ScoMo saves borrowers from certain rate hike

Christopher Joye

Coolabah Capital

Today I explain how ScoMo (and Turnbull) saved Australia's AAA rating, and in the process also saved borrowers from a certain 10bps per annum rate hike worth over $10,400 over the life of a typical home loan. Last week S&P shocked the market, but not us, by upgrading Australia's AAA rating from a long-held "negative outlook" to "stable". It's also put Australia's economic risk score on a positive trend for an upgrade, which is important because if this happens it is likely that the major banks' subordinated bonds and hybrids will have their credit ratings upgraded, pushing their Additional Tier 1 capital hybrids from their current sub-investment grade BB+ status back up to their historical investment-grade BBB- rating. That could be a big deal for institutional investors that are limited to allocating to investment-grade securities. Technically, the upgrade is most likely to occur on CBA and Westpac securities because they have the highest S&P Risk-Adjusted Capital (RAC) ratios---as Australia's economic risk score is upgraded, S&P lowers the risk-weight assumptions on home loans, which then boosts the banks' RAC ratios above the 10% threshold that entitles them to an increase in their Stand Alone Credit Profiles on which T2 and AT1 security ratings are predicated. Excerpt enclosed (click here to read or AFR subs can use the direct link here):

The major banks' AA- credit ratings are crucially reliant on Australia's sovereign rating remaining in the prized AAA band. Had the nation been downgraded one notch to AA+, as was universally expected in 2017 (but not by this column), S&P would have immediately downgraded the big banks in lockstep to A+.

Based on the interest rates paid on AA- and A+ rated bonds, this would have lifted the majors' annual borrowing costs by 0.10 percentage points (or 10 basis points), which would have been passed on to borrowers. On a $500,000 mortgage, former Treasurer ScoMo has spared borrowers $10,410 in interest over the loan's life...

Behind the scenes, ScoMo worked furiously to convince S&P that the Coalition, which had adopted a more conservative forecasting framework than its Labor predecessors (including highlighting downside scenarios), was hell-bent on under-promising and over-delivering. Yet the S&P analyst who covered Australia was under pressure from his New York masters to push through a downgrade because they were worried the RBA's ultra-easy monetary policy had blown a housing bubble.

ScoMo's persistence won a temporary stay of execution when S&P reluctantly reaffirmed Australia's AAA rating with a "negative outlook". Market participants were sure an eventual downgrade was inevitable, a risk reinforced five days later when S&P shocked investors by slashing the credit ratings of 23 local banks and the major banks' hybrids and subordinated bonds. It did this because it raised Australia's economic risk score given concerns about the brewing bubble. New York had traded off a sovereign rating reprieve against the immediate bank rating downgrades.

Over the next 18 months ScoMo would, however, relentlessly prove S&P and virtually all analysts and investors wrong...All told, he ended up delivering revenues in 2018 that were $13.4 billion better than the budget guided. Concurrently, payments were $6.9 billion lower than planned. The result was a final budget outcome that was an enormous $19.3 billion better than ScoMo promised in May 2017.

In fact, he came within a whisker of delivering a technical surplus: the $4 billion net operating deficit was within one monthly standard deviation of a surplus. The underlying cash deficit of $10.1 billion was similarly within one quarterly standard deviation of a surplus. It's possible we are in surplus right now on some measures.

Read more here. 

Christopher Joye
Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs $7 billion with a team of 33 executives focussed on generating credit alpha from mispricings across fixed-income markets. In 2019, Chris was selected as one of FE fundinfo’s Top 10 “Alpha...

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