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ECONOMICS LEGISLATION COMMITTEE
21/10/2010
TREASURY PORTFOLIO
Australian Office of Financial Management

CHAIR —Thank you for coming in a little earlier, Mr Hyden. Do you have an opening statement that you would like to make?

Mr Hyden —Thank you. I would just like to say that our annual report for the last financial year was tabled in the parliament on Monday. It provides a comprehensive picture of our activities in the AOFM over the last year.

Senator BUSHBY —I anticipate that you may expect the question, but have you updated the graphs for each line offered through the AOFM and the rates achieved as we have in past estimates?

Mr Bath —Yes, I have.

Senator BUSHBY —Do you have copies of those with you?

Mr Bath —I have a copy. Do you want me to table it?

Senator BUSHBY —I imagine they are all in different colours?

Mr Bath —Yes, they are.

Senator BUSHBY —So we will probably have difficulties photocopying them and distributing them.

Mr Bath —There are several lines.

Senator BUSHBY —I know—exactly. I think I may have asked at the last estimates whether it was possible to break it up into a number of graphs.

Mr Hyden —I am unaware of that.

Senator BUSHBY —I apologise if I did not ask, but I certainly was thinking about it. In future I will continue to ask for this graph. How many lines are on that page? How many lines do you currently offer?

Mr Bath —The yule curve is quite flat at the moment, Senator, so you will just have to bear with me while I try to separate them.

Senator Wong —Is it possible to take this on notice?

Senator BUSHBY —Yes. Essentially, without—

Senator Wong —I think you are asking for disaggregated—

Senator BUSHBY —I am asking for disaggregated graphs—something that is a bit easier to read.

Mr Bath —There are 14 lines, and I have got more lines there.

Senator BUSHBY —Maybe if you could put it into two graphs so there are seven in each, and if you introduce new lines—

Mr Bath —I am happy to give you the data and perhaps you could use excel to draw the graphs that you care to. You lose a lot of the detail in the colour if you break it up. I fear that if I give you what you ask for we will be here again in another three months and you will say, ‘Can I have it a different way?’

Senator BUSHBY —Okay.

Mr Bath —I am happy to give you the data, and perhaps you could slice it and dice it however you like.

Senator BUSHBY —I get your emails advising of the results of every tender that you put out, and I have always intended to get my staff to actually start mapping it as it comes in, but—

Mr Bath —This is a different chart. This is not a chart of our individual tender results; this is a chart of market yields each day. We do not issue every bond every day—

Senator BUSHBY —No, I know that.

Mr Bath —We issue one or two bonds a week.

Senator BUSHBY —Okay, it is probably worth exploring that.

Mr Hyden —I might say that this data is published on the RBA’s website.

Senator BUSHBY —Yes, I have had a look at that data on the RBA website as well. When you put your tender out and you get a result, you do not know what the yield is going to be when you go to tender, do you? It depends on the bids that people put in as to how it ends up? That is correct, is it not?

Mr Hyden —It is correct, yes.

Senator BUSHBY —So how do the yields that end up on those tenders that are accepted relate to the yields that you have got mapped in that graph?

Mr Bath —The graphs that we provide are I believe end of day revaluation yields, so they are the secondary market yields at probably 4.30 pm of each closing day, whereas we tend to run our bond tenders at 11 am. So the market is a 24-hour market from about 8.30 am on a Monday morning until very early Saturday morning I believe now. You have to take certain snapshots in order to get daily revaluation rates and it is those rates that we give you but we do not run our bond tenders at 4.30 in the afternoon because all the bond traders would be packing up and heading home. We tend to want them to be at their desk and ready to buy our bonds so we tend to run the bond tenders when they are going to be there.

Senator BUSHBY —That makes sense. If you could provide that data to the committee on notice, I will see what we can do with that. I would be interested in a copy of the graph that you have brought along, even if it is in black and white for the moment.

Mr Bath —I have a coloured chart that you are welcome to have.

Senator BUSHBY —Just one?

