Part 2: Performance and Outcomes
- 1 Performance and outcomes
- 1.1 Introduction
- 1.2 Section 1: Annual Performance Statement
- 1.3 Section 2: Outcomes
- 1.4 Bond issuance
- 1.5 Debt portfolio management
- 1.6 Cash management
- 1.7 Residential mortgage‑backed securities
- 1.8 Market engagement
Performance and outcomes
The role of the AOFM encompasses a number of principal functions that serve three key objectives. These key objectives are to: (1) meet the Budget financing task in a cost‑effective manner subject to acceptable risk; (2) facilitate the Government’s cash outlay requirements as and when they fall due; and (3) be a credible custodian of the AGS market and other portfolio responsibilities.
This part of the annual report is presented in two sections: Section 1 is focused on the PGPA Act requirement to provide an Annual Performance Statement; and Section 2 gives context to the outcomes achieved through the AOFM’s operations to support its principal functions and discusses relevant market aspects of the environment in which the AOFM operates.
The principal functions of the AOFM are:
- issuing AGS to support the Government’s financing task (including maturing debt) in accordance with broader Government policy objectives (such as promoting liquidity);
- managing the Government’s daily cash balances through borrowing 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
- supporting the efficient operation of the Australian financial system through its debt issuance choices.
The purpose of the AOFM is achieved through three key objectives (above). Table 1 presents the Annual Performance Statement, outlines these objectives, and provides a summary of key performance indicators and results for the year. The statement of results refers to detailed context in Section 2 of this part, which provides a comprehensive explanation of a range of outcomes important to the AOFM’s achievement of annual and longer‑term aims.
The Annual Performance Statement is prepared in accordance with paragraph 39(1)(a) of the PGPA Act.
Table 1: Annual Performance Statement 2015‑16
|Key performance indicator||Measure||Result|
|Objective: Meet the Budget financing task in a cost‑effective manner subject to acceptable risk|
|The financing task is met||Shortfall in volume ($) between actual issuance and planned issuance announced at the Budget and subsequent releases||
The shortfall in issuance was zero, with the financing task for 2015‑16 fully met through sufficient issuance ($96 billion)
Discussion from page 12
|Debt issuance is cost effective||Compare cost of funds (total accrual costs as a percentage of the average stock of debt) with the cash rate and the average 10 year bond rate||
Debt issuance in 2015‑16 was cost effective, and consistent with the AOFM strategy of lengthening the average term to maturity of the nominal portfolio to reduce refinancing risk and variability in interest costs. The effective yield of the AGS portfolio for 2015‑16 was 3.74 per cent (2014‑15: 4.06 per cent). The average yield of issuance for 2015‑16 was 2.48 per cent (2014‑15: 2.91 per cent). This is below the average 10 year bond rate for 2015‑16 (2.61 per cent). The average term to maturity of the portfolio reached around seven years and 9.5 years for new issuance which is why effective yields are higher than the RBA targeted cash rate.
Refer discussion from pages 14 and 23‑25
|Debt issuance is targeted to market demand and the capacity of the market to absorb issuance||Difference between the yields at tender with yields in the secondary market (issuance at yields significantly higher than secondary market yields could reflect the confidence of intermediaries they can distribute bonds readily into the market).||
The weekly selection of bond maturities and issuance volumes for tenders facilitated continual efficient functioning of the primary market. This is reflected by average tender yields being below secondary market yields for Treasury Bonds (‑0.43 basis points), and Treasury Indexed Bonds (‑1.31 basis points).
Discussion from page 18
|Objective: Facilitate the Government’s cash outlay requirements as and when they fall due|
|Efficient cash management||Number of business days usage of the overdraft facility||
Sufficient cash was available at all times to meet the Government’s outlays such that there was no requirement during the year to use the RBA overdraft facility.
Discussion from page 28
|Objective: AOFM is a credible custodian of the AGS market and other portfolio responsibilities|
|Secondary market for Treasury Bonds and Treasury Indexed Bonds is liquid and efficient||Annual turnover in the secondary market for Treasury Bonds and Treasury Indexed Bonds (turnover is widely accepted as a key measure of the ease with which bonds can be bought and sold).||
Annual secondary market turnover for Treasury Bonds was $1.2 trillion and for Treasury Indexed Bonds $0.05 trillion in 2014‑15. Liaison suggests that turnover in 2015‑16 was broadly similar. This is adequate for the market to function effectively.
Discussion from page 19
|Monitor usage of AOFM securities lending facility (shortages in the secondary market will result in banks having to rely on ‘borrowing’ bonds via the facility to cover commitments).||
The securities lending facility was used 29 times (excluding intra-day uses), but only for small volumes and for short periods.
Discussion from page 19
This section outlines AOFM operations undertaken in 2015‑16 toward achieving its principal functions, and reports on the aims underpinning them and its achievement of these functions. It is presented according to five primary operational considerations: bond issuance; debt portfolio management; cash portfolio management; RMBS portfolio management; and market engagement. The discussion of each refers to underlying aims, how they are achieved and outcomes.
