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Part 2: Performance and Outcomes

Introduction

This part of the annual report is presented in three sections: Section 1 provides an Annual Performance Statement as required by the PGPA Act; Section 2 details the AOFM’s issuance operations, debt and cash portfolio management task and its engagement with the market (namely investors); and Section 3 presents the main considerations for how the AOFM approaches strategy development to underpin its operational objectives.

Section 1: Annual Performance Statement

As the accountable authority of the Australian Office of Financial Management, I present the 2018-19 Annual Performance Statement of the Australian Office of Financial Management, as required under paragraph 39(1)(a) of the Public Governance, Performance and Accountability Act 2013 (PGPA Act).

In my opinion this annual performance statement accurately reflects the performance of the Australian Office of Financial Management, is based on properly maintained records and complies with subsection 39(2) of the PGPA Act.

Rob Nicholl

Chief Executive Officer

27 September 2019

Purpose

The AOFM’s purpose is to ensure the government’s debt financing needs are met each year while managing the cash, debt and other portfolios over the medium-long term at low cost subject to acceptable risk. The AOFM takes into account the potential for its operations to impact domestic financial markets.

The AOFM has adopted three key objectives to achieve its purpose:

  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 meet other portfolio responsibilities as directed by government.

The AOFM balances cost and risk considerations but its overriding aim is to ensure that the financing requirements of government are able to be met in full and on time. The AOFM has minimal appetite for failure in any function associated with issuance, settlement and cash management. The design and conduct of its core business processes (including its business continuity arrangements) reflect this risk appetite.

The AOFM monitors its performance against the performance indicators presented in Table 1, sourced from the AOFM’s Corporate Plan 2018-19 and Portfolio Budget Statements 2018-19. Sections 2 and 3 of this part of the Annual Report provide detail on a range of outcomes important to achievement by the AOFM of its annual and longer-term aims. This detail is provided separately to the Performance Statement because it is aimed at financial market participants as the relevant audience.

Table 1: Performance Information 2018–19

Performance Indicator(a)

Measure (b)

Objective 1: Meet the budget financing task in a cost effective manner subject to acceptable risk

1. Term issuance

Shortfall in volume ($) between actual Treasury Bond issuance and planned issuance announced at the Budget and subsequent releases.

2.1 Financing cost (portfolio)

2.2 Financing cost (issuance)

The cost of the long-term debt portfolio compared to the 10 year average of the 10-year bond rate.

The cost of Treasury Bond issuance over the past 12 months compared to the average 10-year bond rate over the same period.

3. New issuance yields

Weighted average issue yield at Treasury Bond and Treasury Indexed Bond tenders less prevailing mid-market secondary yields.

Objective 2: Facilitate the government’s cash outlay requirements as and when they fall due

4. Use of the overdraft facility

Number of instances the RBA overdraft facility was utilised to the extent that it required Ministerial approval during the assessment period.

Objective 3: AOFM is a credible custodian of the AGS market and other portfolio responsibilities

5. A liquid and efficient secondary market

Annual turnover in the secondary market for Treasury Bonds and Treasury Indexed Bonds.

6. Market commitments

Number of times the AOFM failed to undertake actions consistent with public announcements.

(a)  Source: AOFM Corporate Plan 2018-19; Portfolio Budget Statements 2018-19 Budget Related Paper No. 1.16 — Treasury Portfolio, p. 108

(b)  Source: AOFM measures performance against indicators using data captured from its market transactions; its financial systems recording portfolio composition; official notices to the market; and secondary financial market turnover data requested from intermediaries.

Performance Results 2018–19

Objective 1: Meet the budget financing task in a cost effective manner subject to acceptable risk

Indicator 1

Term Issuance: Shortfall in volume ($) between actual Treasury Bond issuance and planned issuance announced at the Budget and subsequent releases

Target

Zero

Result

Target met

The shortfall between actual and planned issuance was zero, with the financing task for 2018-19 fully met through the issuance of $60.9 billion of term securities. The financing task in any year comprises: funding for maturing AGS; any Budget deficit; and off-Budget funding requirements. If the AOFM undertakes higher bond issuance than planned it will adjust issuance in the following financial year accordingly and carry the additional cash as assets in the cash management portfolio. In the event bond issuance is lower than planned AOFM will have the choice of covering the difference with short-term funding (through the use of Treasury Notes) or running a lower asset balance in the cash management portfolio until increased bond issuance to compensate for this position has been executed.

Indicator 2.1

Financing cost (portfolio): The cost of the long-term debt portfolio compared to the 10 year average of the 10-year bond rate

Target

Lower

Result

Target met

The effective yield of the long term debt portfolio for 2018–19 was 3.26 per cent
(2017–18: 3.30 per cent). This is an expected outcome and is below the 10 year average of the 10 year bond rate of 3.52 per cent.

The trajectory and level of financing costs is an important consideration for the AOFM although in the short-term financing costs will lag movements in market yields due to the size of the debt portfolio. In an environment of declining interest rates (which characterises most of the period since the GFC), the financing cost of the long term debt portfolio will, all other things equal, decline as the AOFM replaces maturing debt issued (when rates were higher) with new debt issued at lower rates. The maturity profile of the portfolio is also relevant. If mainly longer term AGS are being issued for instance, the average term to maturity of the portfolio will be increasing while over time there will be fewer debt maturities to refinance each year. In a declining interest rate environment, this will result in a generally slower rate of decline in financing costs compared to issuing shorter term debt. The AOFM monitors the cost of the portfolio against the average 10-year bond rate because this is a globally relevant benchmark indicator. It is also closely associated with AOFM’s task of supporting the 10-year futures contract and it represents a highly liquid part of the AGS yield curve.