Mr Bath —Yes.

Senator BUSHBY —If you give it to me though, you have to give it to the committee.

Mr Bath —I see.

Senator BUSHBY —You mentioned that the yield curve is fairly flat at the moment. I was going to ask whether the costs of funds are generally going up, steady or falling?

Mr Bath —As I said, the yield curve is flat. What has happened is that short bond rates have gone up slightly whereas long bond rates have fallen slightly.

Senator BUSHBY —Has that made them converge?

Mr Bath —Yes, that is essentially what a flat yield curve means.

Senator BUSHBY —But across all lines?

Mr Bath —That is correct; that is what a flat yield curve means.

Senator BUSHBY —Are you saying that a flat yield curve means that across all lines they are showing similar characteristics?

Mr Bath —Similar yields, yes. So a steep yield curve typically would have a short dated bond with a yield very close to the overnight cash rate set by the Reserve Bank and a long bond yield that might be one or two per cent higher than that is what we would call a steep yield curve. A flat yield curve would be all at essentially the cash rate. Sorry, I cannot refer to the chart because I have given it to the secretariat.

Senator BUSHBY —That is all right. I understand what you are saying.

Mr Bath —And an inverted yield curve would be the opposite to a steep yield curve where the long bond yield is lower than the cash rate and the short bond yield is still close to the cash rate.

Senator BUSHBY —Since the last estimates how have the yields performed: are they going up or down?

Mr Bath —A picture paints a thousand words. You will see in a moment that the short rates have risen slightly since June and the long rates have fallen slightly since June, so they have all converged on about five to 5¼ per cent, although I am at a bit of a disadvantage now that you have the chart and we don’t.

Senator BUSHBY —The original will come back to you. It certainly has converged a lot.

Mr Bath —A way that helps me is to think of this chart as a mountain range where the horizontal axis is through time. Think of it as a contour map looking up a mountain range, so when the yield curve is steep you will get the lines far apart—a little bit like isobars or a topographical map—whereas when they are converged, like they are now, that is essentially telling you that the yield curve is very flat.

Senator BUSHBY —What do you think the reason is for that convergence? What is the characteristic of the market that is actually causing that to happen?

Mr Bath —Demand for long bonds has improved. Demand for our bonds has been quite strong and that has driven long bond yields lower. Short bond yields tend to track the cash rate. When expectations of monetary policy changes are such that rates are expected to rise then the short bond yields tend to rise more and, because the long bond yield is more sensitive to longer term inflationary expectations, the fact that in the short term monetary policy is expected to tighten by the market then there is considered to be a dampening effect on demand and that tends to be reflected in a flatter yield curve or lower longer bond yields relative to shorter bond yields. So what you are seeing there is characteristic of the sort of yield curve you would see when the central bank of any country is in a tightening cycle.

Senator BUSHBY —Okay, that explains that. I presume there has been no change to the limit on borrowing since the last estimates because it would have had to go through parliament. Does it still stand at $200 million?

Mr Hyden —That is correct. It is $200 billion.

Senator BUSHBY —Did I say $200 million? Is this based on gross borrowings?

Mr Hyden —The coverage of it is defined in the legislation. It covers almost all Commonwealth government securities on issue—that is, the stock of debt that is outstanding, with some small exceptions relating to stock that was issued before the legislation came into effect.

Senator BUSHBY —Has there been any change in your predictions of the anticipated gross value of securities that will be outstanding at the end of the financial year? The last time you were here, about four months ago, it was about $209.4 billion market value.

Mr Hyden —The only change would have come from the economic statement by the government and then the subsequent PEFO. I do not think that changed it significantly.

Mr Bath —Not significantly.

Mr Hyden —We did not change our issuance program as a result, so that means that it is the same.

Mr Bath —In the short term, over the next year or so, it has hardly changed, but there may be a different peak.

Senator BUSHBY —If you could have a look at it: what I am interested in is what it will be at the end of the financial year and also what it will be when it is anticipated to peak. I note that as at today on your website the total Commonwealth government securities on issue are $167,401,000,000. Is that correct?