The AOFM currently has two term debt instrument choices — nominal Treasury Bonds and Treasury Indexed Bonds, for which the capital value is adjusted over time according to inflation outcomes. During times of Australian Government Budget deficits the main aim of Treasury Bond and Treasury Indexed Bond issuance is to meet the budget financing task; however the issuance program is also determined such that it will assist with meeting overall debt portfolio aims (such as increasing the average term to maturity of the portfolio). The AOFM plans its programs each year to undertake issuance in a cost effective manner.
The AOFM also aims to support the efficient operation of Australia’s financial markets by being a credible custodian of the AGS market. This takes account of the following financial market activities:
- 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.
Another element of market efficiency that is important to issuers, intermediaries and investors is market liquidity. Bond market liquidity is broadly accepted to mean the ability to trade bonds immediately, at low cost, without materially moving prices. Strong liquidity is attractive to investors and reflects favourably on a sovereign bond market. There is no single measure of liquidity; it is an assessment by individuals (and institutions) based on a number of considerations. These considerations include, but are not restricted to, turnover in secondary markets, the frequency of primary market activity, bid‑offer spreads, and the time it takes to execute ‘large’ transactions (something in itself that has a different meaning to different parties).
Approach to achieving these aims and market influences
An overriding aim of the issuance program is to meet the AOFM’s key objective of achieving the Government’s financing task in full. The annual issuance program is also devised on the basis of:
- formulating a strategy that will allocate issuance such that it balances promoting liquidity through building existing lines, against establishing new long‑end maturities to support yield curve (and portfolio duration) extensions;
- issuing into and establishing new bond lines that will form part of the futures contracts throughout the year; and
- supporting bond lines in parts of the yield curve that reflect a concentration of interest by various investor types.
The AOFM only uses competitive tenders and syndications to conduct bond issuance. The use of competitive tenders remains the mainstay of AOFM’s issuance operations; 98 Treasury Bond tenders and 17 Treasury Indexed Bond tenders were conducted during the year. Three new Treasury Bond lines and a new Treasury Indexed Bond line were launched via syndication.
The environment in which the funding task was completed reflects appreciable changes in the banking sector, where as a result of regulatory and cost changes the appetite of some banks to allocate balance sheet to fixed interest market‑making has reduced. This has contributed to a concentration in the number of intermediaries active at tenders; Treasury Bond prices cheapening relative to futures prices; narrowing and negative swap spreads; and elevated costs to fund holdings of AGS.
Although AGS yields were at historically low levels, yields on Treasury Bonds relative to other highly rated sovereign bonds remained attractive to investors. However, non‑resident holdings of AGS were on average around 62 per cent of the total outstanding during 2015‑16, a continuation of the decline in recent years from a peak of around 76 per cent in 2012, as illustrated in Chart 1.
Chart 1: Non‑resident holdings of Australian Government Securities
Source: Australian Bureau of Statistics and the AOFM
Meeting the Budget financing task
The financing task for 2015‑16 was fully met. A total of over $96 billion of term debt was issued during the year.
At the time of the 2015‑16 Budget, Treasury Bond and Treasury Indexed Bond issuance for the year was expected to total around $78 billion in face value terms. This volume rose over the course of the year to meet the Government’s financing requirement and increase the cash balances managed by the AOFM. This left the AOFM in a strong operational position.
Treasury Bond Issuance
Gross Treasury Bond issuance for the year totalled $92.6 billion. The bulk of issuance was into existing bond lines in order to enhance the liquidity of them and in turn, the attractiveness of the AGS market. In addition, three new Treasury Bond lines were launched in 2015‑16:
- new bond lines with maturity dates in November 2027 and May 2028 were opened to support the operation of the 10 year Treasury Bond futures contract and to reduce growth in the amount outstanding in surrounding bond lines, which will make it easier to manage maturity of those bonds lines; and
- a new bond line maturing in June 2039 was issued to consolidate the 20 year Treasury Bond yield curve and as support for operation of the 20 year Treasury Bond futures contract.
In selecting the bond lines to issue each week, the AOFM took account of its debt issuance strategy; prevailing market conditions; information from financial market contacts about investor demand; relative value considerations; scope for increasing the liquidity of outstanding bond lines; and the need to manage the maturity structure to limit funding risk. Two tenders were held during most weeks, typically comprising a tender of a long‑dated bond line and a tender of a short‑dated bond line. To facilitate tenders of very long‑dated (around 20 year tenor) Treasury Bonds, three tenders were held in some weeks. The amount offered at each tender ranged from $300 million to $1.2 billion.
At the end of the year, there were 22 Treasury Bond lines with 14 of these lines having over $15 billion on issue and 18 having over $10 billion on issue. Chart 2 shows Treasury Bonds outstanding as at 30 June 2016 and the allocation of issuance across bond lines during 2015‑16.
