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Lower for longer interest rates drive SMSF hunt for yield

Tony Perkins
— 1 minute read

With credit markets being fundamental to the operation of the financial system, many governments have acted in timely, appropriate and proportionate ways to reduce the negative impacts of the COVID-19 pandemic which has created great uncertainty across economies, both socially and financially. Historically, governments using fiscal and monetary responses via their central banks have created mixed outcomes when managing the operation of the financial system.

Tony Perkins

However, the governmental and central bank responses to the COVID-19 pandemic have been bold and decisive, reducing the consequences of consumers not spending and preventing further slowdowns across economies. In Australia for example, JobKeeper as a governmental fiscal response has been critical to supporting the economy and society. Through the Reserve Bank, a number of monetary initiatives were enacted, such as interest rate targeting (three-year bond buying); overnight cash rate (“OCR”) reductions; large-scale liquidity injection into the banking system; and Treasury lending into the structured finance market to support non-bank lenders. Results were stellar: bank liquidity was very sound, credit spreads (the risk margin for non-government, non-bank borrowers), after an initial uptick, are now at pre-pandemic levels.

Interest rate targeting and OCR reductions have created the ultra-low interest rate environment that we are currently experiencing – this has been a boon for borrowers and has helped companies refinance their debt on very cheap terms – but this has not been so positive for investors. With the OCR and three-year bond rate at or close to zero, where do investors go to generate capital stability and reliable income? The most obvious answer is credit markets. Credit markets are innately riskier than risk-free markets (government and let’s say bank deposits) but well-structured and appropriately priced corporate bonds/loans represent an appropriate risk versus return trade-off. A diversified pool of such bonds can produce an interest return ranging from say 3 per cent right up to 8 per cent and for loans, well north of 10 per cent. Sounds risky? Depends on the bond or the loan being offered. It’s all about risk assessment of the borrower mitigated by appropriate structural protections, matched by an appropriate interest rate.

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FIIG Securities recently reopened Australia’s high-yield unrated corporate bond market in 2020 with the first corporate deal in 12 months for a dual-listed company, Evolve Education (ASX: EVO), a childcare provider in New Zealand and Australia. What did FIIG like about EVO?:

  • Underlying cash flows payable to EVO are majority government-supported, subject to children occupying the centres.
  • Management team is highly experienced in the childcare sector.
  • The bond was secured over EVO’s operations.
  • There were, among other restrictions, limitations on the capacity for EVO to take on more debt.
  • The fixed interest rate was attractive at 7.5 per cent, for a five-year term.

For loan structures earning over 10 per cent, the same concepts apply but the company assessment, both in terms of the business case and management, becomes more critical.

A thorough and robust assessment of the creditworthiness of companies looking to borrow money is also critical, along with post-credit assessments and the establishment of structural protections for investors.

Tony Perkins, head of syndicate, FIIG Securities

 

Lower for longer interest rates drive SMSF hunt for yield
Tony Perkins
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