Part 2: Operations and Performance
- 1 Introduction
- 2 Treasury Bond and Treasury Indexed Bond issuance
- 2.1 Objective
- 2.2 Achieving the objective
- 2.3 Performance
- 3 Cash management
- 4 Minimising debt servicing costs subject to acceptable risk
- 5 Residential mortgage‑backed securities
- 6 Investor Relations
- 7 Public Register of Government Borrowing
- 8 Information technology operations
- 9 Operational risk
- 10 Settlement operations
- 11 Agency financial performance
- 12 Cooperation with other debt managers
The principal functions of the AOFM are:
- issuance of Commonwealth Government Securities (CGS) to support the Commonwealth’s financing task (including debt maturities) and in accordance with broader Government policy objectives (such as promoting liquidity);
- managing the Government’s daily cash balances through short-term borrowings and investments;
- undertaking investments in financial assets according to policy directives, or as part of broader portfolio management;
- developing risk assessments that support the effective cost management of the debt and asset portfolios; and
- where appropriate, supporting the efficient operation of the Australian financial system.
This section outlines the activities undertaken in 2012-13 and reports on AOFM performance against these functions.
Treasury Bond and Treasury Indexed Bond issuance
One objective of Treasury Bond and Treasury Indexed Bond issuance is to raise monies in order to meet the Commonwealth’s financing needs in full and on time.
Another objective is to support the efficient ongoing operation of Australia’s financial system. This second objective is achieved in the following ways:
- Treasury Bonds, Treasury Indexed Bonds, and Treasury Bond futures are used by financial market participants as benchmarks for the pricing of other capital market instruments and to manage interest rate risk; and
- the existence of active and efficient physical and futures markets for sovereign debt strengthens the robustness of the financial system and reduces its vulnerability to shocks.
Achieving the objective
This year’s debt issuance task occurred against the backdrop of noticeably improved global financial market sentiment. The task was similar in magnitude to that of the previous three years and was comfortably absorbed. The length of the yield curve was consolidated at fifteen years, and liquidity was built in existing lines.
In 2012-13 the RBA reduced the target cash rate by 75 basis points. Bond yields rose slightly but remained near historic low levels. Improvement in investor sentiment and risk appetite resulted in the difference in yields between CGS and other Australian dollar denominated debt securities contracting.
During the year an increase of $10 billion of Treasury Bond issuance as a substitute for Treasury Notes on issue was announced. An impact of this switch will be to reduce the exposure to refinancing risk associated with short-term funding. It will also have the impact of lengthening the weighted average duration of the AOFM’s debt portfolio as a whole.
Offshore demand for CGS remained strong. Investors are familiar with the Australian economy and the Government’s fiscal position. They were encouraged by the Commonwealth’s AAA credit rating with a stable outlook (from all three major credit rating agencies), and by the high yields relative to those available on other sovereign securities globally.
Non-resident holdings of CGS were around 70 per cent of the total outstanding during 2012-13. The proportion of CGS held by offshore investors has been relatively steady during recent years, as illustrated in Chart 1.
Gross Treasury Bond issuance for the year totalled approximately $54 billion. The bulk of issuance was into existing bond lines in order to enhance liquidity and in turn the attractiveness of the CGS market. This is particularly important to international investors.
Two new Treasury Bond lines were launched in 2012‑13 as follows:
- to maintain the length of the yield curve at around 15 years, a new April 2029 bond line was issued; and
- a new bond line with a maturity date in April 2025 was opened in order to support the operation of the 10‑year Treasury Bond futures contracts.
In selecting the bond lines to issue each week, the AOFM took account of prevailing market conditions; information from financial market contacts about investor demand; relative value considerations; the aim of increasing the liquidity of existing bond lines; the need to manage the maturity structure to limit refinancing risk; and having bonds on issue that support efficient operation of the Treasury Bond futures contracts. Two tenders were held most weeks, typically comprising a tender of a longer‑dated bond line and a tender of a shorter‑dated bond line, with the amount being offered at each tender in the range $500 million to $1 billion.
Chart 2 shows Treasury Bonds outstanding as at 30 June 2013 and issuance during the 2012‑13 financial year.
During the year the total volume of Treasury Bonds on issue increased by around $28 billion, to $234 billion. At the end of the year there were 13 Treasury Bond lines with over $10 billion on issue.
Treasury Indexed Bonds
Treasury Indexed Bond issuance for the year totalled $2.25 billion.
Tenders for the issue of Treasury Indexed Bonds were generally conducted on a monthly basis. The volume of each line outstanding, relative yields and other prevailing market conditions were all considered in the selection of which line to offer in any month.
Chart 3 shows Treasury Indexed Bonds outstanding as at 30 June 2013 and issuance during the 2012‑13 financial year.
Aussie Infrastructure Bonds
The Government’s investment in NBN Co, the builder and operator of the National Broadband Network, is partly funded through issuance of Aussie Infrastructure Bonds (AIBs).
This funding is obtained through the issuance of CGS as part of the Government’s overall debt program. AIBs are not identified separately from other CGS at the time of issue, but amounts of AIB funding are reported separately in the Budget papers.
Of the Government’s $2.4 billion equity investment in the National Broadband Network in 2012‑13, $2.0 billion was financed through the AIB process.
Securities Exchange Trading of CGS
On 12 December 2010 the Government, as part of its Competitive and Sustainable Banking System package, announced that it would facilitate the trading of CGS on a retail exchange platform in Australia.
Trading of Treasury Bonds and Treasury Indexed Bonds on the Australian Securities Exchange commenced on 21 May 2013. The trading of CGS on a securities exchange will help to provide retail investors with a more visible pricing benchmark for investments they may wish to make in corporate bonds issued by Australian businesses, and facilitate retail investor diversification with investments into fixed income assets, such as government and corporate bonds.