Mr Bath —I think that would have been correct as at 15 October. We update the website weekly.

Senator BUSHBY —I had a look at it on Tuesday and again today, and it has not changed, so that explains why.

Mr Bath —I beg your pardon?

Senator BUSHBY —I had a look at it on Tuesday and it is the same today as it was then, so that explains why.

Mr Bath —Yes, but we only update it weekly. We update it on the 15th and the 22nd. Today is the 21st, so, assuming that you checked it any time between the 15th and the 21st, it will not have changed.

Senator BUSHBY —How much is it rising by per week on average?

Mr Bath —It varies from week to week.

Senator BUSHBY —How much did it rise last week?

Mr Bath —I do not have last week’s tenders in front of me. We would have issued $500 million of long bonds and $700 million of shorter bonds, so that is $1.2 billion. I am not sure how many T-notes we issued; I think it might have been $1 billion. That would be $2.2 billion. I am not sure whether we had any maturities of T-notes that week. Certainly we do this week. If you are looking at the stock, you have to take account of maturities. For example, this week we have $5.5 billion maturing tomorrow. The week-on-week movement this week would actually be lower because we are issuing, I believe, another $2 billion or thereabouts of T-notes and T-bonds this week and we have $5.5 billion of maturing T-notes, so the stock would fall by a few billion dollars.

Senator BUSHBY —As part of your forward program, you would know that $5.5 billion is maturing this week—

Mr Bath —Yes, we keep good track of—

Senator BUSHBY —and, to make sure that the government has access to cash as it needs it, you would be ensuring that you are putting out there enough new stock or new securities to tender to cover those needs?

Mr Bath —Yes. We manage the government’s cash position.

Senator BUSHBY —Looking at the beneficial ownership information on your website, it appears that in September there was a substantial increase in Australian ownership of securities moving from 20 per cent to 26 per cent, which was the highest level of ownership by Australians in the past 12 months. Correspondingly, there was a fall in unidentified ownerships from 61.7 to 56.1. Are these two events related? Regardless, are you aware of any reason for this change?

Mr Hyden —The short answer is: yes they are related—that is, the rise in the first figure corresponds, broadly, to the fall in the second. But, going to the reason for it, we had substantial maturities of stock in August. It appears likely that the proportion of that stock that was held by domestic custodians affected that result. So the retirement of the maturity of the stock brought a change in the composition of the beneficial ownership of it, which is reflected, then, in the September figure.

Senator BUSHBY —Did it cause a change in the composition because some of the stock that was retired was unknown, which then reduce the overall level of stock at that point, which left Australian beneficiaries holding a larger proportion of stock, or was there a corresponding increase in Australian beneficiary owned stock at that time as well to replace that which matured?

Mr Hyden —We do not have direct knowledge of that. It is just informed speculation, if you like, as to what might lie behind the figures. But I think it is likely that, this being stock that was maturing that had been held for a long time—so it is different to the newly issued stock that we have been issuing over the last couple of years—it would have reflected some of the ownership pattern that applied earlier.

Senator BUSHBY —So, possibly, it was stock that you had held for some time, predating the requirement that you ask voluntarily where the country of beneficial ownership is. It may have matured, decreasing the unknown somewhat, and an element of the newer stock that was bought may well have volunteered where the country of beneficial ownership was. Presumably, that could explain it. I am just trying to work out why there was such a big jump in one month. I understand that it is a complex outcome of a change of maturing securities and new securities that are going out there, but I am trying to get a handle on why we had a six per cent increase in Australian owned stocks that we knew of that month and a fall in those stocks where we do not know the country of beneficial ownership.

Mr Hyden —In simple terms, it would look as though that might be explained by a larger proportion of the maturing stock being held by domestic nominee companies and custodians in Australia than for the newer stock that has been taken up in the last couple of years.

