Investing in the Future
Using the
Australian Fixed Income Markets
By
Contents
Part 1 – Australian Bond Market Characteristics
1.
2.
3.
4.
Investments available
Explanation of Securities
Who issues Bonds
Ratings - Standard and Poor's, Fitch, Moody's
Part 2 – How it works
1.
2.
3.
4.
5.
Underlying investment premise
What affects yield
What causes credit risk premium to change
Yield curve
Markets – Supras, Federal & Semi Government, Govt Guarantee Bank Fixed &Floaters, Corp Fixed & Floating and CPI Indexed Bonds
Part 3 – Market Changing
1.
2.
3.
4.
Changes in the Market
Current Disconnect with Deposits
Current disconnect with Discounts
Current disconnect with Bonds
Part 4 –The Future - Issuing Bonds
1.
2.
3.
4.
Debt Capital Markets Intro
What is a debt strategy
The debt strategy process
Critical Areas That Will Affect Outcome
Part 5 - How does Gilt Investments Pty Ltd fit in ?
1.
2.
3.
4.
5.
6.
Who is Gilt Investments Pty Ltd
Criteria for consideration
Reasons for setting up your portfolio
Deposits part of Fixed Income market
What to Look for
Contact Details
PART 1
Bond Market Characteristic's
Investments available in the Australian interest
rate markets

Less than 1 year to maturity

Greater than 1 year to maturity … Bond investments
(Long term capital markets)
… Discounted investments
(Short term money market)
Less than 1 year to maturity
Discounted & ‘yield’ investments

Cash & Short term deposits with:
 Major Bank
 Foreign Bank
 Regional Banks
 Credit Union
 Building Society

Discount Securities issued / sold by:
 Bank Bills
 Promissory Notes
 Negotiable Certificate of Deposit (NCD)
 Treasury Notes
Greater than 1 year to maturity
Less than 1 year to maturity
Greater than 1 year to maturity
Bond Investments

Floating Rate Notes (FRNs)

Bonds (fixed rate)
 Government
 Semi government
 Corporate
 Inflation linked

ASX listed hybrids
 Income Securities
 Convertible Notes or Preference
Shares

Structured products

Collateralised Debt Obligations
(CDOs)
Explanation of Securities
Discount Investments

Cash - is the most liquid of investments generally referred to as a “24 hour call deposit” or “11am term deposit” funds can be accessed any time.

Term deposits - all approved deposit taking institutions (ADIs) will quote interest rate yields on set, fixed
maturities (terms) for deposits.

Discount securities -
in order to provide investors with the ability to sell their investments, institutions will issue
securities to investors. The securities are offered at a discount to their face value using a discount formula. The full face
value of a discount security is paid out on maturity.
- More on discount securities next…
Explanation Continued

Bank Bills (or Bills of Exchange) - A bill of exchange that has been accepted or endorsed by a bank. This puts primary
liability for repayment of the bill onto the bank which accepted the bill.

Negotiable Certificate of Deposit (NCD)
- is similar to a bank deposit, but instead of the ownership being recorded in
a register by the bank, there is a certificate issued. Again - it is negotiable in that whoever holds the certificate owns the claim on the
cash flow at the end. The terms of NCDs can range over many years, but we usually only refer to those that mature within 1 year.

Promissory Note
- An unconditional promise to pay to the holder of the note a fixed amount (face value) at a fixed date
(maturity date). Defined more fully in the Bills of Exchange act as: "an unconditional promise in writing by one person to another,
signed by the maker, engaging to pay on demand or at a fixed or determinable future time a sum certain in money for or to the order
of a special person or to bearer"

Treasury Note - Commonwealth Government issued short term securities for 5, 13 and 26 week periods, issued at a discount
from face value
Bond Investments

- Similar features to bonds except that the periodic coupon payments are
not equal. Payments are reset in line with a given market indicator each period. Usually set as a margin above the bank
bill rate.