Domestic debt registry services
During the year debt registry services were procured to support the securities exchange trading of CGS and to replace the current domestic debt registry service provided by the RBA. Work on transitioning the current domestic debt registry service to the new service provider is expected to be completed by the end of 2013.
Funding the Budget
The Commonwealth’s financing requirement in 2012‑13 was fully met.
The underlying cash deficit for 2012‑13 was higher than estimated at the time of the 2012‑13 Budget; this was principally due to lower than forecast receipts. Weaker corporate profitability had a significant impact on the level of company tax receipts while capital gains tax and resource rent taxes were also significantly lower than originally forecast (as explained in the 2013‑14 Budget). The larger than expected budget financing task was managed primarily by increasing Treasury Bond issuance.
Market liquidity and efficiency
The Treasury Bond and Treasury Indexed Bond markets operated smoothly throughout 2012‑13 with liquidity again being maintained throughout the year.
One indicator of liquidity is turnover in the secondary market. Charts 4 and 5 show the evolution of total secondary market turnover1 from July 2008 through to June 2013. Turnover steadily increased over the period and was around $280 billion per month in 2012‑13 for Treasury Bonds (14 per cent higher turnover than in 2011‑12) and $19 billion per month for Treasury Indexed Bonds (19 per cent higher than in 2011‑12).
Turnover in the Treasury Bond futures market is significantly higher than in the underlying Treasury Bonds. The 3‑year Treasury Bond futures contract is amongst the ten most traded interest rate futures products in the world.2 Treasury Bond futures continued to display strong liquidity in 2012‑13 with the turnover of 3‑year Treasury Bond futures contracts increasing by 9 per cent over the previous year and turnover of the 10‑year contracts increasing by 23 per cent. Turnover in recent years is illustrated in Chart 6. All Treasury Bond futures contract close‑outs in 2012‑13 occurred smoothly.
The AOFM’s securities lending facility allows market participants to borrow Treasury Bonds and Treasury Indexed Bonds for short periods when they are not otherwise available. This enhances the efficiency of the market by improving the capacity of intermediaries to make two‑way prices and reduces the risk of settlement failures.
Less volatile market conditions during the year resulted in less use of the securities lending facility than during the previous year. The facility was used 14 times for overnight borrowing in 2012‑13 compared with 66 instances of use in 2011‑12. The face value amount lent was around $0.2 billion compared to $1.5 billion in 2011‑12.
Efficiency of issuance
The AOFM continued to use competitive tender and syndication as the only means by which issuance of CGS was undertaken in 2012‑13.
Tenders held during 2012‑13 were well supported. Table 1 summarises the results of Treasury Bond tenders conducted during the year. The results are shown as averages for each half‑year and grouped by the maturity dates of the bonds offered.
|Period||Maturity||Face value amount allocated ($m)||Weighted average issue yield (%)||Average spread to secondary market yield (basis points)||Average times covered|
|July – December 2012||Up to 2018||10,300||2.6604||-0.32||4.96|
|January – June 2013||Up to 2018||10,000||2.8196||-0.17||4.15|
The average ratio of the volume of bids received to the amount of stock on offer was 3.99 for Treasury Bonds in 2012‑13, an increase from 3.02 in 2011‑12. No tenders had a coverage ratio less than two, compared to six tenders in 2011‑12. Shorter‑dated bond tenders generally received a greater volume of bids.
The strength of bidding at tenders was also reflected in the issue yield spreads to the secondary market. At most Treasury Bond tenders, the weighted average issue yields obtained were below prevailing secondary market yields.
The average ratio of the volume of bids received to the amount of stock on offer was 3.43 for Treasury Indexed Bonds in 2012‑13, a decrease from 3.47 in 2011‑12. At most tenders the weighted average issue yields were above prevailing secondary market yields.
Full tender details are given in Part 5 of this annual report.
The AOFM manages the daily cash balances of the Australian Government in the Official Public Account (OPA).3 The AOFM’s primary objective in managing these balances is to ensure that the Commonwealth is able to meet its financial obligations as and when they fall due. The most efficient means by which to achieve this is through minimising the cost of funding the daily cash balances and investing excess cash balances in a low risk manner. In minimising cost the AOFM seeks to avoid any use of the overdraft facility provided by the RBA.4
Achieving the objective
Achieving the cash management objective involves undertaking appropriate short‑term investments and debt issuance.
Cash balances not required immediately were invested in term deposits at the RBA, with the magnitudes and tenors of the term deposits determined by the AOFM.5 Maturity dates of term deposits were selected to match the financing of large outlays. Interest rates for term deposits at the RBA reflect the rates earned by the RBA in their open market operations.
Borrowing to support the cash management task is undertaken by the issuance of Treasury Notes. The volume of Treasury Notes on issue ranged from $5.5 billion to $25.0 billion during 2012‑13.
The size and volatility of the within‑year funding requirement are indicated by changes in the short‑term financial asset holdings managed by the AOFM, after deducting Treasury Notes on issue. Chart 7 shows the movement in the funding requirement in 2012‑13.
The objective of meeting the Commonwealth’s financial obligations as and when they fall due was met without use of the overdraft facility provided by the RBA.
During 2012‑13 the AOFM placed 333 term deposits with the RBA. The stock of term deposits fluctuated from a minimum of $4.0 billion in February 2013 to a maximum of $34.4 billion in May 2013.
- The average yield obtained on term deposits during 2012‑13 was 3.11 per cent, compared with 4.24 per cent in 2011‑12. The decrease in average yield reflects the lower average level of interest rates that prevailed during 2012‑13.
A total of $53.5 billion of Treasury Notes were issued in 2012‑13 (in face value terms). The tenders were well supported with an average coverage ratio of 5.28. Yields averaged around 14 basis points less than bank bill yields of corresponding maturities (compared to 32 basis points less than bank bill yields in 2011‑12). Yields were on average two basis points higher than Overnight Indexed Swap rates for corresponding tenors. Further details are presented in Part 5 of this report.