Senator BUSHBY —Okay. I will move on from there. I saw that your annual report came out on Monday, and I managed to obtain a copy. At page 32 of that report, you note that the Australian Custodial Services Association has advised it cannot provide beneficial ownership details, because of fiduciary and contractual obligations to its clients, unless there is a clear legal or regulatory compulsion to do so. I also note that it held around 63.2 per cent of CGS, or Commonwealth guaranteed securities, as at 30 June. Does this account for all of the unknown beneficial ownership of these securities?

Mr Hyden —It accounts for all of this line, domestic custodian nominee companies. I think that is the figure that you refer to.

Senator BUSHBY —I note that it says that they held 62.3 per cent of CGS, or Commonwealth guaranteed securities. I was comparing that to information that you have on your website, which indicates that with roughly 60 per cent, on average, of securities on issue the country of beneficial ownership is not known.

Mr Hyden —Yes.

Senator BUSHBY —I was wondering whether that 62 per cent that is noted in your annual report correlates with the 60-odd per cent on your website and, as a result, all those securities that we do not know the country of beneficial ownership of are actually held through that company.

Mr Hyden —The 62 per cent is the same as on the website. It refers to both CGS and state government debt that has a Commonwealth guarantee that is held by these custodial firms. There is a significant amount of guaranteed state government issued debt that is included in the register.

Senator BUSHBY —If such a clear legal or compulsory compulsion, as referred to in your report, did exist, would it then remove all obstacles to that association providing this information?

Mr Hyden —I am not sure that I can speak on their behalf. What I have quoted in the report is what they have said to us or put to us.

Senator BUSHBY —I will move on from beneficial ownership. On RMBS, where is the investment strategy currently at? Last time you were here you talked to us about the arrangements you had made with Suncorp. I believe you have done something similar with ING. Could you update us as to the outcome of that?

Mr Bath —Yes, we have done several deals of a similar ilk to the deal that we did in May with Suncorp. I do not have every transaction in front of me, but they are on our website.

Senator BUSHBY —Okay.

Mr Bath —I beg your pardon, I might be able to give those to you. We have done one with Suncorp; one with Members Equity Bank; one with Bendigo and Adelaide Bank; one with MyState Financial; one with Liberty Financial, which did not have quite the same structure; one with the Bank of Queensland, one with Macquarie Bank; one with FirstMac, again with not quite the same structure; another with Members Equity Bank; and another with ING Bank, which is the last one. That takes us up to just over $11.5 billion.

Senator BUSHBY —It was about $9 billion last time, so is it roughly $2 billion involved in those deals that you have just outlined?

Mr Bath —That sounds about right. In the third quarter of 2010 we settled $2.242 billion of investments. So far in this quarter we have done just the ING deal, which was $250 million. That is the amount that AOFM invested. The market is improving, and also part of our strategy was to deliberately buy a smaller portion of each transaction. The total issuance in the third quarter was $6.9 billion, of which 2.24 was the number I said that the AOFM has bought.

Senator BUSHBY —So 6.9 was the total—

Mr Bath —For Q3. And that is the highest RMBS issuance in a quarter since the program started.

Senator BUSHBY —You mentioned in passing that the market is improving.

Mr Bath —It is improving in the last short while, probably since we last spoke in June. It has not been a uniform improvement over that time, there have been fits and starts, and a lot of that is to do with the travails in Europe and the second—

Senator BUSHBY —There was a big hiccup in the second quarter of this year.

Mr Bath —Yes, there was a bit of an overhang of that, so it has not been a perfect straight line since we last spoke. Particularly in recent weeks there has been a bit of an improvement in secondary market pricing, but also—and this is another measure of how we think things are going—the proportion of each transaction that we are asked to buy has been lower.

Mr Hyden —Also, the total volume that has been invested by private investors has increased. That is an important measure of—

Senator BUSHBY —So these deals that you have entered into since June—I recall that with the Suncorp deal that was a new approach that you were taking and that actually occurred because Suncorp approached you about a different way of—

Mr Bath —No, that is not quite right.