Fixed Bonds


o
Floating Rate Note Bonds (FRNs)
- Term to describe a fixed-rate transferable debt instrument that is an financial obligation for the
issuer to pay, a fixed sum (face value) at a specified date (maturity date); and a series of equal periodic payments called
coupon payments.
Hybrids
- These securities are subordinated in nature and convertible to shares either at maturity or at a given
date in the future. Before conversion pay either a fixed or floating coupon.
Structured products
- Collateralised Debt Obligations (CDOs) - are complex structured products typically
arranged by investment banks with a range of tranches that are independently rated by a credit rating organisation.
If none of the underlying portfolio of securities default over the life of the CDO, investors will receive their capital back
in full. If more than a handful defaults, investor’s capital is at risk.
Who issues bonds to borrow from market

Commonwealth Government via the Reserve Bank

State Government

Australian Companies

International issuers

Banks

Finance Companies

Special issuers e.g. infrastructure, mortgage backed
Standard & Poor's long-term ratings
The following are considered investment grade assets.

AAA - The borrowers capacity to meet its financial commitment on the obligation is
extremely strong

AA - The borrowers capacity to meet its financial commitment on the Obligation is very
strong

A - The borrower is more susceptible to the effects of changes in economic conditions. The
borrowers capacity to meet its financial commitment on the obligation is strong.

BBB – A borrower shows adequate protection parameters. However, lowering economic
conditions are more likely to result in a fragile capacity by the borrower to meet its financial
commitment.
Standard & Poor's long-term ratings
The following are considered non-investment grade – i.e. considered to be speculative
and investors should seek advice or be aware before investing.

BB - Less vulnerable

B - More vulnerable

CCC - Currently vulnerable

CC - Currently highly vulnerable

C - Payments are still being made but bankruptcy proceedings have been filed.

D - In default
PART 2
How it Works
“The greater the risk the greater
the return”
Risk
Return
What affects the Yield
• Before you buy any fixed income investment you need to
know what affects the yield. This then guides you towards
what to buy, after an investment policy has been put in place;
•
•
•
•
Inflation Premium
Credit Premium
Liquidity Premium
Market influences
To get the yield the risk premium needs to be
added to the nominal rate of interest
Real Yield + Inflation Premium = Nominal Yield
Nominal Yield + Risk Premium = Security Yield
What causes credit risk premiums to change
•
•
•
•
•
Industry volatility
Term to maturity
Financial stability & gearing
Liquidity
Management decisions
The Yield Curve

What is it?

How can it move?

What effect does this have on bond values?

How do I manage it?
Normal yield curve
10
%
9
Yield
%
8
7
6
5
1
2
3
4
5
Years
6
7
8
9
10
Yield curve changes shape
10
9
Yield
%
10 yr - Yields up 0.1%
Price down approx. 1.0 %
8
2 yr - Yields up 1%
Price down approx. 2 %
7
6
5
1
2
3
4
5
Years
6
7
8
9
10
The yield curve changes again
10
9
Yield
%
8
4 year - no change
in value
7
6
10 year - gains 5 %
in value
2 year - loses 1%
in value
5
1
2
3
4
5
Years
6
7
8
9
10
Supranational Bonds
Federal & State Government Bonds
Bank Government Guaranteed Fixed
Bank Government Guaranteed Floating Rate Notes
Corporate Fixed Bonds
Corporate Floating Bonds
CPI Indexed Bonds
PART 3
Market Changing
Changes in the Bond Market
• New Basel Rules guiding Banks capital adequacy, stress
testing and market liquidity risk.
• Foreign Bank Branches
• Wholesale Pricing vs. Retail Pricing – Retail get above
benchmark
• Compliance on Financial Planners
• Shrinking Competition and Dominance of the Majors
Banks
• Shadow Banking influence
Current disconnect to Deposit Markets
Current ‘disconnect’ to Discount Markets
Current ‘disconnect’ in Bond Markets
PART 4
Issuing Bonds Into The Market
Debt Capital Markets - Introduction
Context

Every business should have a sound understanding of debt capital markets, including:

The role of debt in funding a borrower’s assets;

The benefits and risks of using debt compared with other sources of capital (equity);

The different types of debt available;

Potential sources of debt;

Pricing of debt; and

Covenants, reporting requirements and review processes required by debt providers.
Why is this Important?