The movement in total short‑term financial asset holdings managed by the AOFM (OPA cash balance plus term deposits with the RBA), together with the volume of Treasury Notes on issue, during 2012‑13 are shown in Chart 8.
In undertaking its cash management activities, the AOFM is required to maintain the 91‑day moving average of the daily OPA cash balance within operational limits. In 2012‑13 these limits were the same as applied in recent years, with operational upper and lower limits of $1,000 million and $500 million respectively. There is also a Ministerially approved upper limit of $1.5 billion.
The 91‑day moving average OPA cash balance was maintained within operational limits, and within the Ministerial limit, throughout the year.
Movements in the 91‑day moving average OPA cash balance over the year are shown in Chart 9.
Minimising debt servicing costs subject to acceptable risk
In managing the Commonwealth’s debt portfolio, the AOFM seeks to minimise debt servicing costs over the medium term at an acceptable level of risk, by which is meant an acceptable level of variability in cost outcomes. It also seeks to maintain liquid bond lines to facilitate the issuance of debt at acceptable cost and to manage the refinancing risk that arises when bond lines mature, while also managing the impact of its issuance on the CGS market.
In order to meet its objective, the AOFM uses cost and risk measures that appropriately reflect the costs and risks faced by a sovereign debt manager. The primary cost measure used is historic accrual debt service cost. This includes interest payments made on CGS, realised market value gains and losses, capital indexation of indexed debt and the amortisation of any issuance premiums and discounts. Total accrual debt service cost can be expressed as a percentage of the stock of debt outstanding, to provide the effective yield of the portfolio. This measure of cost is the most appropriate in circumstances where financial assets and liabilities are intended to be held, or in the AOFM’s case, to remain on issue until maturity. The use of an historical accrual debt service cost measure excludes unrealised market value gains and losses.
An alternative measure of cost is ‘fair value’, which takes account of unrealised gains and losses resulting from movements in the market value of physical debt and assets. Debt service cost outcomes are presented in the AOFM’s financial statements on this basis. A comprehensive income format is used that allows revenues and expenses on an historic basis to be distinguished from the effects of unrealised market value fluctuations, that is ‘re‑measurements’. Fair value is useful in circumstances where it is possible that changes in market value may be realised in the future.
Variability in cost outcomes, or risk, can be measured in several ways. The AOFM calculates and compares several metrics to assess risk. In general, an acceptable level of risk can be characterised as an acceptable level of variation in cost outcomes over time. Debt issuance decisions made today have an impact on the variability of future cost outcomes because of their influence on the maturity profile of the portfolio and hence the amount of debt that needs to be refinanced and therefore ‘re‑priced’ through time.
Achieving the objective
The AOFM influences the cost and risk profile of the portfolio primarily through its decision making on the composition and maturity structure of the debt securities it issues. These decisions are framed through an annual debt issuance strategy approved by the Treasurer, which identifies the overall scale of the issuance task and its breakdown into different instrument classes. Within these broad strategy parameters approved by the Treasurer, the AOFM separately determines issuance weightings (specified as a range) applicable to different segments of the yield curve which are approved by the AOFM Chief Executive. Operational issuance decisions such as determining if, when, how much and what lines to issue each week, are made by the AOFM over the course of the year and are influenced by a range of factors including general market conditions, relative value considerations and feedback from investors. It is the AOFM’s standard practice to regularly test the ongoing suitability of its overarching strategy with the AOFM Advisory Board which is chaired by the Secretary to the Treasury.
Strategic decision making around the portfolio is supported by an ongoing research program focussed on exploring the cost and risk characteristics of alternative portfolio structures and issuance strategies. Informed by this research, the AOFM entered 2012‑13 with the intention of continuing the lengthening trend established in the debt portfolio since the latter half of 2010‑11. This stance reflected, among other things, the AOFM’s judgement that portfolio risks could be cost effectively reduced in the prevailing environment. The cost effectiveness of this strategy was underpinned by a continuation of historically low outright bond yields, which meant that the AOFM could continue reducing its overall cost of funds in percentage terms, and with a CGS investor community that was positively predisposed towards the issuance of longer‑dated securities. A key enabler for the lengthening strategy has been the extension of the CGS yield curve from 11‑12 years to 15‑16 years, commencing with the launch of the April 2027 line in October 2011 and followed up with the launch of the April 2029 line in October 2012.
Chart 10 reveals that the AOFM ultimately allocated around 60 per cent of 2012‑13 Treasury Bond issuance into lines that were either basket stocks underpinning the 10 year Treasury Bond futures contract or had even longer maturities. This boosted the average tenor of issuance in 2012‑13 by one and a half years to nearly nine years, a level more than three years higher than the post global financial crisis low recorded in 2009‑10. Chart 11 shows that this lengthening underpinned a 0.5 year increase in the weighted average term to maturity of the Treasury Bond portfolio to 5.7 years. The modified duration of the portfolio also increased, but by a more muted 0.2 years to 4.7 years. This more muted increase was a result of a general sell‑off in bond yields towards the end of the financial year, triggered by statements from the US Federal Reserve that it would consider ‘tapering’ its program of quantitative easing.
The strategy of lengthening the portfolio has had a beneficial effect on the level of risk in the debt portfolio. Variability and uncertainty surrounding future debt servicing cost outcomes are expected to be lower by virtue of having locked in a greater proportion of the AOFM’s funding base for an extended period. Similarly, the strategy of lengthening has contributed to a general flattening of the distribution of maturities across the yield curve resulting in a more easily managed refinancing profile. Indeed one of the catalysts for the AOFM’s lengthening strategy was a build up in short to medium term maturities in the portfolio that occurred in the aftermath of the global financial crisis that had skewed refinancing risks towards the front half of the yield curve.6 Chart 12 highlights how these risks have been progressively declining in the period since June 2010.
