NO RTH SYD N E Y COUN CI L R E POR T S · 2018-06-22 · ITEM G05 REPORTS 18/08/14 NO RTH SYD N E Y COUN CI L R E POR T S Report to General Manager Attachments: 1. Investment Portfolio

ITEM G05 REPORTS 18/08/14

N O R T H S Y D N E Y C O U N C I L R E P O R T S

Report to General Manager Attachments:

1. Investment Portfolio as at 30 June 2014 2. Investment Portfolio as at 31 July 2014

3. Quarterly Investment Report 30 June 2014

SUBJECT: Investments Held as at 30 June 2014 and 31 July 2014 AUTHOR: Garry Ross, Manager Financial Services ENDORSED BY: Ross McCreanor, Director Corporate Services EXECUTIVE SUMMARY: This report provides details of the performance of Council’s investment portfolio for the months of June and July 2014. The portfolio provided an annualised return of 4.46% for the year to date as at 30 June 2014, 1.75% above the reportable benchmark (BBSW Bank Bill Index) and an annualised return of 4.53% for the year to date as at 31 July 2014, 1.79% above the reportable benchmark. FINANCIAL IMPLICATIONS: Interest returns for the financial year ended 30 June 2014 were higher than expected. This was attributed to additional funds being made available for investment and prudent selection and allocation of these funds to the financial institutions which make up the investment portfolio. Interest returns for this financial year reflect estimated available funds and predicted expenditure of Council’s reserves. Comment by Director Corporate Services: The 2014/15 budget estimate for returns from Council’s investment portfolio will be reviewed in the September Quarterly Budget Review. RECOMMENDATION: 1. THAT the Investments Held as at 30 June 2014 and 31 July 2014 report be received.

Report of Garry Ross, Manager Financial Services Re: Investments Held as at 30 June and 31 July 2014

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LINK TO DELIVERY PROGRAM The relationship with the Delivery Program is as follows: Direction: 5. Our Civic Leadership Outcome: 5.2 Council is financially sustainable BACKGROUND The Responsible Accounting Officer must provide Council with a monthly report detailing all funds invested under Section 625 of the Local Government Act 1993. This report must include certification that the investments have been made in accordance with the Act and the Regulations made thereunder, the revised Investment Order issued by the Minister for Local Government and Council’s Financial Investment Policy. CONSULTATION REQUIREMENTS Community engagement is not required. SUSTAINABILITY STATEMENT The following table provides a summary of the key sustainability implications: QBL Pillar Implications Environment There are no perceived short or long-term environmental implications. Social There are no perceived short or long-term social implications. Economic Provides Council with a significant source of income. Governance Compliance with all legislative requirements and statutory obligations. DETAIL The following table provides details of the performance of Council’s investment portfolio against the benchmark for the months of June and July 2014. June 2014 YTD as at

30 June 2014 July 2014 YTD as at

31 July 2014

Actual Return 0.36% 4.46% 0.38 % 4.53%Benchmark 0.22% 2.71% 0.23 % 2.74%Variance 0.14% 1.75% 0.15 % 1.79%


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The following table shows the actual cash inflows received from the portfolio for the months of June and July 2014 and for the year to date as at 30 June and 31 July 2014. June 2014 YTD as at

30 June 2014 July 2014 YTD as at

31 July 2014

Capital Guaranteed $0.00 $0.00 $0.00 $0.00Cash Enhanced Funds $0.00 $0.00 $0.00 $0.00Fixed Cash Fund $0.00 $0.00 $0.00 $0.00Senior Bonds $71,132.58 $966,386.58 $111,145.61 $111,145.61Term Deposits $497,550.00 $2,401,823.68 $22,558.38 $22,558.38Trading Accounts $18,216.31 $210,218.43 $10,992.46 $10,992.46 $586,898.89 $3,578,428.69 $144,696.45 $144,696.45 Investment Performance

Investment returns continue to exceed the indicative benchmark (BBSW Bank Bill Index). All funds invested have been done so in accordance with the Act and the Regulations made thereunder and with Council’s Financial Investment Policy. Further, Council’s investment portfolio complies with the revised Investment Order issued by the Minister for Local Government, which places restrictions on the type of investments permitted. These restrictions have placed greater emphasis on obtaining competitive investment options and the need for sound investment advice from Council’s independent advisor. Council continues to seek independent advice for all investments and is actively managing the portfolio to ensure that returns are maximised, taking into account diversification and risk. Summary of Returns from Investments: Year Original

