Consider these Tier 2 AUD-denominated bonds with yields above 6%

The Australian Dollar (“AUD”) is part of the G10 currencies which comprises of the 10 most liquid currencies in the world. Over the course of a year, the AUD depreciated against major currencies due to China’s zero-covid policy and the aggressive rate hikes by the US Federal Reserve.

Currently, the SGDAUD currency pair is trading at 1.13 (30 May 23), increasing from 1.02 from a year ago. AUD is mainly driven by price of commodities and China’s growth. Australia is the largest exporter of iron ore in the world and exported AUD 116b worth of iron ore in FY22. China is Australia’s largest trade partner accounting for 25.9% of Australia’s exports and main importer of iron ore from Australia.

With the US Federal reserve expected to slow down and enter into a pause in 2H23 and the end of China’ zero COVID policy will likely support the AUD in 2023. We think the resumption of normality within China will drive demand for AUD from the increased consumption and growth of the Chinese economy.

We have highlighted a few AUD issuers below, primarily from Australian banks which we think can be a good alternative to SGD bank issuers.

Commonwealth Bank of Australia

Commonwealth Bank of Australia (“CBA”) was founded in 1911 by the Australian Government. It is considered one of the “big four” banks in Australia, alongside with National Australia Bank, ANZ and Westpac. It is one of the largest companies on the Australian Stock Exchange with a market capitalisation of AUD 168.4b. CBA provides a variety of financial services, including retail, business and institutional banking, funds management, superannuation, insurance, investment, and broking services. CBA is rated AA-/Aa3/A+ by S&P/ Moody’s/ Fitch respectively.

During its half year financial year ending 31 Dec 22 (“1H23”), revenues increased by 15% to AUD 13.9b while net profit after tax saw an increase of 10% to AUD 5.2b. CBA had higher net interest margin of 2.1%, an increase of 23 basis points (“bps”) from 2H22, mainly due to a higher interest rate environment. As a result, net profit improved due to higher net interest income but offset by higher loan impairment expense. Loan impairment expense increased to AUD 511m from decline in house prices and rising interest rates. Portfolio credit quality still remains sound as impaired assets fell by AUD 0.5b to AUD 6.3b. Loan impairment provisions increased by AUD 194m to AUD 5.5b in order to manage the risks from higher interest rates and home prices. Home loan arrears within its portfolio is still low remaining below 0.6% of its total home loans portfolio. While home prices in Australia have been falling quickly, the quality of its loans is still supported by a tight labour market in Australia and low unemployment rate.

In 1H23, CET1 ratio based on the new APRA framework was 12.1%, above requirements of 10.25%. Based on international Basel 3 requirements, CET1 ratio for the bank will be 18.5%. CBA maintains a sound liquidity profile with a NSFR and LCR ratio of 129% and 131% respectively. Liquid assets was AUD 193b as of 31 Dec 22 and household deposits made up more than 50% of its deposit base.  

Macquarie Bank Limited

Macquarie Bank Limited (“MBL”) is a debt funding vehicle for Macquarie Group Limited (“MGL”), responsible for providing funding for its banking divisions. Macquarie Group is a diversified financial group with divisions in Banking and Financial Services, Asset Management, Commodities and Global Markets and Capital Advisory Services. MBL will provide funding for MGL’s Banking and Financial Services (“BFS”) and Commodities and Global Markets (“CGM”) divisions. MBL is rated A+/A2/A by S&P/ Moody’s/ Fitch respectively.

In the full year ending 31 March 2023 (“FY22”), BFS saw operating income increasing by 20% to AUD 2.96b while net profit saw an increase of 20% to AUD 1.20b. Deposits increased to AUD 129.4b (+32%), representing ~4.8% of the Australian market. CGM experienced a stellar performance in FY22 due to higher commodity prices and volatility. Operating income was up 41% to AUD 8.72b and net profit up 54% to AUD 6.01b. Higher hedging and trading activity within its commodities division contributed to the improvement in profits.

In FY22, CET1 ratio (APRA) was 13.7% and based on Basel III requirements CET1 ratio was 18.4%. Liquidity also remains strong as LCR and NSFR was 214% and 124% respectively, above regulatory levels of 100%. MBL had liquid assets of AUD 65.6b of which AUD 57.3b were high quality liquid assets while AUD 8.3b is in cash.

National Australia Bank Limited

National Australia Bank Limited (“NAB”) is one of Australia’s big 4 banks. It was founded in 1981 as the National Commercial Banking Corporation of Australia. NAB provides financial service mainly in Australia and New Zealand with other businesses in Asia, the UK and the US. NAB group consists of corporate and retail banking businesses NAB, UBank, and Bank of New Zealand. NAB is rated AA-/ Aa3/ A+ by S&P/ Moody’s/ Fitch respectively.

For the first half financial year ending 31 Mar 22 (“1H23”), NAB reported growth throughout its business segments. Net profit saw growth of 18.8% to AUD 3.97b while underlying profit gained 18.4% to AUD 6.11b from the acquisition of Citigroup’s Australian consumer business. NIM was 1.77% for 1H23. NAB maintains a well provisioned despite the current Australian housing situation with AUD 5.58b of provisions for credit losses. NAB has also been reducing its exposure to commercial real estate (“CRE”) since 2009 and CRE exposure now make up 9.4% of its gross loans and acceptances.

As of 1H23, the group’s CET1 ratio was 12.21% based on APRA level II requirements and 17.3% based on international Basel III standards. Liquidity positions remain sound with LCR and NSFR of 130% and 117% respectively.

AUD Tier 2 bonds

We think Tier 2 AUD bonds from the mentioned Australian banks can be a good alternative for investors who seek a higher yield on Tier 2 bonds. In Table 1, we highlight some recommendations. All of the bonds mentioned are rated investment grade and have a yield to above 6%. With the depreciation of AUD against the SGD, we think this presents a buying opportunity for AUD denominated bonds.

While we are positive on the outlook for AUD in 2023, we would still like to caution against currency risks. The AUD may depreciate against SGD and thus eroding away potential returns. Another key risk is loss absorption risk as these Tier 2 bonds have loss absorption features which may be triggered upon the occurrence of a non-viability trigger event. Nonetheless, the 3 banks mentioned have strong solvency and CET1 ratios are above regulatory APRA levels.

Table 1: AUD Tier 2 bonds

Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a NIL position and the analyst who produced this report holds a NIL position in the abovementioned securities.