The AOFM’s alternative long‑term funding instrument to Treasury Bonds is Treasury Indexed Bonds. Indexed bonds, whose capital value is adjusted periodically with changes in the Consumer Price Index, typically attract a different class of investor to nominal bonds and are a source of diversification in the AOFM’s funding base. The AOFM re‑commenced issuance of indexed bonds in 2009‑10 following an extended period of absence from this segment of the market and has issued regularly in the period since. The AOFM is guided in its strategic decision making on indexed bonds by the 10 to 15 per cent target share announced by the Australian Government in May 2011.7 Despite growing the stock of indexed bonds on issue in the period since, Chart 13 shows that their share has declined to around 9.2 per cent due to relative growth in the stock of nominal bonds outstripping growth in indexed bonds (with the bulk of upwardly revised financing tasks necessarily met through the issuance of Treasury Bonds).
Reducing debt servicing cost at an acceptable level of risk
The debt servicing cost8 of gross debt managed by the AOFM in 2012‑13 was $12.23 billion. This represented a cost of funds of 4.58 per cent for the period. Table 2 provides further details of the cost outcomes for the combined portfolio by instrument and portfolio for 2011‑12 and 2012‑13.
Debt servicing costs on gross debt increased by $804 million compared with the previous year. This was largely due to an increase in the average volume of debt on issue from $225.07 billion to $266.65 billion in 2012‑13. The return on gross assets for the period was $843 million, a reduction of $569 million compared to 2011‑12. This fall in the return on gross assets can be attributed to two factors. Firstly, lower interest rates over the course of the year reduced returns on term deposits and RMBS. Returns on term deposits were down $87 million to $500 million, despite the AOFM holding a higher average balance compared to 2011‑12, while RMBS investment earnings fell $159 million. The second factor was the Government’s decision to waive $320 million (face value) in state housing advances.9 This debt waiver offset around $149 million of interest receipts to produce a negative net return of $135 million on this asset class.
Expressed on an effective yield basis, funding costs in 2012‑13 for gross CGS debt fell 49 basis points to 4.58 per cent. This improvement was principally driven by the issuance of new Treasury Bonds through the year at yields that were substantially below the average of pre‑existing debt. Falling rates also reduced the yield on funds invested in term deposits from 4.24 to 3.11 per cent and RMBS investments from 5.80 to 4.62 per cent.
Taken together, the net servicing cost of the combined portfolio of debt and assets was $11.38 billion, with an effective yield of 4.79 per cent. The corresponding figures for 2011‑12 were $10.01 billion and 5.08 per cent, respectively.
To summarise, an increase in the overall volume of debt generated a larger net interest cost in 2012‑13 in dollar terms. However, the effective cost of funds on the portfolio as a whole decreased in percentage terms, due to the beneficial effect of having issued new debt into the low interest rate environment that prevailed through 2012‑13. The improvement in the percentage cost of funds was more pronounced for gross debt than for net debt due to the lower returns recorded on floating rate RMBS holdings and term deposits, combined with the effect of the waiver of some state housing advances.
|Interest expense||Book volume||Effective yield|
|Contribution by instrument|
|Treasury fixed coupon bonds||(9,642)||(10,570)||(192,038)||(228,365)||5.02||4.63|
|Treasury inflation indexed bonds||(1,215)||(1,174)||(19,868)||(22,872)||6.12||5.13|
|Repurchase agreements (a)||–||–||–||–||0.00||0.00|
|Foreign loans (b)||(0)||(1)||(5)||(5)||8.49||18.44|
|Gross physical CGS debt||(11,421)||(12,225)||(225,072)||(266,654)||5.07||4.58|
|Term deposits with the RBA||587||500||13,842||16,060||4.24||3.11|
|Investments in bank paper||96||34||–||680||4.97||0.00|
|Term investments (c)||–||–||–||–||0.00||0.00|
|State Housing Advances||154||(135)||2,620||2,532||5.86||-5.32|
|Net CGS debt||(10,009)||(11,383)||(196,952)||(237,717)||5.08||4.79|
|Contribution by portfolio|
|Long Term Debt Portfolio||(10,856)||(11,745)||(211,911)||(251,243)||5.12||4.67|
|Cash Management Portfolio||57||19||1,361||649||4.18||2.89|
|State Housing Portfolio||154||(135)||2,620||2,532||5.86||-5.32|
|Total debt and assets||(10,009)||(11,383)||(196,952)||(237,717)||5.08||4.79|
|Total after re-measurements||(30,575)||285||(196,952)||(237,717)|
Note: Sub totals and totals are actual sum results, rounded to the nearest million dollars. Effective yields are based on actual results before rounding, and then rounded to two decimal places. Book volume is a through the year average.
- Repurchase agreements using investments in State and Territory government bonds as collateral.
- Interest expense and effective yield on foreign loans incorporates foreign exchange revaluation effects.
- Investments in State and Territory government bonds.
- Re‑measurements refer to unrealised gains and losses from changes in the market valuation of financial assets and liabilities.
Movements in market interest rates had a favourable impact on the market value of the portfolio in 2012‑13, with unrealised or ‘mark to market’ gains from re‑measurements amounting to $11.67 billion. This re‑measurement gain was primarily driven by a $11.50 billion reduction in the value of CGS debt10 resulting from a year on year increase in the level of market interest rates. This was complimented by a gain of around $170 million on the RMBS portfolio which benefitted from a general contraction in credit spreads.11The re‑measurement effect is significantly more pronounced on CGS debt due to their much larger size and longer average duration. Because re‑measurement items are highly volatile from one year to the next,12 they generally have no bearing on the AOFM’s debt issuance strategy. Indeed, were the AOFM to adopt a strategy designed to minimise the ‘noise’ from re‑measurements, issuance would be limited to only very short‑term debt securities, for example Treasury Notes, creating a portfolio structure that would maximise expected variability in debt servicing costs when measured in cash, accrual and public debt interest terms while also maximising exposure to refinancing risk. In practice, the AOFM has been seeking to reduce refinancing risk, as evidenced in its October 2012 announcement that it planned to reduce its ongoing reliance on Treasury Note issuance by $10 billion.13
Residential mortgage‑backed securities
The Australian residential mortgage‑backed securities (RMBS) market is acknowledged as a critical source of funding for smaller mortgage lenders. The global financial crisis that started in 2007‑08 reduced the availability of funding through the Australian RMBS market, which limited mortgage lenders’ access to funding and in turn their ability to offer competitive mortgage products.