Chart 2: Treasury Bonds outstanding as at 30 June 2016 and issuance in 2015‑16
The AOFM has for some years been pursuing a strategy of lengthening the average term to maturity (an alternative measure to duration) of the debt portfolio. This has been achieved through issuance choices biased towards longer bond lines, and extending the yield curve. This is demonstrated in Chart 3 which shows that more than 60 per cent of issuance in 2015‑16 was allocated to longer bonds. It also shows how the Treasury Bond yield curve has been progressively extended each year since 2011 to be just under 23 years (up from 11.8 years in 2011). Yield curve extensions have been integral to the lengthening strategy by providing additional long issuance points and broadening the appeal of the AGS market to longer duration investors.
Chart 3: Treasury Bond issuance distribution by financial year and term to maturity of longest line (years)
A long issuance bias, together with the longer yield curve, allowed the AOFM to achieve an average term to maturity of 9.41 years on its Treasury Bond issuance during 2015‑16 (see Chart 4). The Treasury Bond program benefited from historically low interest rates and was delivered cost effectively, with an average yield on issuance of 2.48 per cent.
Chart 4: Treasury Bond issuance — average yield and term to maturity
TERM PREMIUM FROM THE PERSPECTIVE OF A SOVEREIGN DEBT MANAGER
A key component of the cost‑risk puzzle that contributes to the AOFM’s deliberations on issuance strategy is the extra return investors demand for holding a longer‑term bond as opposed to investing in a series of short‑term bonds, known as the term premium. From the sovereign debt manager’s perspective, the term premium provides an answer to the question: what is the cost of issuing debt out along the term structure, relative to issuing short term debt and consequently refinancing it in future periods?
Unfortunately, as market expectations are not directly observable, neither is the term premium. As such, many academics and practitioners over the years have contributed to a body of literature dedicated to term premium estimation. The AOFM has, in the past, utilised a variety of estimation techniques to help inform its strategic decision making processes. Most recently, a linear‑regression based affine term structure model developed by economists Adrian, Crump and Moench (ACM) has been implemented. The AOFM has adapted the ACM model for AGS as a gauge of term premium within an Australian context. Chart 5 illustrates how the Australian fitted ACM term premium has evolved over time.
Chart 5: Australian Government Securities fitted ACM term premium estimation
The profile of the estimated term premium clearly suggests compression relative to historical levels. This may be symptomatic of several factors including broad risk premia erosion globally, low interest rate environments and changing investor risk preferences in search of acceptable yield. From a sovereign debt manager’s perspective, this compression implies a lower cost of issuing longer term debt relative to market expectations (and relative to issuing shorter term debt), as a lower term premium is paid to the investor.
The AGS fitted ACM model provides another information source that is used in conjunction with a variety of other quantitative and qualitative inputs to inform AOFM strategic decision making. At current levels, the lengthening strategy is supported by term premium estimates.
Treasury Indexed Bond Issuance
The AOFM’s alternative long‑term funding instruments to Treasury Bonds are Treasury Indexed Bonds, the capital values of which are adjusted with changes in the CPI. The issuance of these bonds typically attracts a different (and predominantly domestic) class of investor to nominal bonds and thus provides a source of diversification in the funding base. The regular issuance of indexed bonds re‑commenced in 2009‑10 following an extended absence from this market. While the indexed portfolio has been relatively stable as a share of the long term funding base for several years, the stock of indexed bonds has continued to grow steadily (as shown in Chart 6).
Chart 6: Treasury Indexed Bonds — average term to maturity and share of the long‑term funding base
Treasury Indexed Bond issuance for the year totalled $3.8 billion. Two tenders for the issue of Treasury Indexed Bonds were conducted in most months. The volume of each line outstanding, relative yields and other prevailing market conditions were considered in the selection of which line to offer.
The inflation‑linked yield curve was extended to around 25 years via the issue of a new Treasury Indexed Bond maturing in 2040. Demand for the issue was strong: $2.82 billion of orders were received for a $1.25 billion capped deal. The majority of the demand was from domestic fund managers.
Chart 7 shows the amount outstanding in each of the seven Treasury Indexed Bond lines as at 30 June 2016, and the allocation of issuance during the 2015‑16 year.
Chart 7: Treasury Indexed Bonds outstanding as at 30 June 2016 and issuance in 2015‑16
Efficiency of issuance
Table 2 summarises the results of Treasury Bond tenders conducted during the year. The results are shown as averages for each half‑year and grouped by the maturity dates of the bonds offered.
Table 2: Summary of Treasury Bond tender results
|Period||Maturity||Face value allocated amount($m)||Weighted average issue yield(%)||Average spread to secondary market yield (basis points)||Average times covered|
|July – December 2015||Up to 2023||17,400||2.1290||-0.59||3.63|
|2024 – 2039||22,000||2.9672||-0.26||2.58|
|January – June 2016||Up to 2023||17,200||1.9115||-0.68||3.39|
|2024 – 2039||20,400||2.5782||-0.30||2.58|
The average coverage ratio for all Treasury Bond tenders in 2015‑16 was 2.99, a decrease from 3.66 in 2014‑15. The average tender size of $786 million was larger than in 2014‑15 due to the higher issuance program. Shorter‑dated bond tenders generally received a greater volume of bids, which reflects core investor base interest.