Budget Revised Budget YTD/Annual

Actual (July)YTD Budget

Variance (July)

2014/15 $3,400,000 $3,400,000 364,708 $81,375

2013/14 $2,700,000 $3,400,000 $3,983,515 $583,5152012/13 $2,000,000 $2,887,751 $4,238,785 $1,353,0692011/12 $2,000,000 $3,400,000 $3,728,080 $328,080 Investments held for June (Annualised):

Investment Type %Portfolio June 2014 June % Return

June YTD% Return

Fixed Cash Fund 0.0% $0.00 0.00% 0.00% Senior Bonds 22.75% $21,824,982.42 4.01% 3.98% Term Deposits 71.61% $68,685,600.00 4.60% 4.60% Trading Accounts 5.64% $5,412,012.60 2.70% 2.92% Grand Total 100.00% $95,922,595.02 4.46% 4.71%


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Investments held for July (Annualised):

Investment Type %Portfolio July 2014 July 2014 % Return

July 2014 YTD% Return

Fixed Cash Fund 0.0% $0.00 0.00% 0.00%Senior Bonds 22.41% $21,818,062.42 3.98% 3.98%Term Deposits 70.54% $68,685,600.00 4.60% 4.60%Trading Accounts 7.05% $6,861,341.93 2.69% 2.69%Grand Total 100.00% $97,365,004.35 4.53% 4.53%

S & P Rating Investments Market Value % of Portfolio (July) AAA $74,573.48 0.00%

AA $0.00 0.00% AA- $38,854,510.87 40.00% $38,854,510.87 40.00%

A+ $6,500,000.00 7.00% A $2,000,000.00 2.00% A- $22,000,320.00 22.00% $30,500,320.00 31.00%

BBB+ $12,250,000.00 13.00% BBB $0.00 0.00% BBB- $9,500,000.00 10.00% NR $6,185,600.00 6.00% $27,935,600.00 29.00% $97,365,004.35 100.00%

The maximum holding limit in each rating category and the target credit quality weighting for Council’s portfolio shall be:

S & P Rating Investments Market Value % of Portfolio (June) AAA $4,204.39 0.00%

AA $0.00 0.00% AA- $37,475,550.63 39.00% $37,475,550.63 39.00%

A+ $7,500,000.00 8.00% A $1,006,920.00 1.00% A- $22,000,320.00 23.00% $30,507,240.00 32.00%

BBB+ $12,250,000.00 13.00% BBB $0.00 0.00% BBB- $9,500,000.00 10.00% NR $6,185,600.00 6.00% $27,935,600.00 29.00% $95,922,595.02 100.00%


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Long Term Rating Range Maximum Holding AAA Category 100.00% AA Category 100.00% A Category 60.00% BBB Category and Unrated ADIs 40.00%

Investment S&P Net Returns - 1 Month Net Returns - FYTDMarket Value % Rating # Return* Income^ Return Income^ Maturity

Trading Account:CBA Trading Account - General Fund 407,808.21 0% AA- 2.70 2,151.57 2.61 28,481.45 At CallCBA Business On-Line Saver 5,000,000.00 5% AA- 2.70 13,204.72 2.95 158,404.96 At CallUBS Cash Management Trust 4,204.39 0% AAA 1.62 1,237.46 1.64 8,039.63 At CallRaboDirect High Interest Account 0.00 0% AA 3.15 0.11 3.12 3.25 At CallDelphi Bank - Midas Account 0.00 0% A- 3.45 1,622.45 3.54 5,430.27 At Call