In response, the Government decided to invest in Australian RMBS to support competition in lending for housing during the market dislocation. In October 2008 the Treasurer directed the AOFM to invest up to $8 billion in eligible RMBS, of which up to $4 billion was to be invested in deals with sponsors that were not ADIs (Authorised Deposit‑taking Institutions). In November 2009 the Treasurer extended the program by directing the AOFM to invest up to a further $8 billion in RMBS. This Direction also extended the objectives of the program to include supporting small business lending, through broadening the potential use of funds raised under the program.
In December 2010 the Treasurer announced, as part of the Competitive and Sustainable Banking System package, a further extension of the program. The subsequent Direction, issued in April 2011, directed the AOFM to invest up to an additional $4 billion and thus a cumulative total of up to $20 billion in RMBS. Importantly, this direction also identified the need to encourage a transition towards a market not reliant on Government support.
In April 2013, the Treasurer directed the AOFM to cease investment in new RMBS. This Direction continues to allow the AOFM to consider sale opportunities. Accordingly, the AOFM stopped investing in RMBS on the 10th of April 2013, and is now managing the existing portfolio to maturity and may sell to assist with price discovery or to adjust the portfolio in line with the Directions.14
Achieving the objective
RMBS market conditions and developments in the program
The Australian RMBS market enjoyed relatively buoyant conditions in 2012‑13 with improved investor demand and economic sentiment resulting in good issuance volumes and tighter spreads. In fact, spreads reached their tightest levels since the AOFM investment program commenced in late 2008. The benchmark for this sector is the AAA senior tranche with a weighted average life of around three years which tightened as far as 88 basis points from the lows of 100 basis points seen previously. Mezzanine and junior tranches also tightened significantly over the year resulting in securitisation offering a more competitive funding option for mortgage lenders.
Contemporaneously, and in light of this healthy pace of issuance, the market demonstrated a reduced reliance on Government support. The AOFM received fewer submissions for support and was repeatedly and consistently scaled out of transactions through the year.
In 2012‑13, the AOFM was prepared to invest in seven RMBS transactions from six issuers and only invested $160 million across two transactions from two issuers due to strong demand from other investors. The seven transactions the AOFM was prepared to invest in sourced $4.8 billion in funding. In addition, a further 16 transactions totalling $14.6 billion were completed, bringing total prime RMBS issuance to $19.4 billion this financial year.
This implies a $6.2 billion (47 per cent) increase in total issuance from the previous year. However, when making this comparison, we need to note that RMBS issuance in 2011‑12 was impacted by the introduction of covered bonds.
In any case, activity this year is partly explained by the major banks returning to RMBS issuance having established their covered bond programs, but it reflects more the growth in issuance from other financial institutions including new issuers. Table 3 provides a summary of market activity to date.
|Year||AOFM Investment||Total Issuance in AOFM Supported Transactions||Other Issuance||Total Issuance|
Since the inception of the program, the AOFM has invested $15.5 billion in support of 67 transactions from 20 issuers. Amortisation of $5.7 billion, coupled with $0.6 billion in sales, left $9.1 billion outstanding by the end of this financial year. Table 4 details the AOFM’s investment activity and portfolio holdings by sponsor.
|Total Investment||Number of deals||Outstanding|
|Programme||Sponsor||Amount ($m)||%||Amount ($m)||%|
|Torrens||Bendigo and Adelaide Bank||1,922||12.4||6||1,329||14.6|
|Reds||Bank of Queensland||1,248||8.1||3||876||9.6|
|IDOL||ING Bang (Australia)||853||5.5||5||449||4.9|
|Light Trust||People’s Choice Credit Union||434||2.8||3||296||3.3|
|WB||Wide Bay Australia||404||2.6||2||257||2.8|
|GBS||Greater Building Society||190||1.2||1||100||1.1|
|Pinnacle||Police & Nurses||111||0.7||1||111||1.2|
|Barton||Community CPS Australia||91||0.6||1||91||1.0|
Chart 14 summarises the participation of AOFM and other investors in the wider spectrum of Australian prime RMBS issues since the inception of the program. Participation from other investors averaged 23 per cent of total market activity from inception until the end of June 2009, and has gradually grown from 81 per cent in 2009‑10, 82 per cent in 2010‑11, 85 per cent in 2011‑12 to 99 per cent this financial year.
During the year, the AOFM also completed a number of sales.15 Either full or partial interest across seven lines were sold to various market participants at a tighter margin than at purchase, resulting in further incremental profit for the Government. These sales enabled the AOFM to adjust its holdings and provide secondary market pricing transparency.
The funds raised by the RMBS issues supported by the AOFM have provided an important component of total lending for housing and small business since the inception of the program. Without this funding, new lending by the financial institutions supported would have been lower and would have impacted the extent of competition in the market.
The investments made under the program continue to provide reasonable financial returns. Interest income in 2012‑13 was $472.6 million. In addition, sales through the year contributed a further $5.3 million in incremental income. Total income of $478 million represented an annualised return of 4.62 per cent on the average portfolio book value of $10.3 billion. The average margin over the one month bank bill rate (weighted by each of AOFM’s investments) for the book outstanding as at 30 June 2013 remained around 133 basis points. Capital repayments as at the end of the year totalled $6.4 billion.16
The RMBS securities held by the AOFM are valued using indicative margins for secondary market trading as estimated by an independent valuation service provider. Furthermore, market bid rates are used for these purposes. Accordingly, the RMBS portfolio was valued at $9.1 billion as at 30 June 2013, implying an unrealised gain of $17 million (or 0.19 per cent of the portfolio book value). This represents an improvement in the value of the portfolio of around $170 million for the year. Losses or gains in the mark‑to‑market value of the portfolio change with prevailing conditions and therefore vary at any particular point in time. They are not realised losses or gains, but are referred to as re‑measurements.