The strength of bidding at tenders was reflected in competitive issue yield spreads to secondary market yields. At most Treasury Bond tenders the weighted average issue yields were below prevailing secondary market yields.
The average coverage ratio was 3.69 for Treasury Indexed Bond tenders, a decrease from 4.61 in 2014‑15. At most tenders, the weighted average issue yields were below prevailing secondary market yields.
Full tender details are available in Part 5 of this annual report.
Market liquidity and efficiency
The Treasury Bond market operated smoothly throughout 2015‑16 with liquidity and efficient price discovery being maintained throughout the year. Investors and intermediaries provide consistent feedback that liquidity in this market continues to compare favourably to other fixed interest markets in which they operate. Data on secondary market turnover in Treasury Bonds is obtained from the Australian Financial Market Association (which surveys banks for the data). At the time of finalising this report the data for 2015‑16 were not available. At the time of finalising this report turnover data for 2015 16 were not available, although market liaison suggests that liquidity was broadly similar to during 2014-15, which saw turnover of around $1.2 trillion.
Although liquidity in Treasury Indexed Bonds remains good compared to global inflation‑linked debt markets, it is more challenging than for Treasury Bonds. This is consistent with the relative liquidity of nominal and inflation‑linked securities in other sovereign debt markets. Market participants reported that large trades may have to be executed carefully and over time, and can at times move market prices. Treasury Indexed Bond turnover in 2014‑15 was around $50 billion. Market liaison suggests that liquidity may have deteriorated slightly in 2015‑16.
Turnover in the Treasury Bond futures market is significantly higher than in the underlying Treasury Bonds. The three and 10 year Treasury Bond futures contracts are highly liquid: they are the ninth and eleventh most traded long‑term interest rate futures products in the world, respectively. Turnover in the 20 year contract is considerably lower. All contract close‑outs in 2015‑16 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 in the secondary market. This enhances the efficiency of the market by improving the capacity of intermediaries to continuously make two‑way prices, reduces the risk of settlement failures and supports market liquidity. The facility was used 29 times for overnight borrowing in 2015‑16 compared with 13 times during 2014‑15. However, the volumes borrowed tended to be small, with the total face value amount lent in 2015‑16 being $261 million, a decrease from $348 million in the previous year.
In managing the Commonwealth’s debt portfolio and meeting the Government’s financing requirements, 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.
To meet these aims the AOFM endeavours to execute a debt issuance strategy that appropriately accounts for the trade‑offs between cost and risk while simultaneously providing effective and transparent stewardship of the AGS market in order to underpin confidence and promote participation in the market. Facilitating an efficient and resilient market allows for the Australian government to have continued access to financial markets.
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 AGS, 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. The use of an historic 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. Fair value is useful in circumstances where it is possible that changes in market value may be realised in the future.
Approach to achieving the aims
Variability in portfolio outcomes 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 interest cost outcomes over time. Debt issuance decisions made today impact the variability of future interest 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.
The AOFM influences the cost and risk profile of the portfolio primarily through the maturity structure of the debt securities it issues (and to a lesser extent, the mix between nominal and inflation linked securities). Issuing longer‑term securities will typically involve paying higher debt service costs (in the presence of a positive term premium) although this is compensated by reduced variability in future interest cost outcomes and lower exposure to refinancing or rollover risk. Issuing shorter term debt securities by contrast will typically be cheaper (avoiding a term premium) but result in higher variability in cost outcomes through time and a greater debt refinancing task. Striking the right balance between these cost and risk considerations is the debt manager’s ongoing challenge.
Strategic decision making around the portfolio is informed by an ongoing research program focussed on exploring the cost and risk characteristics of alternative portfolio structures and issuance strategies in light of prevailing fiscal and economic circumstances. Drawing on this research, a strategy for the structure and composition of issuance for the financial year was formulated and tested with the AOFM Advisory Board prior to seeking formal approval from the Treasurer. Separately, a range of complementary limits, thresholds, guidelines and targets governing the AOFM’s operations were submitted to the Secretary to the Treasury for approval through an Annual Remit. In implementing the strategy, operational issuance decisions such as determining if, when, how much and which lines to issue each week were made by the AOFM over the course of the year. These operational decisions were influenced by several factors including general market conditions, relative value considerations and feedback from investors. The ongoing suitability of any issuance and portfolio strategy is constantly under review.
During the year, the total volume of Treasury Bonds outstanding increased by around $50 billion, to $385 billion.
Portfolio risk management
The AOFM’s strategy was based on a continuation of lengthening the average term to maturity of the portfolio. This decision was influenced by a range of factors including a continuation of low outright bond yields, a below average term premium (which increases the attractiveness of longer term issuance), anticipated growth in the debt stock (and refinancing task) and an external environment characterised by heightened levels of volatility and uncertainty. In short, the opportunity to lengthen cost effectively and thereby limit growth in the risk profile of the portfolio as the stock of debt increased was a key driver of the AOFM’s strategy.