Senator BUSHBY —Not quite right?

Mr Bath —No. We came up with something—

Senator BUSHBY —It was a reverse something strategy.

Mr Bath —No, Senator.

Mr Hyden —That is different.

Mr Bath —The reverse inquiry channel—

Senator BUSHBY —The reverse inquiry channel—that is it.

Mr Bath —is the channel under which nearly all the transactions since the beginning of this year have been executed. There have been a few that we have done under what is called our serial pipeline channel, where we have agreed for five issuers to buy a series of investments. But that is not what happened in May with the Suncorp deal. What happened back in April-May was that we sensed that the market had slowed down, that buyers and sellers had become further apart, and we saw it as our job to get them back together again. So we did two things. The first thing we did was deliberately look to structure a transaction where we would buy, if you like, the slowest third of the capital to be repaid, and that created a larger tranche of securities that would have a relatively fast repayment speed and for which, we sensed, there was an investor base that was ready to buy. We said to ourselves, ‘Well, the next suitable candidate that puts a proposal to us, we’ll ask them to consider changing to suit our strategy,’ and that happened to be Suncorp. That is what happened.

Senator BUSHBY —Are the alliances you outlined earlier a similar deal, with the two-stage—

Mr Bath —When I listed them out, I said that some of them were slightly different structures.

Senator BUSHBY —Yes, some were slightly different—but basically similar to that, apart from the ones which were a bit more different.

Mr Bath —Yes, apart from the ones that I said were different. The ones that I did not say that about are the same as the Suncorp one. That is correct, yes.

Senator BUSHBY —You say the market is improving at the moment. What do you see as your role in the coming months? What is your strategy? Do you think it is improving to the extent that you might not need to continue with the same will level of activity and can wind back at all?

Mr Hyden —We will continue to watch the market, obviously. We will assess individual proposals that are put to us. Some issuers may feel they can issue without recourse to us, and we would encourage that, but we will continue to respond positively to proposals so long as we feel that they are needed to support the objective of competition in lending for housing.

Senator BUSHBY —Up to the ceiling of the $16 billion you have available?

Mr Hyden —Yes.

Senator BUSHBY —Have you sold any more of the RMB securities, over the $80 million that you had sold at June this year?

Mr Hyden —No, not since last time.

Senator BUSHBY —Okay. And what sort of return are you making on the RMBS at the moment?

Mr Bath —We are earning about 130 basis points, or 1.3 percentage points, over the bank bill rate. So, for the financial year that just finished, I think it was 5.2 per cent across the year.

Mr Hyden —That is correct. That compares with 4.8 per cent in the previous year, so it is up slightly, reflecting the movement in rates.

Senator BUSHBY —And 5.2 per cent is probably covering the cost of finance, on average. I had a long discussion with Mr Ray from Fiscal Group about how you would actually assess that, but it is probably not costing the government any money to have those sitting in there.

Mr Hyden —It is broadly in line with the overall cost of physical debt in our portfolio, you could say, should one try to match it with new debt. But I think that gives you a broad impression.

Mr Bath —To give you an idea of the margin, Senator, we are earning about 1.3 per cent over the bank bill rate. If we were to enter into interest rate swaps against our physical debt issuance, so that we could compare term debt that we are raising with floating rate debts, we would be able to raise debt at about 40 to 50 basis points under the bank bill rate. So, theoretically, our margin could be as much as 180 basis points. However, we are not using interest rate swaps to reduce that mismatch. We are quite happy to—

Senator BUSHBY —The purpose of the exercise is not to make money; it is to support the security of the RMBS market.

Mr Bath —That is right.

Senator BUSHBY —Okay. I am happy with that. Thank you.

CHAIR —Are there any further questions for AOFM? No. In that case, thank you for coming this evening. Thank you, Minister. And thank you to Broadcasting and Hansard for your help over the last two days, and of course our secretariat. The committee will now adjourn.

Committee adjourned at 10.25 pm