Further information on the AOFM’s investments in RMBS up to 30 June 2013 is available in Part 5 of this annual report.
Investor Relations activities focused on supporting smooth debt issuance through regular and consistent communication with investors. This was done through a range of investor engagements such as one‑on‑one meetings, presentations and group discussions. Regular investor focused activities allows for new investors to become aware of, and current investors to remain up‑to‑date on, the main influences underlying CGS issuance and developments in the CGS market more generally.
One of AOFM’s main objectives has been to encourage diversity in the investor base via the entry of new investors with differing investment mandates, while maintaining relationships with strategically important investors. Diversity is obtained through a spread of investors over geography, sector, product and investment policies or mandates. A wide diversity of investors reduces the risk of large simultaneous moves in the demand for or (secondary market) sale of CGS. This facilitates the maintenance of a liquid and orderly market, whilst also contributing to the AOFM achieving a lower cost of borrowing.
Non‑resident holdings of Australian Government Bonds (Treasury Bonds and Treasury Indexed Bonds combined) reached a peak in the March 2012 quarter of 78.3 per cent. Non‑resident holdings as a proportion began falling in the next quarter and continued falling through the year with the amount being held at the end of June 2013 standing at 69.4 per cent. This was widely reported in financial market commentary and was ascribed to a number of causes including selling by Japanese retail investors,17 the historically low level of interest rates, the rapid fall in the AUD (later in the year) and supposed broader slowdown in demand by offshore investors particularly the offshore public sector. All of these events influenced the slowdown in non‑resident demand, and in some cases contributed to outright selling, but most often the situation was more complex than what might otherwise appear to be the case from only examining the headline proportion of non‑resident holdings.
What tended to attract less attention was that the non‑resident proportion reported each quarter was based upon market values. Thus, changes in the proportion of non‑resident ownership could be affected by changes in the price of the bonds trading in the market, as well as changes due to net transactions (buying less selling plus the effect of any maturities). Indeed, 5 of the last 6 quarters (from March 2012 to June 2013) exhibited negative price changes that resulted in the reported overall market value of non‑resident holdings being lower than what it might have otherwise been, as shown in Chart 15. Over that same period, there was only one quarter that net transactions were negative, which was related to proceeds of a bond maturity not being fully reinvested in the market soon thereafter. The actual value of Australian Government Bonds held by offshore investors based on market values has risen by around $2.1 billion since March 2012.
It was widely reported that Japanese investors were active in 2012‑13 and were large sellers of overseas assets, particularly AUD bonds (including Treasury Bonds and Treasury Indexed Bonds). This occurred from around December 2012 through to about April 2013. Given the relatively small decline in non‑resident holdings of Australian Government Bonds over this period, it would suggest there was still considerable offshore buying from other regions, resulting in a take‑up of much of the stock released to the secondary market from Japan. It would also appear domestic investors were taking an increasingly larger position in CGS.
As non‑resident investors still account for the largest holdings of CGS and as a group remain substantially the greatest source of potential new buyers with which to diversify the investor base, the AOFM predominantly focused its investor relations activities offshore.
Consequently, the during 2012‑13 the AOFM undertook or attended 8 overseas investor road shows or conferences. Throughout the year, the AOFM participated in slightly fewer events (presentations, speeches, investor road shows) than last year, with the 2012‑13 total being some 14. The AOFM, however, still engaged with a similar total audience size, being around six hundred.
About the same number of face to face meetings were attended (two more this year) and slightly more cities were visited than was the case in 2011‑12. CGS market makers were again essential in setting up meetings and assisting with the considerable logistics of the road shows. This year nine different banks were used.
With a focus on further diversification of the investor base, a substantial number of investors were met for the first time. This involved the AOFM travelling to some new regions for the first time (Canada and the Middle East) or returning to some regions not visited for a few years (South America). From these and other meetings, around two thirds of all meetings were with first time contacts. From the offshore meetings with public sector institutions, 20 out of the 35 were with entities that had not been previously met; of the private sector investor meetings (predominantly offshore) just over 70 per cent of the 63 meetings were with investors being met for the first time.
|Conferences, speaking engagements and investor meetings||14 events.|
|Approximate total audience size||600 attendees.|
|Individual meetings||98 investor meetings. (63 Private Sector and 35 Public Sector)|
|Hosted roundtable/small presentations||4 presentations with 24 investors.|
|Individual cities visited||28 cities.|
|Two AOFM staff members travel on each overseas trip||CEO, Head of Investor Relations, Director of Financial Risk, Senior Analyst from Investor Relations.|
|Hosting banks||ANZ, Bank of America Merrill Lynch, Barclays, Citi, Commonwealth Bank of Australia, Deutsche Bank, Royal Bank of Canada, UBS, Westpac.|
The AOFM also undertook a number of other activities throughout the year. In September 2012 this included a two page article published in the annual Australian supplement of Finance Asia magazine on the persistence in offshore demand for CGS.
The AOFM was also largely responsible for creating, designing and launching the new Australian Government Bond web page. This standalone website was especially created for retail investors looking to seek information on Exchange‑traded Government Bonds, which began trading on the ASX on the 21st May 2013. Investor information statements for both the Exchange‑traded Treasury Bonds and Exchange‑traded Treasury Indexed Bonds were also created and printed.
|July 2012||North Asia: 13 meetings, 1 luncheon presentation with 3 investors.|
|September 2012||Canada: 10 investor meetings, Central Bank Conference, 1 presentation with 80 investors.|
|October 2012||Sydney: Fixed Income Conference, 1 presentation with 80 investors.
