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Bushby, Sen David
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Economics Legislation Committee
(Senate-Thursday, 6 June 2013)
Content WindowEconomics Legislation Committee - 06/06/2013 - Estimates - TREASURY PORTFOLIO - Australian Office of Financial Management
Australian Office of Financial Management
CHAIR: I welcome Mr Nicholl and Mr Bath from the Australian Office of Financial Management.
Senator BUSHBY: Thank you for assisting us this afternoon rather than this evening, which I am sure you are as pleased about as we are.
Senator Wong: He is very sad that he is not here later.
CHAIR: You did not want to go to dinner afterwards!
Senator BUSHBY: I might start by asking whether you prepared the graph that you normally prepare, indicating the development in yields? Would you care to describe quickly what has happened since the last estimates and, in particular, where things are going?
Mr Nicholl : I will give you a copy of it.
Senator BUSHBY: Thank you. I see a slight uptick.
Mr Nicholl : Rates have fallen since we were last here, but in recent times the yields have increased slightly and the spread of the curves there suggest that the yield curve is about as steep as it was.
Senator BUSHBY: But looking fairly consistent over the last 12 months or so, with a slight up-and-down, and still near the low that we saw in January 2009.
Mr Nicholl : Yes, we are above our historic lows, but we have seen ups and downs since that period.
Senator BUSHBY: Very good, thank you for that. You may well have heard that I just asked the markets group some brief questions about the costs of funds. I am particularly interested in the mortgage-backed securities market. Do you have some updated figures? I know that the AOFM has been transitioning out of that, so you might give an update on that, and also on the overall state of the mortgage-backed securities market and what is being issued in Australia.
Mr Nicholl : I will make an opening comment before I pass to Mr Bath. I will just say that, yes, on 10 April the Treasurer announced that we would no longer be investing in RMBS; the investment phase of the program would be concluded. So we are now holding stock of RMBS with the outstanding value of about $9.2 billion, I think. Our task from here will be to continue to look for appropriate opportunities to sell small parcels of that stock, for the purposes of price discovery in the secondary market.
Senator BUSHBY: How much have you sold so far?
Mr Nicholl : We have sold about $634.4 million, with the last sale being just some weeks ago, and that was at just over $300 million.
Senator BUSHBY: How high did the holdings that you had in the RMBS get to? I think it was up to $20 billion at its peak.
Mr Nicholl : At the peak investment, it was $15.5 billion. Sorry, it was $11 billion.
Mr Bath : I might be able to clarify. We have invested $15.5 billion, but—in terms of the cash amount—the portfolio reached a peak at around $11 billion. There is amortisation, and there were some other sales, as Mr Nicholl said. So the peak cash value amount of the portfolio was around about $11 billion.
Senator BUSHBY: And the broader RMBS market or the mortgage-backed security market?
Mr Bath : It has improved since we last spoke. The chase for yield globally has continued, by and large, since we last met. Just in the last couple of weeks there has been a bit of volatility in markets, which you might be aware of—essentially since Mr Bernanke made a few comments about the potential for quantitative easing coming to an end in some months. That spooked a few markets. Credit markets have consolidated and some spreads have widened just in the last week or so.
Senator BUSHBY: Is that the reason for the up-kick on your yields?
Mr Bath : Yes. Well, it is related. It is not a direct consequence, but it is broadly related. We have not seen spreads in mortgage-backed securities and we have not seen a primary deal print since that time. The day before he spoke, we did that last sale at a reasonably tight level of 75 basis points over the bank bill rate, for a 2½-year weighted-average life across three tranches. That has probably been about the low in the market or the tightest level in the market since the global financial crisis for a 2-½ year transaction. And then there are a couple of transactions in the market at the moment that are slightly longer and at slightly wider spreads. But, by and large, the theme has been continued improvement as investors chase yield, given that there is a lot of liquidity in the market and there are other interventions in other markets, such as the funding-for-lending scheme in the UK that causes a shortage of mortgage-backed securities supply. So global investors who like that product have been coming to Australian dollars.
Senator BUSHBY: What is the total value of the mortgage-backed security market in Australia so far this year?
Mr Bath : I believe the amount of issuances have been just under $10 billion. There are about $1 billion worth of deals in the market at the moment, but they could be upsized.