Indicator 2.2

Financing cost (issuance): The cost of Treasury Bond issuance over the past 12 months compared to the average 10-year bond rate over the same period

Target

Lower

Result

Target not met

The average yield of Treasury Bond issuance (accounting for the bulk of long term issuance) for 2018–19 was 2.29 per cent (2017–18: 2.70 per cent). This compares to the 2018–19 average of the 10 year bond rate of 2.26 per cent (2017–18: 2.71 per cent). The AOFM monitors issuance cost outcomes against the 10-year bond rate because it is a market relevant benchmark indicator and represents a highly liquid part of the AGS yield curve (making it a useful cost indicator of market conditions for the year overall). The 3 basis point outcome deviation from the indicator is within the AOFM’s expectation of a range of around plus/minus 10 basis points.

The average term to maturity of the Treasury Bond portfolio was 7.44 years as at 30 June 2019 (30 June 2018: 7.38 years). The average term of new issuance in 2018–19 was 11.27 years, which was longer than planned issuance of 11 years average term to maturity (2017-18 actual: 11.08 years).

The average yield on Treasury Bonds issued during 2018–19 was higher than the average 10 year bond rate during the year. This outcome reflected the longer average tenor of issuance of 11.27 years (compared with the 10 year cost performance indicator) and the ‘front-loading’ of the issuance program in the first half of the year in advance of what was a significant rally in bond yields through the second half of the year. It should be noted that the AOFM typically aims to achieve more than half of the issuance task prior to mid-year in order to mitigate funding risk for the remainder of the fiscal year.

Overall, debt issuance in 2018–19 was 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.

Indicator 3

New issuance yields: Weighted average issue yield at Treasury Bond and Treasury Indexed Bond tenders less prevailing mid-market secondary yields

Target

Issuance yields at or below the market rate

Result

Target met

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 (0.23 basis points), and Treasury Indexed Bonds (1.37 basis points).

How AOFM achieves this objective

Each year the AOFM’s financing task is determined by the forecast Budget balance, the need to refinance maturing debt, and funding to be undertaken by government that is additional to Budget requirements. The financing task can be adjusted in response to changes in management of the cash portfolio and the AOFM makes this operational judgement as appropriate from year to year.

The financing task is achieved through issuance of AGS, the mix of which is determined through an annual issuance strategy that balances debt portfolio risks (such as future interest rate volatility and funding risks) against differences in short and long-term borrowing costs.

The method of issuance is determined by balancing considerations of supporting AGS market liquidity and managing execution risk against the anticipated transaction costs associated with different issuance approaches (all of which contribute to overall portfolio costs). The majority of issuance occurs via competitive tender, which achieves the ‘best cost’ outcome for the government in most circumstances. The syndication method is reserved for situations in which execution risk (due to large issuance volume) and/or the trading liquidity of the security being issued are of primary consideration.

The criteria above show that the financing task was fully met while meeting expected costs associated with how this was achieved. Of the $60.9 billion in gross term issuance for the year, $53.55 billion was issued via competitive tender, with new issuance yields consistently lower than secondary market yields. The remainder was issued via syndication. Financing costs on the overall portfolio also compared favourably against market indicator rates. More detail on each of these aspects is provided in Section 2 below.

Objective 2: Facilitate the government’s cash outlay requirements as and when they fall due

Indicator 4

Use of overdraft facility: Number of instances the RBA overdraft facility was utilised to the extent that it required Ministerial approval during the assessment period

Target

Zero

Result

Target met

Sufficient cash was available at all times to meet the government’s outlays. The overdraft facility was not utilised in 2018–19.

How AOFM achieves this objective

This objective is achieved through management of the cash portfolio with the AOFM forecasting daily revenue collections and expenditure. At times there are significant mismatches between expenditure needs and revenue collected, which the AOFM accommodates through managing cash reserves and the use of short-term borrowing. There were no instances during the year where there was a need for the RBA overdraft facility to be used. The facility is used when the overnight cash balance in the official public account is not sufficient to cover expenditures.

Objective 3: AOFM is a credible custodian of the AGS market and other portfolio responsibilities

Indicator 5

A liquid and efficient secondary market: Annual turnover in the secondary market for Treasury Bonds and Treasury Indexed Bonds

Target

Greater than previous year

Result

Target met

AGS liquidity remained strong in 2018-19. Turnover of Treasury Bonds totalled $1.3 trillion (a 2 per cent increase from the previous year). Annual Treasury Indexed Bond turnover increased by 3 per cent, to $52 billion. Strong secondary market liquidity is a reflection of a range of factors but importantly includes regular AGS issuance by the AOFM that, amongst other factors, takes account of prevailing market conditions and the objective of supporting the futures contracts, active market making by intermediaries, and diversity of the AGS investor base.

Indicator 6

Market commitments: Number of times the AOFM failed to undertake actions consistent with public announcements

Target

Zero

Result

Target not met

The AOFM did not proceed with a previously planned and publicly announced operation on one occasion. The AOFM announced in both its annual speech to the Australian Business Economists Forum (Sydney, May 2018) and the Budget Operational Notice (May 2018), that it was planning to establish four new bond lines for 2018-19; these were to be: September 2023; May 2030; December 2030 and May 2041. The May 2030 and May 2041 new bond lines were introduced as planned and announced.

However, due to a reduction in the Budget financing task reported at MYEFO 2018-19, the AOFM decided it prudent, for reasons of supporting AGS market liquidity, to cancel establishment of the September 2023 and the December 2030 bond lines because there would not have been sufficient issuance in the reduced program to adequately support the introduction of these two bond lines at ‘liquid’ levels. The post-MYEFO Operational Notice made the statement that: “These lines are no longer planned to be issued”, which while sufficient notice to the market of the change in plan, was nonetheless inconsistent with the original Budget notice. The AOFM does not consider this type of change to be a material underachievement given the change in plan was appropriately timed and publicly transparent.

How AOFM achieves this objective

That the AOFM is judged by financial markets to be a credible custodian of the AGS market can be assessed from a number of perspectives. It is important to note, however, that the AOFM does not have any regulatory or statutory authority and any influence it has in the market is only by virtue of its operations (although it recognises the potential for this influence to be appreciable at times).