France/United Kingdom: 13 investor meetings.
|December 2012||Japan: 18 investor meetings.
Canberra: 1 investor meeting.
|January 2013||OECD meeting of sovereign debt managers in France.
North Africa: 3 investor meetings.
|February 2013||Sydney: 2 investor meetings.
Sydney: Inflation Roundtable with 8 investors.
|March 2013||Sydney: 1 presentation with 3 investors.
Canberra: Investor Mission, 1 presentation with 30 investors.
|April 2013||India and Middle East: 13 investor meetings.
Sydney: 3 investor meetings.
|May 2013||South America and Mexico: 18 investor meetings, 1 presentation with 30 investors.|
|June 2013||Sydney: Australian Business Economists luncheon, CEO keynote speaker.
Switzerland: Central Bank Conference, 1 panel discussion with 100 investors, 2 investor meetings, 1 luncheon presentation with 10 investors.
Sydney: CEO Speech at the Asiamoney Annual Awards.
Public Register of Government Borrowing
The Guarantee of State and Territory Borrowing Appropriation Act 2009 requires the AOFM to establish and publish a register recording the beneficial ownership, by country, of all CGS and any Australian State or Territory government securities guaranteed by the Commonwealth.
The Act does not contain any mechanisms to compel the provision of information to the AOFM by the beneficial owners of these securities or persons holding these securities on their behalf. In the absence of a legal or regulatory compulsion to do so, nominee and custodial services firms have not provided information to AOFM due to their fiduciary and contractual obligations to clients. Many investors wish for their holdings to remain confidential for valid commercial reasons.
This has limited the information available to the AOFM to form an opinion on the extent of beneficial ownership of the securities. Without detail on the country of beneficial ownership, information on the holdings of nominee/custodial firms alone provides a very limited indicator of ‘offshore’ CGS ownership.
During 2012‑13, the AOFM published the register each quarter and following the latest update the register contains monthly data up to 30 June 2013. The register indicates that around $282.7 billion of CGS, together with State and Territory securities guaranteed by the Commonwealth, were on issue at year end. Country of ownership could be identified for $92.9 billion or 32.8 per cent, of which $48.0 billion was identified as Australian and $44.8 billion was recorded as held offshore. Country of beneficial ownership could not be identified for around $189.9 billion or 67.2 per cent. Most of this unidentified component was held by nominee/custodial firms.
The Australian Bureau of Statistics (ABS) also collects and publishes information on the holdings of securities. The legal powers provided to the Australian Statistician enable the ABS to obtain information from nominee/custodial firms on security holdings, however, there are also set confidentiality requirements that can constrain how and to what extent the ABS publishes such information at the country specific level.
The quarterly ABS publication 5302.0 Balance of Payments and International Investment Position, Australia indicates that 68.8 per cent of Commonwealth Government Securities were held by non‑residents as at June 2013.18
The annual ABS publication 5352.0 International Investment Position, Australia provides information on the country of domicile for portfolio investment in debt securities. This information covers a broader range of debt securities, issued in Australia and overseas, than that covered by the AOFM register (that is State and Territory securities not guaranteed by the Commonwealth, as well as debt securities issued by financial intermediaries such as banks and those issued by companies).
The publication estimates that there was $884.7 billion of this foreign portfolio investment in debt securities at 31 December 2012. The survey indicated the country of investor domicile breakdown as: the United States, $231.7 billion; United Kingdom, $154.1 billion; Japan, $53.2 billion; Luxembourg, $20.4 billion; Switzerland, $14.7 billion; Hong Kong, $10.9 billion; Singapore, $9.7 billion; Canada, $4.7 billion; Germany, $2.6 billion; New Zealand, $2.4 billion; Netherlands, $1.7 billion; France, $1.5 billion; and Austria, $0.9 billion. The remainder of holdings were attributed to international bond markets, were unspecified, or were not published for confidentiality reasons.
Information technology operations
The AOFM upgraded its storage and data management systems during 2012‑13. These upgrades provide greater assurance as to the integrity and availability of the AOFM’s information and data. The storage and data management systems were selected to meet the needs of its expanding, dynamic and flexible network. They have also increased the capacity of information that can be stored and the period of time that it can be retained, whilst reducing the complexity and cost of storage management. Both the storage and data systems were extended to cover the AOFM disaster recovery site, thus providing additional redundancy and resilience.
Operational risk arises from the potential for loss due to operational failures resulting from deficiencies in internal processes, people, systems, or from external events. It encompasses risks such as fraud risk, settlement risk, accounting risk, personnel risk and reputation risk.
The AOFM aims to manage its exposure to operational risk to acceptably minimum levels. It maintains a culture of prudence and awareness, together with high ethical standards, which are reinforced by regular in‑house training and adherence to the Australian Public Service Code of Conduct and the Australian Financial Markets Association (AFMA) Code of Conduct. Responsibility for the design and monitoring of risk and compliance activities resides with the Enterprise Risk Management, Legal and Compliance (ERMLC) Group. A dedicated Enterprise Risk Management unit maintains the currency and relevance of the AOFM’s risk framework and register, while the Compliance unit monitors compliance with external obligations and internal controls and procedures. The ERMLC Group reports to the AOFM Executive Group and Audit Committee on matters relevant to risk management, internal controls and compliance.
Operational risk activities undertaken in 2012‑13 included:
- internal audits of the control effectiveness over treasury systems and interface controls, employee entitlements, financial risk policies and frameworks, taxation liabilities, pre‑implementation readiness of the retail exchange trading of CGS (Phase One), IT backup and recovery procedures, and the RMBS sales process;
- preparation of the Certificate of Compliance for the AOFM’s compliance with the financial management framework under the Financial Management and Accountability Act 1997;
- implementation of the annual enterprise risk assessment and Compliance Assurance Plan, with monthly reporting provided to the Executive Group and quarterly reporting provided to the Audit Committee;
- enhancement of the Enterprise Risk Management (ERM) Framework (refer below for further information); and
- a review of the AOFM’s Chief Executive Instructions and internal financial delegations issued under the Financial Management and Accountability Act 1997.