5,412,012.60 6% 2.70 18,216.31 2.92 200,359.56Term Deposits:RaboDirect @ 3.60% to 14 August 2014 1,000,000.00 1% AA- 3.60 2,958.90 3.60 7,495.88 14-Aug-14AMP @ 4.05% to 28 August 2014 1,000,000.00 1% A+ 4.05 3,328.77 4.05 34,064.42 28-Aug-14BoQ @ 5.20% to 28 August 2014 1,000,000.00 1% A- 5.20 4,273.97 5.20 52,000.00 28-Aug-14St George @ 5.20% to 28 August 2014 3,000,000.00 3% AA- 5.20 12,821.92 5.20 156,000.04 28-Aug-14AMP @ 4.00% to 9 September 2014 ~ 3,000,000.00 3% A+ 4.00 9,863.01 4.00 96,986.29 9-Sep-14Heritage @ 5.00% to 11 September 2014 1,500,000.00 2% BBB+ 5.00 6,164.38 5.00 74,999.96 11-Sep-14Quay CU @ 4.75% to 3 December 2014 1,000,000.00 1% NR 4.75 3,904.11 4.75 20,171.25 3-Dec-14NAB @ 4.47% to 26 February 2015 2,000,000.00 2% AA- 4.47 7,347.95 4.47 89,400.04 26-Feb-15ING @ 3.82% to 2 March 2015 3,000,000.00 3% A- 3.82 9,419.18 3.82 38,618.63 2-Mar-15RaboDirect @ 4.06% to 16 March 2015 1,500,000.00 2% AA- 4.06 5,005.48 4.06 48,720.01 16-Mar-15AMP @ 3.80% to 26 March 2015 1,500,000.00 2% A+ 3.80 4,684.93 3.80 15,147.95 26-Mar-15St George @ 4.52% to 27 April 2015 2,000,000.00 2% AA- 4.52 7,430.14 4.52 90,400.02 27-Apr-15Quay CU @ 4.00% to 10 June 2015 1,185,600.00 1% NR 4.00 3,852.89 4.00 45,704.98 10-Jun-15Investec @ 4.28% to 27 August 2015 3,000,000.00 3% BBB- 4.28 10,553.42 4.28 108,348.49 27-Aug-15Investec FRTD @ 3m BBSW + 2.00% to 26 October 2015 2,000,000.00 2% BBB- 4.68 7,690.36 4.66 93,893.93 26-Oct-15Investec @ 6.41% to 27 October 2015 500,000.00 1% BBB- 6.41 2,634.25 6.41 32,049.98 27-Oct-15ME Bank @ 4.05% to 22 February 2016 1,000,000.00 1% BBB+ 4.05 3,328.77 4.05 14,646.59 22-Feb-16Police CU @ 4.21% to 22 February 2016 1,000,000.00 1% NR 4.21 3,460.27 4.21 15,225.20 22-Feb-16Police CU @ 4.70% to 29 February 2016 1,000,000.00 1% NR 4.70 3,863.01 4.70 46,999.98 29-Feb-16NAB @ 4.08% to 7 March 2016 5,000,000.00 5% AA- 4.08 16,767.12 4.08 64,832.87 7-Mar-16NAB @ 4.00% to 17 March 2016 5,000,000.00 5% AA- 4.00 16,438.36 4.00 58,082.20 17-Mar-16ME Bank @ 4.05% to 17 March 2016 4,000,000.00 4% BBB+ 4.05 13,315.07 4.05 46,602.74 17-Mar-16RaboDirect @ 7.15% to 21 March 2016 3,000,000.00 3% AA- 7.15 17,630.14 7.15 214,500.02 21-Mar-16Police CU @ 4.50% to 6 June 2016 2,000,000.00 2% NR 4.50 7,397.26 4.50 90,000.02 6-Jun-16RaboDirect @ 4.30% to 6 June 2016 1,000,000.00 1% AA- 4.30 3,534.25 4.30 42,999.98 6-Jun-16Rabobank @ 5.70% to 6 June 2017 2,000,000.00 2% AA- 5.70 9,369.86 5.70 113,999.98 6-Jun-17BoQ @ 4.50% to 28 November 2016 2,000,000.00 2% A- 4.50 7,397.26 4.50 53,013.71 28-Nov-16BoQ @ 4.90% to 28 August 2017 3,000,000.00 3% A- 4.90 12,082.19 4.90 124,043.82 28-Aug-17BoQ @ 4.70% to 27 September 2017 1,000,000.00 1% A- 4.70 3,863.01 4.70 35,668.48 27-Sep-17Investec @ 5.60% to 2 November 2017 500,000.00 1% BBB- 5.60 2,301.37 5.60 25,698.62 2-Nov-17BoQ @ 5.00% to 29 October 2018 3,000,000.00 3% A- 5.00 12,328.77 5.00 100,684.95 29-Oct-18ME Bank @ 5.10% to 14 February 2019 3,000,000.00 3% BBB+ 5.10 12,575.34 5.10 57,427.39 14-Feb-19ING @ 4.95% to 18 February 2019 3,000,000.00 3% A- 4.95 12,205.48 4.95 53,704.11 18-Feb-19