Good market liquidity is a key consideration for most investors because it reflects an ability to transact in the market (either through buying or selling AGS) in a timely manner and in volumes to meet their needs, without market prices being materially moved as a result of those transactions. Liquidity is a product of having a wide range of active ‘price makers’ in AGS and a large, diverse and active investor base. The AOFM supports liquidity through: restricting the number of individual bond lines so that each can have greater volume outstanding, regular and consistent issuance into maturities that are chosen to reflect investor demand, clear communication and transparency regarding the AOFM’s operations and issuance strategy, and a long standing focus on the development of a functional and resilient AGS market. High levels of secondary market turnover and regular feedback from investors attesting to their capacity to buy and sell large parcels of AGS at acceptable prices are strong indicators of liquidity for 2018–19. They also reflect favourably on the AOFM’s credibility as a sovereign issuer and custodian of the AGS market.

Section 2: Outcomes

This section gives context to the outcomes achieved through the AOFM’s operations in supporting its principal functions, and discusses relevant market aspects of the environment in which the AOFM operates.

Bond issuance

Aims

The AOFM currently has two different term debt instrument choices — nominal Treasury Bonds and Treasury Indexed Bonds, the latter for which the capital value is adjusted over time according to inflation outcomes. During times of Australian Government budget deficits the main aim of 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 while supporting market liquidity). 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.

A key 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 at short notice and 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.

Bond buybacks

The AOFM repurchases Treasury Bonds before their maturity with several aims in mind: to increase the duration of the debt portfolio, reduce refinancing risk, to assist in the cash management task around the time of bond maturities, enhancing the operation of the secondary market, and to offer broad assistance to the RBA in its liquidity management task when bond lines mature.

Treasury Indexed Bonds may be repurchased ahead of maturity from time to time. This may be to assist in the issue of a new line, or to enhance the operation of the secondary market.

Approach to achieving these aims and market influences

The AOFM uses competitive tenders and syndications to conduct bond issuance. Competitive tenders are the mainstay of AOFM’s issuance operations. 62 Treasury Bond tenders and 15 Treasury Indexed Bond tenders were conducted during the year. One new Treasury Bond line was launched by syndication and one new Treasury Bond line was launched by tender. One new Treasury Indexed Bond line was launched by syndication in 2018-19 extending the linker curve by ten years (to 2050).

Buybacks of short-dated Treasury Bonds were conducted via tenders, in conjunction with syndicated issues, and via bilateral transactions with the RBA.

Issuance volumes were lower than last year.

Bond yields during the first half of 2018-19 remained relatively stable with the market expecting higher policy rates. Over the same period the elevated funding rates experienced by some investors since late 2017 (including Australian repo markets) persisted, with heightened stress around quarter ends, continuing to limit some investors and market-makers ability to hold large positions in AGS.

The second half of 2018-19 saw a rapid reversal in market views of the next policy rate movement from a hike to a cut, driving a strong, consistent rally in the AGS market in concert with the strong rally across the major sovereign bond markets generally. By the end of the financial year, AGS yields had hit historic lows with the three-year bond yield below 1% and the entire curve trading below 2%. The lower yield environment resulted in the spread between yields on ten-year Australian Treasury Bonds and US Treasuries remaining negative, with the 30-year spread also turning negative during the year. The tightness of the funding pressures experienced during 2018 eased somewhat during the second half of 2018-19. Whilst lower relative AGS yields and periods of elevated funding can affect demand, investor diversity across the AGS market means there has been little aggregate change in demand.

The proportion of outstanding AGS held by offshore investors remained relatively stable throughout 2018–19, as illustrated in Chart 1. This followed a period of declining relative holdings of non-residents from 2012. Strong offshore demand from across a diverse investor base remains with interest spread across the curve. Ongoing interest for the futures basket bonds reflect their continued strong liquidity.

Chart 1: Proportion of AGS held by non-resident investors — 2012-2019

This chart shows the quarterly non-resident percentage holdings of Australian Government Securities from June 2012 to March 2019. Non-resident holdings had fallen slightly over that period, with a low of 54 per cent in June 2017 and a high of 76 per cent in June 2012.

 

Source: Australian Bureau of Statistics and the AOFM

Bond buybacks

The AOFM conducts regular competitive buyback tenders for the repurchase of short-dated Treasury Bonds. These operations are funded by separate tenders for issuance of longer-dated Treasury Bonds. Buyback tenders add to the AOFM’s operational flexibility and have become accepted as a standard feature of the AOFM’s operations.

There are two other ways in which the AOFM can repurchase bonds prior to maturity. Switches or buybacks can be accommodated in conjunction with syndicated issues; and via transactions with the RBA, which purchases short-dated Treasury Bonds in its liquidity operations.

During the year the AOFM repurchased Treasury Indexed Bonds several times. Holders of the 2018 Treasury Indexed Bond line were invited to submit offers of this line to the AOFM, in conjunction with the syndicated issue of the new 2041 bond line. The AOFM twice offered to repurchase the 2020 Treasury Indexed Bond: once in conjunction with the syndicated issue of the new 2050 line; and once via a special single price, unconstrained volume buyback auction.

Outcomes

Meeting the Budget financing task

The financing task for 2018–19 was fully met. A total of $60.90 billion of term debt was issued during the year.

At the time of the 2018–19 Budget, Treasury Bond and Treasury Indexed Bond issuance for the year was expected to total around $77 billion in face value terms. This volume was revised at the time of MYEFO in accordance with a revised improvement in the government’s fiscal position compared to Budget forecasts.

Treasury Bond issuance

Gross Treasury Bond issuance for the year totalled $55.0 billion. This was a significant reduction from the $75.5 billion of Treasury Bonds issued in 2017–18. The bulk of this issuance was into existing bond lines in order to enhance market liquidity. In addition, two new Treasury Bond lines were launched in 2018–19:

  • a new bond line maturing in June 2031 was issued 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 May 2041 was issued to support the operation of the 20-year Treasury Bond futures contract.

In selecting the bond lines to issue each week, the AOFM continued to follow its standard practice of taking into account the debt issuance strategy, prevailing market conditions, information from financial market contacts about investor demand, relative value considerations, the liquidity of outstanding bond lines, and managing the maturity structure to limit funding risk. One or two tenders were held during most weeks.