Senator BUSHBY: They are still a fair way short of the $50-odd billion that was occurring before the GFC and even short of what it reached a couple of years back when there was a bit of a—
Mr Bath : I think in 2011 we had just over $21 billion. We are tracking at roughly that pace, given that it is early June now.
Senator BUSHBY: Then that all fell over because of the European upset.
Mr Bath : Yes, the second half of 2011 was slower than the first half. That is right.
Senator BUSHBY: So this is building more sustainably, do you think? This $10 billion—is it more likely to be sustained at this level of interest? I suppose it would depend on what happens internationally.
Mr Bath : If you had asked me at the same time in 2011, I would not have—
Senator BUSHBY: Yes, who knows with these international events. Bernanke makes a statement and things change.
Mr Bath : I would like to tell you that I did perfectly foresee the implosion of European sovereign debt markets, but I cannot really claim to have done that.
Senator BUSHBY: Fair enough.
Mr Bath : So, who knows what will happen for the back half of the year? But it is looking promising.
Senator BUSHBY: In the absence of any major shocks it looks like there could be reasonable confidence.
Mr Nicholl : The market has a feeling of stability to it right now.
Senator BUSHBY: Yes. Very good. We will move on from there. I am hoping that you will be able to help me with this. In Budget Paper No. 1 at page 9-7, under Assets there is a category called Investments, Loans and Placements which has a value of over $100 billion in 2012-13, and it gets higher than that over the coming years. This is a fairly large amount. My question is to try and understand what—
Senator Wong: I think this line item was asked about—
Senator BUSHBY: In Finance?
Senator Wong: I think Treasury was asked it earlier at some point in the last two days, and we have taken it on notice. You may want to put it on notice again so you can check, but I am pretty sure that was the line item to which one of your colleagues referred.
Senator BUSHBY: The AOFM may be able to help us.
Senator Wong: It is not their table.
Mr Nicholl : No, it is not our table.
Senator BUSHBY: Maybe if I ask the question, and then if they need to they can take it on notice. I did ask what exactly is in that category. That is not your table so you cannot answer that.
Senator Wong: Of investments, loans and placements in the assets—
Mr Nicholl : In financial assets.
Senator BUSHBY: Primarily under assets.
Senator Wong: I am clear about that. Under Assets, subheading Financial Assets: Investments, Loans and Placements you want to know what that line item represents.
Senator BUSHBY: What does that $100 plus billion represent? Can we answer whether that includes the Commonwealth government's cash holdings at the RBA? Do we know that?
Senator Wong: I think from memory the discussion went to note 14 which also is referenced in the table, and there were Investments Deposits, IMF Quota and Other at note 14, and my recollection is Senator Cormann asked a question about what was included in Other.
Mr Nicholl : I think the RMBS line would be in Other, and our term deposits, as opposed to the balance in the official public accounts, would be under Investments Deposits.
Senator BUSHBY: Would the cash and the debt assets of the Future Fund be involved? You would not know that.
Senator Wong: Yes, this was asked, and I think it was of Finance, because the secretary said,—
Senator BUSHBY: I am aware that he was asked it.
Senator Wong: 'No' and then he said, 'Well, maybe.' So that has been taken on notice.
Senator BUSHBY: That is right, and they were not sure in Finance, as I understand it. I was not there, but as I understand it they were not sure.
Senator Wong: We will provide that on notice.
Senator BUSHBY: I am pretty confident the next one is the AOFM's, unless the officers have something to add from the discussion that they are currently having.
Mr Bath : What I said is correct, Senator.
Senator BUSHBY: Thank you. I refer to Budget Paper No. 1 again, page 10-9, Table 3, Net Interest Payments, which I am pretty sure is yours. I have some questions about how that works. I am looking at the trend in those over the forward estimates, and I appreciate that net interest payments can sometimes decline a little year from year because of the maturity relative to things coming off and things going on. They come off on different yield rates and go on on more attractive or less attractive rates, depending on when they mature. Indeed, as I understand it, that is what is likely to happen in 2013-14 where annual net interest payments are forecast to fall by around $400 million from $8.2 billion to $7.8 billion even as net debt is shooting up at that point. But in 2016-17 there is projected—
Senator Wong: I had better push back on the 'shooting up', given Australia's relatively low levels of debt. Do you want to do this at this time? I will tell you what, if you resist the urge to do talking points and just stick to the questions, I will resist the urge to push back on something which is simply economically untrue.
Senator BUSHBY: You are not suggesting shooting down at that point?