A borrower can minimise its capital cost (taking into consideration its risk profile) by optimising
its debt to equity ratio;

A borrower can reduce its bank interest, fees and charges and increase the flexibility in which it
operates by optimising the facility’s styles and structures (pricing, covenants, security, conditions
etc.);

Borrowers are often not aware of the different types of debt and potential sources of debt
available – many borrowers rely on their existing provider to advise on their capital needs;

Debt instruments are at least as complex and diverse as equity products.
What is a Debt Strategy?
A good debt strategy:

Delivers the optimum mix of debt and equity which minimises the weighted average cost of capital,
maximises return on equity and helps manage risk;

Is integral to implementing and achieving a business’s strategic plan – particularly in terms of funding
growth;

Aligns with and supports the business’s strategic plan, facilitates growth;

Is structured to match cash outflows (principle & interest) with cash inflows and business cycles;

Is competitive on terms, conditions and pricing;

Has tailored, relevant covenants and reporting requirements that add value to the business as valid
lead indicators; and

Aligns with the risk appetite of the borrower.
A poor debt strategy can:

Exposure to loss of control - increase business risk;

Constrain growth;

Trigger breaches if poorly structured covenants (i.e. are not matched to business’s cash flows);

Create an unnecessary administrative and reporting burden;

Cost more than it should if its terms and conditions are not competitive in the current market; and

Create stress if it does not match the risk appetite of the borrower.
“Debt Strategy Analysis” - The Process
Step 1
Step 2
Step 3
Step 4
Fact Find
Capital Structure Analysis
Review of Market Conditions
Options Analysis
 Nature of contracts and
customer profile;
 Board and Senior
Management;
 Recent financial
performance;
 Business drivers;
 Competitors, suppliers,
barriers to entry;
 Tangible and intangible
assets;
 Working capital and
cash flow requirements;
 Financial forecasts;
 Strategic planning;
 Current debt
arrangements;
 Risk appetite;
 Key risks.

Existing equity
structure;
 Capacity and inclination
to further invest;
 Current types, sources
and costs of debt;
 Covenants, reporting
requirements and review
processes;
 Security over current
debt;
 Other sources of
funding currently in
place.

Market attitudes
 Types and sources of
towards debt versus
capital to achieve the
other sources of capital;
identified growth
 Different types of debt
strategies;
available;
 Risk analysis;
 Indicative pricing of
 Developing a plan to
different types of debt;
transition to an optimal
 Providers of debt;
capital mix
 Covenants, reporting
 All of this analysis is
requirements and review based on deep
processes;
relationships with both
 Timing;
debt and equity
 Obstacles or other
providers, and extensive
matters to consider.
experience in arranging
capital raising from
various sources
Some Critical Areas That Will Affect The
Outcome
1.
Borrowing entity? – Investors will want to know who they are lending to, is it syndicated if
so where is the security.
2.
What is the security? – Are the bonds secured by property, are they Government
Guaranteed, what is the history of performance, has there been defaults, are there any
non-performing loans…
3.
What is the rating? – Apart from professionals, others don’t have any means to assess risk.
4.
How liquid are they? – Can investors get out, are there other buyers
5.
What are the custody arrangements? – Can they be transferred or held in custody.
6.
Does the yield match the risk? - Market, liquidity and credit risk
PART 5
How Does Gilt Investments Fit into
The Picture?
Who is Gilt Investments Pty Ltd
Gilt Investments is a privately owned business that specialises in providing clients direct access
to the interest rate markets, in particular the bond markets.












Provides access to the fixed income markets
Assists with liquidity
Not aligned to any financial organisation
Simplified transaction procedures
Offers all institutions products
custody arrangements
Provides valuations
Constructs portolio’s
Updates on markets
Single asset focus
Experienced specialists
Weekly Newsletter
Criteria for consideration…

Credit Rating (A risk measure e.g. by Standard & Poor’s)

Term to maturity (Short term < 1 year or Long term > 1 year)

Liquidity

Return - Fixed or floating

Cash flow
Reasons for setting up your own portfolio

Management expense ratios

Better control

Skills retained

Capital back on maturity

Indication of risk free rate of return (benchmark)

Fixed and floating

Active and passive
Deposits Service
CIBC & BNS - both are
covered bonds, both AAA,
same maturity (approx) but
different yield
LSPLAN
compared to
Mirvac 15/03/15
– same industry,
better rating but
a lot higher yield
MELBAIRPORT vs
WESFARMERS – both
Australian, same
rating & maturity but
different yield –
(possibly due to
amount on issue,
Industry, Coupon)
How to contact
Gilt Investments Pty Ltd





Phone
Fax
Mobile
Email
Web Address
617 3123 7132
617 3123 7142
0414 411 087
ahealey@gilts.com.au
www.giltinvestments.com