Chart 8: Treasury Bond portfolio — modified duration, average term to maturity and cost of funds
Chart 8 shows that the average term to maturity of the Treasury Bond portfolio was lengthened by 0.45 years to 6.97 years over 2015‑2016 while duration increased by 0.59 years to 5.97 years. The effective cost of funds or yield on the Treasury Bond portfolio fell from 3.85 to 3.50 per cent over the same period.
The reduced inherent risk levels of the portfolio flowing from the lengthening strategy are demonstrated in Chart 9 below. The chart shows a steady decline in the short to medium term Treasury Bond refinancing task, measured as the proportion of the stock of Treasury Bonds on issue through time. Whereas at 30 June 2010 the structure of the portfolio was such that 43 per cent and 65 per cent of bonds required refinancing over the next three and five year periods respectively, this has fallen to 24 per cent and 46 per cent. These reductions translate directly into lower medium‑term gross borrowing programs. The AOFM estimates that annual Treasury Bond issuance will be about $12 billion per annum lower on average over the next five years as a result of the lengthening strategy. This is beneficial at a time when borrowing programs are at elevated levels.
Chart 9: Treasury Bond maturity profile
The debt servicing cost of the net AGS debt portfolio managed by the AOFM in 2015‑16 was $14.85 billion on an average book volume of $385.82 billion, representing a net cost of funds of 3.85 per cent for the financial year. The largest component of net AGS debt is the Long Term Debt Portfolio (LTDP), comprised primarily of Treasury Bonds and Treasury Indexed Bonds, which incurred debt servicing costs of $15.49 billion on an average book volume of $411.43 billion, implying a cost of funds of 3.76 per cent. The difference between net AGS debt and the LTDP is attributable to the short term assets and liabilities the AOFM uses for liquidity management purposes (term deposits and Treasury Notes) and other residual assets (such as RMBS).
Chart 10: Net AGS debt and Long Term Debt Portfolio cost of funds analysis (per cent)
Chart 10 shows the funding cost profile of the net AGS debt portfolio and the LTDP back to 2007‑08. These are contrasted with the cash rate and the 10 year moving average of the 10 year bond yield. In an environment where interest rates have been trending down, funding costs on the net debt portfolio and the LTDP have declined by 137 and 153 basis points respectively since 2010‑11. This compares to declines of 300 basis points in the cash rate and 108 basis points in the 10 year bond yield moving average over the same period. Given the largely fixed cost structure of the net debt portfolio and the LTDP, changes in funding cost will always lag changes in the overnight cash rate (changing only when existing debt securities or assets mature or new securities are issued/investments placed). In a comparison with the 10 year bond yield moving average, funding costs have fallen further because of the relative ‘over‑representation’ of recently issued debt in the portfolio through a period where issuance yields have been declining.
Table 3 provides further details of the cost outcomes for the portfolio of debt and assets administered by the AOFM broken down by instrument and portfolio for 2014‑15 and 2015‑16.
Table 3: Commonwealth debt and assets administered by the AOFM
Note: Sub totals and totals are actual sum results, rounded to the nearest million dollars. Effective yields are based on actual results before rounding, rounded to two decimal places. Book volume is a through the year average.
- Interest expense and effective yield on foreign loans incorporates foreign exchange revaluation effects.
- Re‑measurements refer to unrealised gains and losses from changes in the market valuation of financial assets and liabilities.
- State Housing Advances book volume for 2014‑15 was incorrectly reported as $2,321 million in the 2014‑15 Annual Report. The book volume and subsequent calculations of the effective yield on the portfolio have been amended in this year’s Annual Report.
The debt servicing cost of gross debt increased in dollar terms by $1,108 million compared to the previous year. This was primarily due to an increase in the average volume of debt on issue from $360.45 billion in 2014‑15 to $417.85 billion in 2015‑16. In percentage terms however, the funding cost of gross debt declined by 29 basis points (4.03 per cent to 3.74 per cent). This improvement was driven by the issuance of new bonds through the year at yields that were below the average of pre‑existing (and maturing) debt. Low rates also reduced the yield on funds invested in term deposits from 2.37 to 2.01 per cent and RMBS investments from 3.78 to 3.37 per cent.
The return on gross assets in dollar terms for the period was $766 million, a decrease of $156 million compared to 2014‑15. This was driven by a $83 million reduction in income from RMBS (resulting from the maturity and sale of existing investments and lower interest rates) as well as a $67 million reduction in income from term deposits (due to lower investment yields).
The net servicing cost of the combined portfolio of debt and assets was $14.85 billion. This was higher in dollar terms compared to 2014‑15, due to the volume of debt on issue being higher than the previous year. As a percentage of net debt, servicing costs fell from 4.15 per cent to 3.85 per cent, a product of more expensive historically issued debt maturing and continued issuance over the year into a low interest rate environment.
Movements in market interest rates had an unfavourable impact on the market value of the portfolio in 2015‑16. Unrealised losses from re‑measurements amounted to $17.63 billion. This compares to an unrealised loss of $7.51 billion in the previous year. About 97 per cent of re‑measurement losses are attributable to the higher market value of Treasury Bonds. As bond prices move in opposite directions to bond yields, it can be seen that the same favourable, lower interest rate environment responsible for driving down the AOFM’s overall portfolio funding costs in 2015‑16 (expressed as a percentage), was also responsible for this negative re‑measurement impact.