Senator Wong: I am suggesting that the continued scare campaign by the coalition about the nation's debt levels is contrary to the national interest and is untrue. Yes, I am suggesting that, so do you want to have that argument?
Senator BUSHBY: If you do not like the word 'shoot' then I will change that for 'even as net debt continues to rise' at that point. Is that more acceptable to you, Minister?
Senator Wong: Fine.
Senator BUSHBY: Thank you. Nevertheless in 2016-17 there is projected to be an extraordinarily large fall in the net interest payments relative to 2015-16 of just over $2 billion. I am little bit confused as to what might be behind that. It goes from 9.8 to 7.7 even though net debt is little changed between those two years. Indeed the headline budget position is actually still in deficit in 2016-17 as reported.
Senator Wong: Actually the net debt declines by 0.8 per cent of GDP, Senator, which is less than the increase for your so-called shooting up.
Senator BUSHBY: Is that going to account for a $2 billion change in interest payments.
Senator Wong: I am happy to take this on notice. There is a bond line issue that they can talk about.
Senator BUSHBY: That is excellent. That is what I was hoping.
Mr Bath : The maturity of an inflation linked bond in 2015-16 explains $1.7-odd billion of interest cost in that financial year. Essentially, the way inflation linked bonds work is that we pay a real coupon, an after inflation coupon, through the life of the bond, but the capital is protected from inflation. That accretes and accretes until its maturity, and that is realised at maturity. We have one of those maturities in 2015-16.
Senator BUSHBY: Is that the $16 billion one? The $17.198 billion?
Mr Bath : I am looking at 2015-16 and I am seeing a net interest payment of $9.752 billion. I am saying that around $1.7 billion of that $9.7 billion is capital accretion on an inflation linked bond maturing in August 2015.
Senator BUSHBY: I have a printout here from your web page headed, 'Benchmark Treasury fixed coupon bonds on issue at 30 April 2013' and it has coupon maturity dates on it. I cannot see one for August 2015.
Mr Bath : You might be looking in nominal bonds.
Senator BUSHBY: I assumed there was an answer to this.
Mr Nicholl : This is an inflation indexed bond we are talking about, which is different. As Mr Bath was explaining, the face value of the inflation indexed bond after it has been issued is adjusted by an inflation factor, and that capital accretion accumulates and is paid out at the maturity of the bond, but there is a coupon payment to the holder in the meantime. Then, when the bond matures, they get the face value back plus they get it back for inflation adjustment. So, there is a final coupon payment plus there is this capital accretion payment. That is why when we have an inflation index bond maturing in 2015, $1.7 billion of that 9.7 amounts to—
Senator BUSHBY: You take that out and you do not have the jump between.
Mr Nicholl : Yes, that is right, and then back to the $8 billion net of that maturity and net of that inflation accretion effect, so it is a capital effect.
Senator BUSHBY: The remainder of it would probably be explained by the fact that you do have a couple coming off the chart, which I did pull out, during that year and an assumption that you will be rewriting that at a lower level.
Mr Bath : Not necessarily, Senator. It is only Treasury index bonds that have that phenomenon where they have a one-off interest effect at maturity but based on the capital accretion. In other words nominal bonds, the vast majority of a program, do not have any capital accretion.
Senator BUSHBY: For example, on 15 June 2016 there is $16 billion that is currently issued at 4.75 per cent, which would need to be replaced, presumably, at that point. Would some of the change in your net interest payments be because you are assuming that it will be replaced at a different yield?
Mr Bath : Essentially. So we do not replace the bond at maturity by issuing $16 billion on the day it matures. We work out what the financing task is in net terms based on the budget. We add to that our maturities to get our gross financing task and we issue those bonds. The public debt interest cost estimates, part of the budget formulation process, makes assumptions about future interest rates and those future interest rates are typically below the historic yields on our bonds, which is why the market value of our bonds outstanding is essentially above their face value.
Senator BUSHBY: So, just to clarify that, you are assuming that over the forward years that the interest rates will be lower.
Mr Nicholl : Yes. If you look forward and assume that yields will be lower than coupon rates on the bonds that have been historically issued then all other things being equal your interest costs will all put the same value on your debt.
Senator BUSHBY: Very good.
CHAIR: Thank you very much, Mr Nicholl and Mr Bath, for your attendance this evening and your assistance. I now call on the Productivity Commission.