In July 2012, the AOFM commenced a project to enhance its ERM framework. The objectives were set so as to develop and implement an ERM framework that aligned with AS/NZS/ISO 31000:2009 — Risk management principles and guidelines and reflect better practice processes and systems, whilst being scaled to meet the needs of the AOFM.
The enhanced ERM framework was approved by the CEO in May 2013 and endorsed by the Audit Committee in June 2013. The framework is being implemented from 1 July 2013, and will consider risks across strategic, portfolio and operational levels.
The AOFM is a low transaction volume, high transaction value environment. In 2012‑13, it settled around $98.7 billion of payments of interest and principal on CGS and around $837.2 billion in financial asset acquisitions, including term deposits with the Reserve Bank of Australia and residential mortgage‑backed securities. The AOFM also ensures that all administered receipts are settled promptly and correctly by its transaction counterparties.
In 2012‑13, the AOFM was not late in settling any payment obligations on its debt and investment management activities. The AOFM did not seek any compensation for late payments from counterparties as only a negligible amount of interest was forgone due to counterparties failing to settle their payments obligations in line with their contractual obligations.
Agency financial performance
The AOFM recorded an operating surplus on agency activities of $2.53 million for the 2012‑13 financial year, comprising total revenue of $12.31 million and expenses of $9.78 million. The surplus in 2012‑13 was due largely to lower than anticipated costs of undertaking additional issuance activity.
As at 30 June 2013, the AOFM was in a sound net worth and liquidity position, reporting net assets of $27.18 million, represented by assets of $29.59 million and liabilities of $2.41 million.
As at 30 June 2013, the AOFM had unspent appropriations totalling $28.62 million of which $0.1 million was held in cash. Unspent appropriations are available to settle liabilities as and when they fall due and for future asset replacements and improvements.
Cooperation with other debt managers
In 2012‑13 the AOFM continued to support the debt management activities of the Papua New Guinea and the Solomon Islands governments under the Strongim Gavman Program and the Regional Assistance Mission to the Solomon Islands. One staff member is seconded to each of these countries to help develop cash and debt management capabilities. Officials of the debt management agencies of the three countries, including the seconded AOFM staff, met in Port Moresby in July 2012 to discuss their experience with debt management over the year and their progress in capacity development. Meetings such as this occur on an annual basis.
Also in July 2012, AOFM officials met with debt management officials from the Korean Ministry of Strategy and Finance and the Bank of Korea in Seoul to share the AOFM’s experiences on a range of debt management related issues.
In September 2012, senior officials from the AOFM met with officials responsible for sovereign debt management from the Canadian Department of Finance and the Bank of Canada in Ottawa.
The AOFM Chief Executive is currently a member of the Steering Group of the OECD Working Party on Debt Management and attended the annual meeting in Paris in October 2012.
This sharing of information and perspectives with other sovereign debt managers has contributed positively to the AOFM’s knowledge and in particular has enhanced the AOFM’s portfolio research program.
- Total turnover includes repurchase transactions. ↩
- Source: Australian Securities Exchange. ↩
- The Official Public Account (OPA) is the collective term for the Core Bank Accounts maintained at the RBA for Australian Government cash balance management. ↩
- The overdraft facility is more costly than equivalent short‑term borrowing (for example, issuance of Treasury Notes). The terms of the facility provide that it is to cover only temporary shortfalls of cash and is to be used infrequently and, in general, only to cover unexpected events. ↩
- Following a review of unsecured lending to financial institutions (via negotiable certificates of deposit) no such investments have been made since 2011. ↩
- The growth in the AOFM’s funding task following the global financial crisis occurred in an environment where investor preferences were generally anchored towards shorter maturity bond lines. ↩
- Measured on an accreted book value basis as a percentage of the AOFM’s long-term funding base. ↩
- Debt servicing cost includes net interest expenses (measured on an accruals basis and includes realised gains and losses on the disposal of assets or liabilities) plus foreign exchange revaluation gains and losses (now minimal). Unrealised changes in the market valuation of domestic debt are not part of this measure. ↩
- State housing advances are loans that reside in the AOFM’s administered balance sheet. The waiver of this debt generated a realised loss, equivalent to the book value of the loans at disposal, of $284 million. ↩
- The fact that market interest rates were higher as at 30 June 2013 compared to 30 June 2012 and resulted in unrealised market valuation gains (due principally to a decline in the market value of liabilities), should not be confused with the fact that average interest rates over the financial year were significantly lower than 2011-12 which reduced portfolio funding costs measured on an accruals basis. ↩
- This is discussed in more detail in the next section. ↩
- A loss due to re-measurements of $20.57 billion was recorded in 2011-12. ↩
- This is being achieved by replacing $10 billion of Treasury Notes with an equivalent stock of Treasury Bonds. Around half of this planned ‘terming-out’ of Treasury Notes was completed in 2012 13. ↩
- Full details of each Direction are available on the AOFM website. ↩
- Further detail on each sale is available on the AOFM website. ↩
- This includes the RMBS investments sold. Notwithstanding the impact of future sales, the portfolio is expected to amortise at a rate of between $1.5 billion and $2.0 billion per annum for each of the next three years before slowing thereafter. ↩
- The strength of the Australian dollar compared to the Japanese yen in early 2013 triggered some profit taking divestment of CGS by Japanese investors, at the same time making new investment by Japanese investors more expensive. This divestment activity had slowed significantly by the end of the year. ↩
- Note this does not cover Commonwealth guaranteed securities issued by the State and Territory governments under the Act. ↩
Last updated: 20 January 2014