Expired Deposits - Financial Year - - - - 2,275.37 - 593,941.49 Expired

68,685,600.00 72% 4.60 262,066.56 4.60 2,756,074.02Cash Enhanced Funds:BlackRock Care & Maintenance 0.00 0% NR - - - 72,682.07 Matured

0.00 0% - 0.00 - 72,682.07

Senior Bonds:RBS Fixed @ 7.25% 0.00 0% A - - - 7,221.30 27-Aug-13Macquarie FRN @ 3m BBSW + 1.90% 0.00 0% A - - - 31,819.12 13-Mar-14BENHA @ 3m BBSW + 1.40% 0.00 0% A- - - - 45,079.64 17-Mar-14Arab Bank Aus FRN @ 3m BBSW + 1.50% 3,500,000.00 4% BBB- 4.20 12,025.62 4.16 145,551.53 12-Dec-14ING NV FRN @ 3m BBSW + 2.15% 0.00 0% A - - - 38,066.86 3-Sep-15Bendigo FRN @ 3m BBSW + 1.45% 0.00 0% A- - - - 25,759.03 2-Nov-15BoQ FRN @ 3m BBSW + 1.60% 1,000,000.00 1% A- 4.28 3,511.48 4.25 42,489.07 7-Dec-15CBAHA @ 3m BBSW + 1.05% 6,567,742.42 7% AA- 3.76 20,336.26 3.72 221,794.72 24-Dec-15AMP @ 3m BBSW + 1.08% 1,000,000.00 1% A+ 3.76 3,086.30 3.73 37,388.36 14-Mar-16Suncorp @ 3m BBSW + 1.00% 0.00 0% A+ - - - 73,962.72 11-Apr-16Rabobank FRN @ 3m BBSW + 1.15% 0.00 0% AA- - - - 80,291.50 27-Jul-16ING NV FRN @ 3m BBSW + 1.20% 1,006,920.00 1% A 3.89 3,197.26 3.82 32,577.50 23-Aug-16Bendigo FRN @ 3m BBSW + 1.20% 2,000,320.00 2% A- 3.88 6,372.66 3.81 65,903.18 17-May-17Heritage Fixed @ 7.25% 750,000.00 1% BBB+ 7.25 4,469.18 7.25 54,375.00 20-Jun-17ME Bank FRN @ 3m BBSW + 1.30% 2,000,000.00 2% BBB+ 3.98 6,534.25 3.98 16,335.62 17-Apr-18BoQ FRN @ 3m BBSW + 1.00% 2,000,000.00 2% A- 3.69 3,846.85 3.69 3,846.85 12-Jun-18Bendigo FRN @ 3m BBSW + 1.27% 1,000,000.00 1% A- 3.98 3,267.12 3.91 24,782.39 14-Nov-18Suncorp @ 3m BBSW + 1.10% 1,000,000.00 1% A+ 3.79 3,110.96 3.79 7,155.21 23-Apr-19

21,824,982.42 23% 4.01 69,757.94 3.98 954,399.60TOTAL PORTFOLIO ** 95,922,595.02 100% 4.46 350,040.81 4.71 3,983,515.25BENCHMARK 2.71 2.68

North Sydney Council Investment Portfolio as at 30 June 2014ATTACHMENT TO G05 - 18/08/14 Page 6

North Sydney Council Investment Portfolio as at 30 June 2014Term Amount Invested % Wgt. Avg Performance Council UBS BBI OutperformanceWorking Capital (0-3 Months) $15,912,013 17% 3.93% FYTD 4.71% 2.68% 2.03%Short-Term (3-12 Months) $15,640,000 16% 4.17% 1 year 4.71% 2.68% 2.03%Short-Medium Term (1-2 Years) $37,067,742 39% 4.38% 2 years 5.33% 2.98% 2.35%Medium Term (2-5 Years) $27,257,240 28% 4.87% 3 years 5.53% 3.55% 1.98%Long Term (+5 Years) $0 0% 0.00% 4 years 5.97% 3.91% 2.07%Total $95,876,995 100% 5 years 6.15% 3.90% 2.25%