Large transaction volumes were achieved at issues of new Treasury Bonds. The May 2041 ($3.6 billion) was issued by syndication, while a tender was held for the initial issue of the June 2031 ($3.0 billion) bond line.

At the end of the year, there were 25 Treasury Bond lines, with 13 of these lines having over $20 billion on issue and 21 having over $10 billion on issue. Chart 2 shows Treasury Bonds outstanding as at 30 June 2019 and the allocation of issuance across bond lines during 2018–19.

Chart 2: Treasury Bonds outstanding as at 30 June 2019 and issuance in 2018–19

This chart shows the face value of Treasury Bonds outstanding as at 30 June 2019 as well as issuance for the 2018-19 financial year, for each bond line.  As at 30 June 2019 the April 2026 bond line had the highest face value of stock outstanding ($32.4 billion), while the May 2041 bond line had the lowest ($3.6 billion).  The bond lines issued into the most in 2018-19 were the May 2030 and November 2029 bond lines.  More than $11 billion was issued into each of these lines.

 

Treasury Bond buybacks

A total of $23.1 billion of Treasury Bonds were repurchased ahead of maturity in 2018-19, of which $16.7 billion were bonds maturing after 30 June 2019:

  • 25 Treasury Bond buyback tenders were conducted, at which $14.7 billion of bonds were repurchased;
  • the AOFM repurchased $2.05 billion of bonds in conjunction with the syndicated issue of the new 21 May 2041 Treasury Bond;
  • $6.3 billion of bonds were repurchased from the RBA; and
  • a small amount of bonds were repurchased from retail investors who sold their holdings via the Australian Government Securities Buyback Facility.

Buyback tenders are effectively a reverse of normal competitive issuance tenders. The AOFM sets the total volume of bonds it is prepared to buy back and offers from intermediaries are accepted from the highest yield (lowest price) in descending order until the total volume is reached. All Treasury Bond buybacks other than those from retail investors were of lines shorter than the three-year futures basket.

The volume outstanding in short-dated Treasury Bonds was reduced as illustrated in Chart 3.

Chart 3: Volume outstanding in short-dated Treasury Bonds as at 30 June 2018 and 30 June 2019

 

This chart shows the face value of Treasury bonds outstanding as at 30 June 2019 as well as at 30 June 2018, the difference being due to buybacks conducted by the AOFM on short-dated bond lines. The April 2020 bond line had the most buybacks ($7.30 billion).

 

Treasury Indexed Bond issuance

The AOFM maintains less than 10 per cent of the long-term debt portfolio in the form of 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 compared to Treasury Bonds, providing a source of diversification in the funding base. While the indexed bond portfolio has declined marginally as a share of the long term funding, the total stock of indexed bonds has continued to grow steadily (as shown in Chart 4).

Chart 4: Treasury Indexed Bonds — average term to maturity and share of the long-term funding base

Chart 4: Treasury Indexed Bond volume, average term to maturity and share of long-term funding base (OLD)  This is a combined column and line chart showing the quantum of Treasury Indexed Bonds in nominal face value terms together with the cumulative effect of capital indexation due to inflation.  Added together these two components show the inflation accreted face value of Treasury Indexed Bonds on issue.  A separate line shows the share of the long term funding base (measured as the sum of Treasury Bonds

 

Treasury Indexed Bond issuance for the year totalled $5.9 billion, of which $2.2 billion was conducted via tender. 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. A syndicated offer for $3.8 billion of a new February 2050 Treasury Indexed Bond line was conducted in September 2018. In conjunction with the syndication, around $2.1 billion of the August 2020 Treasury Indexed Bond line was repurchased.

Chart 5 shows the amount outstanding in each of the eight Treasury Indexed Bond lines as at 30 June 2019, and the allocation of issuance during the 2018–19 year.

Chart 5: Treasury Indexed Bonds outstanding as at 30 June 2019 and issuance in 2018–19

This chart shows the face value of Treasury Indexed bonds outstanding as at 30 June 2019 as well as issuance for the 2018-19 financial year, for each indexed bond line.  As at 30 June 2019 the September 2025 indexed bond line had the highest face value of stock outstanding ($7.2 billion), the August 2020 indexed bond line had the lowest ($2.1 billion).  The indexed bond line issued into the most in 2018-19 was the February 2050 bond line.

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 amount allocated ($m)

Weighted average issue yield (%)

Average spread to secondary market yield (basis points)

Average times covered

July - December 2018

Up to  2026

4,900

2.1670

-0.51

5.44

2027 - 2031

20,900

2.6644

-0.30

3.39

2032 - 2047

900

3.0703

-0.15

2.38

January - June 2019

Up to  2026

3,200

1.5485

-0.39

4.45

2027 - 2031

19,600

1.8815

-0.10

3.25

2032 - 2047

1,900

2.3736

0.08

2.64

The average coverage ratio for all Treasury Bond tenders in 2018–19 was 3.57, a decrease from 4.44 in 2017–18. The average tender size of $829 million was higher than in 2017-18, reflecting a move to less frequent tenders. Shorter-dated bond tenders generally received a greater volume of bids (higher than average coverage ratios), which reflected both core investor base interest and a lower supply of short-dated bonds.

The strength of bidding at tenders was also 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 4.40 for Treasury Indexed Bond tenders, an increase from 3.53 in 2017–18. 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 during 2018-19 with liquidity and efficient price discovery being maintained throughout the year. Repo rates during the first half of the year remained high compared to long term averages with continued pressure around quarter ends, raising the costs to some investors and market makers of holding AGS. The elevated rates experienced during 2018 eased somewhat during the second half of the year.

Chart 6: Annual Treasury Bond Turnover

This chart shows the turnover by category for Treasury Bonds for 2018-19 compared to 2017-18. Turnover has increased in the Other domestic, Other International, Asia (ex. Japan), Americas and UK categories. Turnover has decreased in the Interbank, Bank Balance Sheet, Japan and Europe categories. The largest category is Interbank which had turnover of $340 billion.

