail space in Melbourne’s CBUS Property. The cost of the acquisition was AUD 608 million. Moody’s assigned the A-REIT sector a ‘stable’ outlook and expects like-for-like net operating income (NOI) growth of 1.5%-2.5% for the sector as a whole over the coming 12-18 months. However, the agency expects weaker growth in the office sector (1%-2%) because of historically elevated vacancy rates. If growth falls below 2%, a negative outlook is likely, while growth exceeding 4% will see a positive outlook. Retail and Industrials are expected to outperform Office.

Woolworths has announced the sale and leaseback by ALH Group Pty Ltd of a portfolio of 54 properties to Charter Hall for AUD 603 million. The ALH Group is 75% owned by Woolworths and 25% by the Bruce Mathieson Hotel Group and operates 329 venues and 545 retail liquor outlets across Australia. Woolworths had highlighted such a move was on the cards stating a preference for long-term leases rather than holding property assets.

Macquarie Group upped its FY15 profit guidance on the back of increased performance fees from the listed and unlisted funds as being slightly up on FY14 from “broadly in line with FY14”. 1HFY15 results are now expected to be up 25%-30% year-on-year. While Macquarie’s annuity style business continues to perform in line, the capital markets businesses were down due to timing of transactions and lower volatility and volumes impacting Macquarie Securities and certain parts of the Fixed Income, Currencies and Commodities (FICC) business.

Standard & Poor’s (S&P) placed Transurban’s A rating on negative outlook due to the company’s plans for the potential expansion of its CityLink road in Melbourne. S&P expects this to occur when other large projects are underway and with little buffer in the credit metrics. The project is expected to require AUD 850 million with completion by 2017. S&P stated it would lower the rating on Transurban were it to go ahead with the project and fund it in a manner that would not restore its financial metrics in line with S&P’s expectations.

Financial issuance this month included GPT, United Overseas Bank (UOB) Sydney Branch, Bendigo & Adelaide Bank, BNG, Metlife, Bank of Tokyo Mitsubishi UFJ Sydney Branch, Glencore, RBC, Kommunalbanken Norway, DBNGP Finance, AMP Wholesale Office Fund and Korea National Oil Corporation. In the securitisation market, REDS EHP Trust issued AUD 950 million and Firstmac issued AUD 700 million of residential mortgage-backed securities (RMBS).

Credit Outlook

Physical credit spreads have continued to tighten, demonstrating an ongoing search for yield, although global geopolitical uncertainty is a potential negative and has affected synthetic spreads. In general, positive factors remain, such as a technical bid for credit due to the search for yield in a low-yield environment, supportive policies of most central banks, strong corporate balance sheets, a low likelihood of major bank failure and relatively solid economic fundamentals. Despite considerable tightening over the past few years, spreads still seem more likely to narrow than widen although at a slower pace. We do not anticipate further major widening although the current heightened geopolitical concerns may place some outward pressure on spreads.

The excess supply of senior debt from the Financial sector seems to be less of a threat than previously due to slower lending growth 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 should outperform if the market becomes more optimistic, although they will remain more challenged in the longer term until regulatory issues are more settled and, in particular, there are more clear-cut resolution regimes for failing banks. Given their strong credit profiles, paper from the major Australian banks appears attractive and should be relatively stable in the longer term. However, its higher liquidity has resulted in more volatility in the shorter term when some investors have tried 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 is uncertain given many investment-grade issuers tend to be lowly geared and so require less debt. In addition, many Australian issuers are attracted to the bank loan market for shorter maturities and for long-term debt are still drawn offshore or to the bank market where very competitive pricing can be achieved.