As re‑measurement items are highly volatile from one year to the next, they 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 and near maturity bonds, 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 and funding risk. In practice, the AOFM has been seeking to reduce these risks, through allocating a greater proportion of issuance to long dated lines.
The AOFM manages the daily cash balances of the Australian Government in the OPA. The AOFM manages these balances so as to ensure that the Government is able to meet its financial obligations as and when they fall due. Other objectives are to minimise the cost of funding and the carrying cost of holding cash balances (which centres on holding only balances assessed as prudent to cover forecast needs and contingencies, while investing excess balances but at low or minimal risk). In minimising cost, the AOFM seeks to avoid use of the overdraft facility provided by the RBA.
Approach to achieving the aims
Achieving the cash management objective involves formulating forecasts of Government cash flows, and developing and implementing appropriate strategies for 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. Maturity dates of term deposits were selected to most efficiently finance net outflows. Interest rates for term deposits at the RBA reflect the rates earned by the RBA in its open market operations.
Treasury Notes are issued to assist with management of the within‑year funding requirement. The volume of Treasury Notes on issue ranged from $4 billion to $10 billion during 2015‑16.
The size and volatility of the within‑year funding requirement are reflected in changes in the short‑term financial asset holdings managed by the AOFM, after deducting Treasury Notes on issue. Chart 11 shows movement in the funding requirement over the year.
Chart 11: Within‑year funding requirement 2015‑16
The task of meeting the Government’s financial obligations as and when they fall due was fully met, without use of the overdraft facility provided by the RBA.
During 2015‑16, the AOFM placed 314 term deposits with the RBA. The stock of term deposits fluctuated according to a range of factors influencing the AOFM’s cash portfolio management needs and decisions. Term deposits ranged from a minimum of $6.5 billion in January 2016 to a maximum of $53.4 billion in June 2016.
The average yield obtained on term deposits during 2015‑16 was 2.01 per cent, compared with 2.37 per cent in 2014‑15. The decrease in average yield reflects the lower average level of interest rates that prevailed during 2015‑16.
A total of $20 billion of Treasury Notes were issued in 2015‑16 (in face value terms). The average coverage ratio at tenders was 3.19, a reduction from 3.57 in 2014‑15. Yields were on average around eight basis points higher than Overnight Indexed Swap (OIS) rates for corresponding tenors (compared to around three basis points higher than OIS rates in 2014‑15). Details are available in Part 5 of this annual 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 2015‑16 are shown in Chart 12.
Chart 12: Short‑term financial asset holdings and Treasury Notes on issue 2015‑16
In undertaking its cash management activities, the AOFM was required to maintain a 91‑day moving average of the daily OPA cash balance below the Ministerially approved upper limit of $1.5 billion. This was achieved throughout the year.
Movements in the 91‑day rolling average OPA cash balance over the year are shown in Chart 13.
Chart 13: 91‑day moving average cash balance 2015‑16
During the period October 2008 to April 2013, the AOFM was directed to invest up to $20 billion in eligible RMBS to support competition in mortgage lending. In total, just under $15.5 billion was invested. On 5 May 2015, the Treasurer issued a new Direction under the PGPA Act to divest the Government’s RMBS portfolio through a regular competitive process.
The Treasurer’s Direction stipulates that sales must not exceed $500 million per month and that the AOFM should exercise its discretion on timing and sales volume to minimise potential market disruptions. The Direction also provides the AOFM with discretion to cancel a sale or suspend the auction process when RMBS sales cannot occur at a price level that the AOFM considers to be acceptable.
Approach to achieving the aim
In accordance with the Treasurer’s Direction, the AOFM commenced a competitive sales process for the Government’s RMBS portfolio in June 2015. Under the current Direction, one auction was held on 24 June 2015 in which around $160.5 million in amortised face value of RMBS were sold.
The Australian RMBS market was not as strong during the 2015‑16 financial year as it was during the two preceding years. Global credit market conditions deteriorated progressively throughout the second half of 2015 and into early 2016. For a large part of 2015‑16, market conditions were not conducive to a competitive sales process for the Government’s RMBS portfolio. As a consequence, the AOFM exercised its operational discretion to suspend RMBS auctions for the majority of the financial year.
During the 2015‑16 financial year, the AOFM completed four monthly RMBS auctions between July and October 2015. A summary of the sales achieved from these four auctions is provided in Table 4. The first three auctions resulted in bids being received that exceeded the reserve price set with reference to prevailing market prices prior to the commencement of each auction. In October 2015, no bids were received that met the RMBS auction reserve prices. RMBS auctions completed by the AOFM during 2015‑16 achieved sales totalling $297 million in amortised face value terms. These sales realised gains totalling $1.71 million.