AOFM monitoring of the market indicates that liquidity in Treasury Indexed Bonds has continued to prove noticeably more challenging than for Treasury Bonds. This is consistent with the relative liquidity of nominal and inflation-linked securities in other sovereign debt markets. Treasury Indexed Bond turnover in 2018-19 was around $52 billion, an increase of 3 per cent from 2017-18. This was driven by a decrease of Interbank turnover Australian investors and in Asia (ex Japan). Intermediaries are responsible for the bulk of trades.

Chart 7: Annual Treasury Indexed Bond Turnover

This chart shows the turnover by category for Treasury Indexed Bonds for 2018-19 compared to 2017-18. Turnover has increased in the Bank Balance Sheet, Other domestic, Americas and UK categories. Turnover has decreased in the Interbank, Asia (ex. Japan), Japan, Europe and Other International categories. The largest category is Other Domestic which had turnover of $26 billion.

There was tightness in several indexed bond lines at times during the year, requiring some market participants to borrow these from the securities lending facility.

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: over 60 million three-year contracts (representing $6.0 trillion face value of bonds) and over 52 million 10-year contracts ($5.2 trillion face value of bonds) were traded in 2018–19. Turnover in the 20-year contract is considerably lower: 259,000 contracts ($15.8 billion face value of bonds) were traded. All contract close-outs in 2018–19 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 21 times for overnight borrowing in 2018–19 compared with 52 times during 2017-18. The volumes borrowed were lower than in 2017–18, with the total face value amount lent in 2018–19 being $393 million, a decrease from $1,667 million in the previous year.

Debt portfolio management

Aims

This section details the outcomes of the AOFM’s portfolio management activities. In managing the debt portfolio and meeting the government’s financing requirements, the AOFM aims for low and stable debt servicing costs over the medium-long term. It also seeks to maintain liquid bond lines to facilitate cost-effective issuance of debt through time and to effectively manage future funding and refinancing risks.

Approach to achieving the aims

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 providing consistent and transparent stewardship of the AGS market in order to underpin confidence and promote market liquidity. Through its operations the AOFM contributes to an efficient and resilient market while seeking to maintain continuity of access to financial markets for the Australian Government.

The AOFM uses cost and risk measures that reflect the considerations faced by sovereign debt managers generally. The primary cost measure used is historic accrual debt service cost. This includes interest payments made on AGS, realised market value gains and losses on repurchases, 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 facilitates an assessment of financial risk exposures and changes in those exposures from year to year, the value of transactions managed and the economic consequences of alternative strategies. It is most useful in the context of trading for profit making purposes.

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 ‘re-priced’) through time.

Outcomes

Portfolio cost

The debt servicing cost[1] of the net AGS portfolio managed by the AOFM in 2018–19 was $17.42 billion on an average book volume of $527.01 billion, representing a net cost of funds of 3.31 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 $17.92 billion on an average book volume of $550.16 billion, implying a cost of funds of 3.26 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 state housing advances).

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 2018-19 as well as 2017–18.

Table 3: Commonwealth debt and assets administered by the AOFM

 

Debt servicing cost

$ million

Book volume

$ million

Effective yield

per cent per annum

 

2017-18

2018-19

2017-18

2018-19

2017-18

2018-19

Contribution by instrument

    Treasury Bonds

(15,854)

(16,136)

(485,291)

(505,825)

3.27

3.19

    Treasury Indexed Bonds

(1,598)

(1,785)

(43,207)

(44,337)

3.70

4.03

    Treasury Notes

(67)

(63)

(3,950)

(3,398)

1.70

1.85

Gross physical AGS debt

(17,519)

(17,984)

(532,448)

(553,560)

3.29

3.25

    Term deposits with the RBA

650

459

37,095

24,748

1.75

1.85

    RMBS investments

37

 

915

 

4.04

0.00

    State Housing Advances

110

106

1,880

1,801

5.86

5.89

Gross assets

797

565

39,890

26,548

2.00

2.13

Net AGS debt

(16,722)

(17,419)

(492,558)

(527,011)

3.39

3.31

Contribution by portfolio

Long Term Debt Portfolio

(17,452)

(17,921)

(528,498)

(550,162)

3.30

3.26

Cash Management Portfolio

583

396

33,145

21,350

1.76

1.85

RMBS Portfolio

37

 

915

 

4.04

0.00

State Housing Portfolio

110

106

1,880

       1,801

5.86

5.89

Total debt and assets

(16,722)

(17,419)

(492,558)

(527,011)

3.39

3.31

Re-measurements (a)

581

(43,550)

       

Total after re-measurements

(16,141)

(60,969)

(492,558)

(527,011)

   

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.

(a)  Interest expense and effective yield on foreign loans incorporates foreign exchange revaluation effects.

(b)  Re-measurements refer to unrealised gains and losses from changes in the market valuation of financial assets and liabilities.

The cost of gross debt increased in dollar terms by $0.47 billion compared to the previous year. This was primarily due to an increase in the average volume of debt on issue by $21.11 billion to $553.65 billion. However, in percentage terms the funding cost of gross debt declined by 4 basis points to 3.25 per cent. This improvement was driven by the issuance of new bonds at yields that were below the average of pre-existing (and maturing) debt.

The return on gross assets in dollar terms for the period was $565 million, a decrease of $232 million compared to 2017–18. This was driven by a $191 million decrease in income from term deposits (resulting from smaller holdings) as well as a $37 million reduction in income following the completion of the RMBS divestment process in February 2018. However, in percentage terms the return of gross assets increased by 13 basis points to 2.13 per cent.

The net servicing cost of the combined portfolio of debt and assets was $17.42 billion. This was higher in dollar terms compared to 2017–18, primarily due to the higher volume of debt on issue. In percentage terms, net debt servicing costs fell from 3.39 per cent to 3.31 per cent, slightly larger than the fall in gross debt servicing costs.

Movements in market interest rates had an unfavourable impact on the market value of the portfolio in 2018–19. Unrealised losses from re-measurements amounted to $43.55 billion. This compares to an unrealised gain of $0.58 billion in the previous year. Most of the re-measurement losses are attributable to changes in the market value of Treasury Bonds. Re-measurement items are highly volatile from one year to the next and 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. However, this would create 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 bond lines.