BenchmarkUBS Bank Bill Index AAA 0%

AA+ 0%Investment Horizon AA 0%Working Capital (0-3 Months) At-Call Accounts, Term Deposits AA- 39%Short-Term (3-12 Months) Term Deposits A+ 8%Short-Medium Term (1-2 Years) Senior Bonds, Term Deposits A 1%Medium Term (2-5 Years) Senior Bonds, Term Deposits A- 23%Long Term (+5 Years) N/A BBB+ 13%

BBB 0%BBB- 10%NR 6%

100%

Investments Summary by Credit Rating #

Cash, Term Deposits, Senior Fixed and Senior FRN's

Investments

ATTACHMENT TO G05 - 18/08/14 Page 7

Investment S&P Net Returns - 1 Month Net Returns - FYTDMarket Value % Rating # Return* Income^ Return Income^ Maturity

Trading Account:CBA Trading Account - General Fund 1,786,768.45 2% AA- 2.70 2,049.99 2.70 2,049.99 At CallCBA Business On-Line Saver 5,000,000.00 5% AA- 2.70 8,942.47 2.70 8,942.47 At CallUBS Cash Management Trust 74,573.48 0% AAA 1.61 0.00 1.61 0.00 At Call

6,861,341.93 7% 2.69 10,992.46 2.69 10,992.46Term Deposits:RaboDirect @ 3.60% to 14 August 2014 1,000,000.00 1% AA- 3.60 3,057.53 3.60 3,057.53 14-Aug-14AMP @ 4.05% to 28 August 2014 1,000,000.00 1% A+ 4.05 3,439.73 4.05 3,439.73 28-Aug-14BoQ @ 5.20% to 28 August 2014 1,000,000.00 1% A- 5.20 4,416.44 5.20 4,416.44 28-Aug-14St George @ 5.20% to 28 August 2014 3,000,000.00 3% AA- 5.20 13,249.32 5.20 13,249.32 28-Aug-14AMP @ 4.00% to 9 September 2014 ~ 3,000,000.00 3% A+ 4.00 10,191.78 4.00 10,191.78 9-Sep-14Heritage @ 5.00% to 11 September 2014 1,500,000.00 2% BBB+ 5.00 6,369.86 5.00 6,369.86 11-Sep-14Quay CU @ 4.75% to 3 December 2014 1,000,000.00 1% NR 4.75 4,034.25 4.75 4,034.25 3-Dec-14NAB @ 4.47% to 26 February 2015 2,000,000.00 2% AA- 4.47 7,592.88 4.47 7,592.88 26-Feb-15ING @ 3.82% to 2 March 2015 3,000,000.00 3% A- 3.82 9,733.15 3.82 9,733.15 2-Mar-15RaboDirect @ 4.06% to 16 March 2015 1,500,000.00 2% AA- 4.06 5,172.33 4.06 5,172.33 16-Mar-15AMP @ 3.80% to 26 March 2015 1,500,000.00 2% A+ 3.80 4,841.10 3.80 4,841.10 26-Mar-15St George @ 4.52% to 27 April 2015 2,000,000.00 2% AA- 4.52 7,677.81 4.52 7,677.81 27-Apr-15Quay CU @ 4.00% to 10 June 2015 1,185,600.00 1% NR 4.00 4,027.79 4.00 4,027.79 10-Jun-15Investec @ 4.28% to 27 August 2015 3,000,000.00 3% BBB- 4.28 10,905.21 4.28 10,905.21 27-Aug-15Investec FRTD @ 3m BBSW + 2.00% to 26 October 2015 2,000,000.00 2% BBB- 4.65 7,940.87 4.65 7,940.87 26-Oct-15Investec @ 6.41% to 27 October 2015 500,000.00 1% BBB- 6.41 2,722.05 6.41 2,722.05 27-Oct-15ME Bank @ 4.05% to 22 February 2016 1,000,000.00 1% BBB+ 4.05 3,439.73 4.05 3,439.73 22-Feb-16Police CU @ 4.21% to 22 February 2016 1,000,000.00 1% NR 4.21 3,575.62 4.21 3,575.62 22-Feb-16Police CU @ 4.70% to 29 February 2016 1,000,000.00 1% NR 4.70 3,991.78 4.70 3,991.78 29-Feb-16NAB @ 4.08% to 7 March 2016 5,000,000.00 5% AA- 4.08 17,326.03 4.08 17,326.03 7-Mar-16NAB @ 4.00% to 17 March 2016 5,000,000.00 5% AA- 4.00 16,986.30 4.00 16,986.30 17-Mar-16ME Bank @ 4.05% to 17 March 2016 4,000,000.00 4% BBB+ 4.05 13,758.90 4.05 13,758.90 17-Mar-16RaboDirect @ 7.15% to 21 March 2016 3,000,000.00 3% AA- 7.15 18,217.81 7.15 18,217.81 21-Mar-16Police CU @ 4.50% to 6 June 2016 2,000,000.00 2% NR 4.50 7,643.84 4.50 7,643.84 6-Jun-16RaboDirect @ 4.30% to 6 June 2016 1,000,000.00 1% AA- 4.30 3,652.05 4.30 3,652.05 6-Jun-16Rabobank @ 5.70% to 6 June 2017 2,000,000.00 2% AA- 5.70 9,682.19 5.70 9,682.19 6-Jun-17BoQ @ 4.50% to 28 November 2016 2,000,000.00 2% A- 4.50 7,643.84 4.50 7,643.84 28-Nov-16BoQ @ 4.90% to 28 August 2017 3,000,000.00 3% A- 4.90 12,484.93 4.90 12,484.93 28-Aug-17BoQ @ 4.70% to 27 September 2017 1,000,000.00 1% A- 4.70 3,991.78 4.70 3,991.78 27-Sep-17Investec @ 5.60% to 2 November 2017 500,000.00 1% BBB- 5.60 2,378.08 5.60 2,378.08 2-Nov-17BoQ @ 5.00% to 29 October 2018 3,000,000.00 3% A- 5.00 12,739.73 5.00 12,739.73 29-Oct-18ME Bank @ 5.10% to 14 February 2019 3,000,000.00 3% BBB+ 5.10 12,994.52 5.10 12,994.52 14-Feb-19ING @ 4.95% to 18 February 2019 3,000,000.00 3% A- 4.95 12,612.33 4.95 12,612.33 18-Feb-19