Table 4: RMBS divestments for 2015‑2016
|Amortised face value ($m)||
Gain on Sale
|PROGRESS 2012‑1 A||26.11||0.44|
|RESIMAC 2011‑1 A||67.58||0.25|
|SMHL 2010‑1 A||2.50||0.01|
|BARTON 2011‑1 A2||39.36||0.33|
|ILLAWARRA 2010‑1 A||40.52||0.25|
|SMHL 2008‑2 A1||42.97||0.16|
|IDOL 2010‑1 A2||77.98||0.26|
In November 2015, the AOFM announced the suspension of sales until at least February 2016, due to concerns that the sale of RMBS at market clearing prices may have added to the disruption then occurring in the secondary market. In February 2016, while the primary RMBS market had ‘re‑opened’ at a new equilibrium price, the AOFM announced that the suspension would continue until further notice, as this new equilibrium price level was considered to be unacceptable. As at the end of June 2016, prevailing market prices indicated that continuing a suspension of the auction process was prudent.
RMBS portfolio and market conditions
Chart 14 plots cumulative volumes purchased under the first four Directions in force between October 2008 and April 2013 on the same axis as the amortised value of the RMBS portfolio through time. The latter series illustrates the $1.45 billion reduction in size of the RMBS portfolio, from $4.3 billion to $2.8 billion, that was achieved in 2015‑16 through both natural amortisation and sales.
Chart 14 also highlights the widening in secondary market RMBS spreads that occurred through the year. It demonstrates that, in early 2016, RMBS spreads returned to levels last seen around the time the AOFM made its final investments under the program, in the third quarter of 2012.
Chart 14: RMBS investments, amortisation and divestments
The widening in spreads through much of 2015‑16 represented a deterioration in domestic RMBS market conditions that was broadly consistent with global trends. Events such as the Greek debt crisis, global equity market volatility, and speculation about the timing of US monetary policy tightening all contributed to a deterioration in global credit market conditions.
The AOFM considers that exercising its discretion to suspend the sales process both reduced the potential for additional market disruption and preserved taxpayer value. Thus, while divestment volumes were lower than expected, the AOFM acted in a manner that was consistent with its Direction.
Table 5 puts the RMBS sales made in 2015‑16 into a historic context. Over the life of the program from October 2008 to June 2016, around $20.6 million in realised gains has been earned from RMBS divestments.
Table 5: RMBS divestments over time
|Financial year||Amortised face value ($m)||
Gain on Sale
The average margin over the one month bank bill rate (weighted by each of AOFM’s investments) for the RMBS book remained stable over the financial year at around 127 basis points. Interest income in 2015‑16 was $109.9 million and, as noted earlier, sales in 2015‑16 contributed a further $1.7 million in realised gains. Total accrual income of $111.6 million represented an annualised return of 3.37 per cent on the portfolio’s average book value of $3.3 billion. This is lower than the corresponding return in 2014‑15, due largely to lower prevailing short term interest rates.
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. These are not realised returns and so are excluded from the accrual returns, but are included as re‑measurements within the AOFM’s comprehensive income statement treatment.
The RMBS securities held by the AOFM are valued using indicative ‘bid’ margins for secondary market trading as estimated by an independent valuation service provider. The cumulative unrealised loss on the portfolio was $9.5 million as at the end of the financial year, a reduction in value of around $29.7 million versus the year before. This reduction was due mainly to the widening of revaluation spreads illustrated in Chart 14. The total return on the RMBS portfolio for 2015‑16, including re‑measurements, was thus around $81.8 million, or approximately 2.47 per cent of the portfolio’s average book value.
In order to achieve its core objectives the AOFM needs to maintain a comprehensive understanding of a wide range of market related issues including planned and possible major announcements and events, impacts on the global flow of capital, changing investor preferences, and the performance of banks that play the role of intermediaries — particularly in the primary AGS market, on which the AOFM relies for access to end investors. While this aim can in part be served by following announced regulatory changes there remains the need for a heavy emphasis on maintaining strong lines of communication directly with intermediaries and both directly (and indirectly through intermediaries) with end investors. Communication with intermediaries is frequent and with investors is based on an investor relations program. The program is underpinned by a strategy that is reviewed periodically, largely in response to changes in market conditions and/or the AOFM’s planned issuance strategy.
Achieving the aims
The Investor Relations strategy in 2015‑16 again focused on identifying opportunities to realise further diversity in the AGS investor base while maintaining and managing engagement with current key investors.
There were four parts to the Investor Relations strategy:
- a targeted focus on direct engagement with investors from specific geographic regions, and of different type based on a review of the current investor base and emerging interest from new and potential investors;
- a lesser (although still regular) use of face‑to‑face investor meetings;
- increased use of opportunities to present to conferences or speaking events to groups of investors; and
- a greater use of the AOFM website to provide updates for investors.
Of greatest interest to investors throughout the year were discussions about AGS market conditions, AOFM plans for issuance and further market development, and AOFM perceptions as to the changing composition of the AGS investor base.