Portfolio risk management

Chart 8 shows the funding cost profile of the net AGS debt portfolio and the LTDP back to 2007-08. These profiles are contrasted with the cash rate and the 10-year moving average of the 10-year bond yield. With interest rates trending down, funding costs on net debt and the LTDP have declined by 188 and 200 basis points respectively since 2010-11. This compares to declines of 350 basis points in the cash rate and 205 basis points in the 10 year average of the 10-year bond rate over the same period. Given the largely fixed cost structure of net debt 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).

Chart 8: Net AGS debt and LTDP cost of funds analysis (per cent)

This is a line chart showing cost (expressed as a percentage) of the net AGS debt portfolio and the Long Term Debt Portfolio since 2007-08. These are compared with the cash rate and a moving average of 10 year government bond yields. Lower interest rates have resulted in net AGS debt funding costs falling to 3.3 per cent in 2018-19 (down from 6.6 per cent in 2007-08). Costs have fallen broadly in line with the moving average of the 10 year government bond yield.

 

The reduced risk levels of the portfolio in terms of funding, refinancing and interest rate risk 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[2]. 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; these have continued to decline and have now fallen to 21 per cent and 39 per cent.

Chart 9: Treasury Bond portfolio — maturity profile

This is a combined line and column chart. The lines show the proportion of Treasury Bonds maturing within 3 years and 5 years respectively, as at 30 June each year since 2009. A stacked column chart is overlayed showing the total face value of bonds on issue broken into matching maturity segments. Three and 5 year maturities now account for 21 and 39 per cent of bonds on issue (down from 43 and 65 per cent in 2010) equal to $103 and $197 billion respectively.

 

Cash management

Aims

The AOFM manages the daily cash balances of the Australian Government in the OPA.[3] This is undertaken in a manner that ensures 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 at low or minimal risk). In minimising cost, the AOFM seeks to avoid use of the overdraft facility provided by the RBA.[4]

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.

A precautionary asset balance is maintained to manage the forecasting risk associated with potentially large unexpected cash requirements (or shortfalls in revenue collections) and the funding risk associated with market constraints.

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 $2.5 billion to $5.0 billion during 2018–19.

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 10 shows movement in the funding requirement over the year.

Chart 10: Within-year funding requirement 2018–19

This chart shows the level of short-term financial assets held by the AOFM less Treasury Notes on issue throughout the 2018-19 financial year. It shows the within-year funding requirements during the year, with peak to trough fluctuations of around $36 billion.

 

Outcomes

The task of meeting the government’s financial obligations as and when they fall due was fully met. The overdraft facility was not utilised in 2018–19.

During 2018–19, the AOFM placed 390 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. The balance of term deposits ranged from a maximum of $46.0 billion in July 2018 to a minimum of $11.3 billion in January 2019.

The average yield obtained on term deposits during 2018–19 was 1.85 per cent, compared with 1.75 per cent in 2017–18. The increase in average yield reflects the higher average level of short-dated interest rates that prevailed during 2018–19.

A total of $13.5 billion of Treasury Notes were issued in 2018–19 (in face value terms). The average coverage ratio at tenders was 4.61, an increase from 4.07 in 2017–18. Yields were on average around 35 basis points higher than Overnight Indexed Swap (OIS) rates for corresponding tenors (compared to around 25 basis points higher than OIS rates in 2017–18), reflecting higher spreads across Australian short-dated funding rates. Details are available 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 2018–19 are shown in Chart 11.

Chart 11: Short-term financial asset holdings and Treasury Notes on issue 2018–19

This chart shows the value of short-term financial assets held by the AOFM and Treasury Notes on issue throughout the 2018-19 financial year, in two separate series. The value of short-term financial assets held by the AOFM ranged from around $12 billion to slightly over $47 billion, whilst the face value of Treasury Notes on issue ranged from $2.5 to $5.0 billion.

 

In undertaking its cash management activities, the AOFM was required to adhere to a set of cash management principles which required that balances in the OPA be sufficient to meet the Commonwealth’s operational needs without being excessive, with use of the overdraft facility expected to be infrequent and in general only to cover unexpected events (due to timing or quantum or both). The AOFM has developed an operational framework to adhere to the principles. The average OPA balance for the year was $1.240 billion.

Market engagement

Aims

Consistent and regular market engagement assists the AOFM to maintain a comprehensive understanding of market related issues including 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 AGS market. While this latter aim can in part be served by assessing announced regulatory changes, there remains the need for ongoing direct engagement with market participants. The AOFM also understands the importance of regular engagement with investors to ensure that they understand the key considerations underpinning the AOFM’s issuance and market maintenance/development strategies and appreciable changes in operation should these arise from time to time.

Market engagement by the AOFM continues to place a heavy emphasis on maintaining lines of communication with investors and bank intermediaries. This is done directly with both, and indirectly, with investors through feedback from the banks. Ongoing engagement assists greatly in understanding how investors view financial markets generally and in turn their view on the outlook for AGS and how intermediaries interact with and service the end investor.

Approach to achieving the Aims

Market engagement is based on an investor relations program underpinned by an investor relations strategy that is reviewed annually. This review takes account of changes in market conditions, investor activity, known changes in the key investor base, and the AOFM’s planned issuance strategy.

The Investor Relations strategy has three themes:

  • collecting and analysing market intelligence from investors;
  • managing and maintaining updates to key investors about the AOFM’s program of activities and its intended operations; and
  • a deepening of the investor base through engagement with new or potentially new investors.

Diversification of the AGS investor base is expected to change with appreciable shifts in financial market conditions. Given the complexity of influences on the attractiveness of AGS relative to alternative investment options it is difficult to predict with a high degree of confidence full detail of the AGS investor composition at any point in time. However, the AOFM is highly active in looking to understand changes as they occur. It does this through high frequency and comprehensive communication with market participants. In this regard the major focus of investor engagement continues to be, engaging with our key investors and collecting and analysing the information on their portfolio activities as we receive it from them.