Activities throughout 2015‑16 included slight changes to the previous year and were particularly focused on regions, countries and sectors where investors in AGS were growing in importance, number and their level of interest in specific and usually longer duration investments (this being of particular interest as the plans to lengthen the yield curve have been gradually implemented). The ability to access new investors has proven more difficult as global and Australian yields have fallen to historically low yields and relative yield spreads to other sovereign bond markets have contracted. The AUD, a major investment consideration for non‑resident investors, remained relatively range bound over the period and quite volatile with many expecting it to further depreciate.
Of the 116 individual meetings held this year, 31 were with investors not previously met. This percentage of new investor meetings (27 per cent) was lower than the previous year (40 per cent). Overall this tends to suggest the breadth of the AGS investor base could be maturing, particularly in light of the strong growth in new investors over past years as the central bank community were actively allocating into AUD assets. All but four of these new investor meetings were with non‑resident institutions. Fewer new investor meetings were held in Asia and Australia but they remain important due to the large number of established investors in both.
Two offshore regions however did stand out for new contacts. Investor roadshows to Tokyo and London contained 11 and 7 meetings respectively, with new investors.
Both of these cities have the largest concentration (by number of individual institutions) of current offshore investors (and seemingly potential investors). These cities, as well as parts of Europe, have a large proportion of private sector investors looking for longer duration and so those regions remained a major focus for AOFM investor engagement.
One area where the current investor base grew in importance was in Australia. Although non‑resident investors are still considerably larger in number than their domestic counterparts and non‑resident holdings of AGS is around 59 per cent, this proportion has been falling for the last four years. This was not due to non‑resident investors buying less AGS, in fact outright holdings continued to rise. The main reason being was domestic investors were buying an increasingly larger proportion of increasing issuance volumes.
Just over 30 meetings were conducted with domestic investors this year (out of 116 investor meetings in total).
As well as face‑to‑face meetings and presentations, the AOFM again conducted a number of phone meetings with international and domestic investors through‑out the year. Regular fortnightly calls with ten domestic Treasury Indexed Bond investors have assisted in the selection of individual lines to tender and were useful in gauging demand for Treasury Indexed Bond in general.
Table 6: Summary of investor relations activities in 2015‑16
|Conferences, speaking engagements and investor roadshows||10 events|
|Presentations: Large engagements/ Roundtables||8 presentations|
|Approximate total audience size: Large Presentations||125 attendees|
|Individual meetings||116 investor meetings|
|Individual cities visited||19 cities|
|AOFM staff participating in investor relation activities||CEO, Head Investor Relations, Head Treasury Services, Senior Strategist Investor Relations, Communications Officer Investor Relations|
|Hosting banks: Investor roadshows, conferences, roundtable discussions||ANZ, Commonwealth Bank, Citi, Deutsche Bank, UBS, Westpac|
Table 7: Timeline of investor relations activities in 2015‑16
|August 2015||Sydney, Asia: Hong Kong, Taiwan, Malaysia, Singapore|
|October 2015||Melbourne: CBA Fixed Income Conference, 1 presentation to 80 attendees|
|November 2015||Europe: UK, France|
|December 2015||Asia: China, Japan|
|February 2016||Sydney: UBS Treasury Indexed Bond Roundtable|
|March 2016||Scandinavia, Canberra: Deutsche Investor Mission; Sydney|
|April 2016||Sydney, Canberra|
 Defined as 8.5 years or longer. The demarcation at this point reflects the typical term of the shortest bond in the 10 year Treasury Bond futures basket.
 Source: AFMA, 2015 Australian Financial Markets Report.
 World Federation of Exchanges 2016, WFE/IOMA 2015 Derivatives Market Survey.
 The term premium is the additional yield demanded by investors in order to hold a long‑term bond instead of a series of shorter‑term bonds. Further exploration of the term premium and its relevance to the AOFM can be found in the Bond Issuance section.
 Refinancing risk, also referred to as rollover risk, is the inability to renew maturing debt by further borrowing.
 These are point in time measures as at 30 June each year, in contrast to the debt servicing cost incurred throughout the year captured in Table 3.
 In absolute dollar terms, the quantum of three and five year maturities in the portfolio has still grown although this has occurred at a considerably slower pace compared to growth in the overall stock of Treasury Bonds.
 Debt servicing cost includes net interest expense (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 and assets are not part of this measure.
 Bond issuance over the past four financial years for instance accounts for around ¾ of the LTDP as at 30 June 2016. Bond yields over this period were on average significantly lower than the preceding years which largely explains why portfolio funding costs have fallen by more than the 10 year bond yield moving average.
 The 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.
 Copies of each Direction are available on the AOFM website.
 Full results for each auction are available on the AOFM’s website at:
 The background shading in the chart highlights the time during which each Direction was in force.
 The AOFM was prepared to assess new investment proposals into 2013, but was scaled out by private sector investment, given the improvement in conditions as reflected by the tightening in RMBS spreads at this time. These improved conditions saw the Treasurer issue a Direction to cease new investment in April 2013 that allowed the AOFM to continue to divest its RMBS under certain conditions. It ceased with the repeal of the FMA Act in June 2014.
Last updated: 31 October 2016