Outcomes

For the last two years the AOFM’s market engagement has been heavily guided by the shift in its operations away from active market development through yield curve extensions and the introduction of a high number of new Treasury Bond and Treasury Indexed Bond maturities, to more of a market maintenance role. There were effectively two key drivers for this change; one was achieving the market and portfolio objectives of establishing 30-year benchmark yield curves for both the nominal and indexed yield curves (with no strong incentive to extend beyond 30-years), and the ongoing reduction in the budget deficit with consequent smaller funding tasks. Together these factors have made the AOFM’s discussion with market participants appreciably more straightforward and this has allowed for an easier task of updating investors via teleconference and videoconferencing as substitutes for the regular face-to-face engagement that had previously been more appropriate. Due to the April Budget followed by the federal election, direct engagement over the months of March through to June was not conducted.

For the year overall, discussions were held with 95 investors directly (compared with 128 in 2017–18). This comprised of 65 face to face meetings and 30 video/teleconferencing calls. Although direct investor meetings were down from the year before, the AOFM was still able to cover a larger number of geographically diverse key AGS investors from differing sectors of the market. Key investors engaged via teleconference and videoconference were from 19 cities outside of Australia.

The AOFM intends to continue these methods where appropriate as a supplement to direct face-to-face meetings. However for some areas or regions the AOFM did not feel that conference calls were an appropriate method to use due to the lack of familiarity with certain investors and other practical considerations.

Face-to-face meetings with investors were held with the domestic investor base; around 30 meetings with large fund managers, bank balance sheets and superannuation funds. Domestic investors continue to hold around 40 per cent of total AGS outstanding. There was one overseas series of meetings conducted in London, Paris and Madrid.

To also supplement communication with investors, the AOFM launched a quarterly investor note (Investor Insights) on the 1st of June this year via the AOFM website. ‘Investor Insights’ will provide AOFM views and background thinking on a range of AGS related matters.

The AOFM continued its past practice of using appropriate opportunities offered through conferences and speaking events. These events offer AOFM the opportunity to engage briefly but directly with investors and to reiterate key messages and themes, regarding AGS issuance and its market impacts. Each year the Australian Business Economists hosts a post-Budget speech by the CEO. It remains an important platform to provide information to the market for the upcoming year by giving the market some detail around the AOFM’s intentions for forthcoming issuance and operations; (June) 2019 was the ninth consecutive year for this event.

The conference and investor missions hosted by the financial intermediaries in which the AOFM participated included a CBA Fixed Income Conference, ANZ Hunter Valley Debt Conference, the Deutsche Bank Investor Mission and an ANZ Investor Tour. The AOFM also spoke at the annual KangaNews roundtable and again participated in its annual year book publication. While these events do not substitute for the benefits derived from face-to-face meetings, they remain useful in their own right and typically offer opportunity for short face-to-face meetings with selected attendees.

The current approach to maintaining investor engagement is considered appropriate during lower and stable issuance programs and with the current operational approach to achieving these programs having been comprehensively explained to and understood by AGS investors. In the event that the AOFM foreshadowed a significant change in issuance or the nature of its approach to the market, a return to more intensive and widespread face-to-face investor engagement would be considered as appropriate.

Table 4: Summary of investor relations activities in 2018-19

Activity

Details

Conferences, speaking engagements and investor roadshows

9 events 

Presentations: large engagements/ roundtables

5 presentations

Approximate total audience size: large presentations

220 attendees

Individual investor meetings

65 investor meetings

Individual investor Tele/ Video Calls 30

Individual cities visited

7 cities

AOFM staff participating in investor relation activities

CEO, Head of Investor Relations, Head Portfolio Strategy & Research, Head Funding & Liquidity. Head of Market Intelligence, Senior Analyst, Investor Relations, Analyst Funding and Liquidity

Hosting banks: Investor roadshows, conferences, roundtable discussions

ANZ, Citi Commonwealth Bank of Australia, Deutsche Bank UBS, Westpac

Section 3: Portfolio and Operational Strategy

Debt Portfolio Management

Aims

The AOFM is a price-taker in global capital markets but influences the cost and risk profile of the AGS portfolio through the maturity structure of the 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)[5] although this is compensated by reduced variability in future interest cost outcomes and lower exposure to refinancing risk.[6] Issuing shorter term debt securities by contrast will typically incur less interest cost (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.

Developing a medium to long-term view on appropriate portfolio management and then translating that into annual decision making on a strategy to implement that portfolio management objective is informed by an ongoing research program. This program is focussed on exploring the cost and risk characteristics of alternative portfolio structures and issuance strategies under a wide range of scenarios. This is done in light of prevailing fiscal and economic conditions, as well as an assessment of broader market trends. Drawing on this research, the AOFM formulated a strategy for the structure and composition of issuance for 2018-19 that was approved by the Treasurer at the time of the Budget. 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. These governance arrangements provide appropriate oversight for the impact of AOFM’s gross issuance decisions each year on overall debt policy.

Implementing the annual issuance strategy involves weekly decisions such as determining how much and which lines to issue, or when a new maturity should be established. These operational decisions are influenced by several factors including prevailing market conditions, relative value considerations and feedback from intermediaries and investors. The ongoing suitability of the annual debt issuance and portfolio strategies is under constant review, but the strategies would only be changed during the year in the face of substantive changes to market conditions or the fiscal outlook.

Debt Issuance Strategy

The AOFM’s strategy for 2018-19 was formulated amid a strengthening global economic environment, and was in large part influenced by a continuation of low outright bond yields (from a historical perspective), and a low term premium (which increases the cost-effectiveness of longer term issuance).

In the first half of 2018-19 the synchronised strengthening of global economic data continued and expectations of higher policy rates tended to result in higher government bond yields. However, there was an abrupt change in the outlook in mid-2018-19 as expectations for global growth and monetary policy were revised to reflect a weakening outlook, leading to a significant rally in government bond yields (Chart 12).

Chart 12: Evolution of Treasury Bond benchmark yields

This is a line chart that shows the yields on 2, 10, 20 and 30 year Treasury Bonds through 2018‑19.  The chart shows that bond yields were generally flat until late in the second quarter of the financial year, where they began to move lower. Across the year, bond yields declined by 100 basis or more across each maturity and ended the year near historic lows.

 

The yield curve flattened through the first half of 2018-19 before re-steepening in the second half of the year. Most of this change in longer bond yields reflected changes in other markets more than appreciable changes in the demand for AGS. Short-term AGS yields decreased in 2018-19 reflecting market expectations for a lower RBA monetary policy rate. The cash rate was subsequently lowered in June 2019 to 1.25 per cent to a new historic low. The 10-year and 30-year benchmark yield ended the financial year at 1.32 and 1.94 per cent respectively (also near historic lows).

In light of prevailing market conditions and funding requirements, the AOFM’s strategy in 2018–19 followed a broadly similar theme to recent years, with a bias toward longer term issuance and further lengthening of the average term to maturity of the debt portfolio. Low outright rates and a very low (or zero) term premium reinforced this strategy from a cost effectiveness perspective. At its core, the 2018–19 portfolio strategy was designed to preserve the AOFM’s operational flexibility under a wide variety of circumstances, while continuing to benefit from the relatively low interest rates on offer. The strategy was complemented by a regular program of bond buyback tenders. The strategy also aimed to support diversity in the AGS investor base.

Debt Portfolio and Issuance Metrics

Chart 13 demonstrates the lengthening bias implicit in the AOFM’s issuance strategy with the average Treasury Bond issued in 2018–19 having a term to maturity of 11.27 years[7]. The issuance program continued to benefit from low interest rates, with an average yield on new issuance of 2.29 per cent. [8]

Chart 13: Treasury Bond issuance — average yield, term to maturity and 10-year bond yield

This is a line chart showing the average yield and term to maturity of Treasury Bond issuance by financial year. It shows that the average term of issuance increased from a low of 5.77 years in 2009-10 to 11.27 years in 2018-19. The average yield of issuance fell from 5.22 to 2.29 per cent over this same period. Average issuance yields have been closely correlated with 10 year bond yields (also shown on the chart).

 

Chart 14 shows that the average term to maturity of the Treasury Bond portfolio as a whole lengthened by 0.06 years to 7.44 years over 2018-2019. Duration was also higher by 0.43 years finishing the year at 6.60 years. The effective cost of funds (or yield) on the Treasury Bond portfolio fell from 3.12 to 2.99 over the same period.[9]

Chart 14: Treasury Bond portfolio — modified duration, average term to maturity and cost of funds

This is a line chart showing average term to maturity, duration and cost of funds of the Treasury Bond portfolio. Average term and duration have steadily increased (consistent with AOFM’s debt strategy) while cost of funds has steadily declined since 2010-11 (due to declining interest rates). As at 30 June 2019, average term, duration and cost of funds were 7.44 years, 6.60 years and 2.99 per cent respectively.

 

The structure and effective yield on the Treasury Bond portfolio as at 30 June 2019 is a product of issuance undertaken since the 2007-08 fiscal year. Around two thirds of the current portfolio for instance was issued in the last four financial years at average yields below the portfolio average of 2.99 percent as depicted in Chart 15.

Chart 15: Treasury Bond portfolio — composition and average yield by issuance year, as at 30 June 2019

This is a combined column and scatter chart. Columns decompose the current Treasury Bond portfolio by the financial year in which they were issued. A separate marker for each financial year shows the yield on that issuance. Around two thirds of the current portfolio was issued in the last 4 years. The average yield achieved on this issuance is below the current portfolio average of around 3 per cent.

 

Chart 16 shows that more than half of current Treasury Bonds were issued with an original term to maturity of between 9 and 12 years. When issuance beyond 12 years is included, around three quarters of the portfolio has been issued with an original term to maturity of 9 years or longer. The predominance of longer term bonds in the portfolio is reflective of the AOFM lengthening bias since the start of the decade. This has contributed considerably to aim of reducing funding risk and the potential for high volatility in future interest rate outcomes.

Chart 16: Treasury Bond portfolio — composition and average yield by original term to maturity, as at 30 June 2019

This is a combined column and scatter chart showing the distribution of Treasury Bonds by original term to maturity. Each column represents a different maturity bucket. The buckets are: 0‑3; 3‑6; 6‑9; 9‑12; 12‑15 and 15+ years. Around half of the portfolio was issued with 9-12 year maturities. Separate markers show the average yield in each bucket. Longer maturities have generally higher yields.

 

The AOFM’s strategy for the indexed bond proportion of the portfolio has been to provide sufficient supply to meet investor requirements while supporting liquidity and the continuing development of the market over time. Over 2018-19, Treasury Indexed Bonds comprised on average around 8 per cent of total term debt (nominal and indexed bonds) on issue. This share has been stable for several years now although the overall size of the market has continued to grow in dollar terms. Issuance of Treasury Indexed Bonds in 2018-19 was $5.9 billion gross and $0.5 billion in net terms after buybacks and maturities. The real yield curve was extended to 30 years through the successful launch of the 2050 line in September 2018.

In 2018–19, the AOFM continued to favour a relatively defensive liquidity strategy by maintaining an asset buffer (in the form of term deposits with the RBA) to act as a precaution against a possible deterioration in funding conditions. The AOFM anticipated that it would have sufficient cash and liquid assets available, each business day of the fiscal year, to fund the next four or more weeks of projected net government outlays and AGS maturities.

 

[1]     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.

[2]     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.

[3]    The OPA is the collective term for the core bank accounts maintained at the RBA for Australian Government cash balance management.

[4]    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.

[5]     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.

[6]     Refinancing risk, also referred to as rollover risk or re-pricing risk, is the risk that renewed borrowings to replace maturing debt occurs on unfavourable terms (or perhaps not at all).

[7]     Calculation is based on the term to maturity of each bond issued during the year, weighted by book value.

[8]     Calculation is based on issue yields during the year weighted by book value.

[9]     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. Figures are calculated by weighting Treasury Bond issuance yields by book volume.