Expired Deposits - Financial Year - - - - 0.00 - 0.00 Expired

68,685,600.00 71% 4.60 268,491.56 4.60 268,491.56Senior Bonds:Arab Bank Aus FRN @ 3m BBSW + 1.50% 3,500,000.00 4% BBB- 4.20 12,470.07 4.20 12,470.07 12-Dec-14BoQ FRN @ 3m BBSW + 1.60% 1,000,000.00 1% A- 4.28 3,633.62 4.28 3,633.62 7-Dec-15CBAHA @ 3m BBSW + 1.05% 6,567,742.42 7% AA- 3.72 20,891.37 3.72 20,891.37 24-Dec-15AMP @ 3m BBSW + 1.08% 0.00 0% A+ 12.18 9,822.75 12.18 9,822.75 MaturedING NV FRN @ 3m BBSW + 1.20% 0.00 0% A 9.85 4,423.59 4.36 4,423.59 MaturedBendigo FRN @ 3m BBSW + 1.20% 2,000,320.00 2% A- 3.88 6,585.08 3.82 6,585.08 17-May-17Heritage Fixed @ 7.25% 750,000.00 1% BBB+ 7.25 4,618.15 7.25 4,618.15 20-Jun-17ME Bank FRN @ 3m BBSW + 1.30% 2,000,000.00 2% BBB+ 3.94 6,727.40 3.97 6,727.40 17-Apr-18BoQ FRN @ 3m BBSW + 1.00% 2,000,000.00 2% A- 3.69 6,276.44 3.69 6,276.44 12-Jun-18Bendigo FRN @ 3m BBSW + 1.27% 1,000,000.00 1% A- 3.98 3,376.03 3.91 3,376.03 14-Nov-18Suncorp @ 3m BBSW + 1.10% 1,000,000.00 1% A+ 3.74 3,203.98 3.77 3,203.98 23-Apr-19Credit Suisse @ 3m BBSW + 1.03% 2,000,000.00 2% A 3.65 3,195.62 3.65 3,195.62 16-Jul-19

21,818,062.42 22% 3.98 85,224.10 3.98 85,224.10TOTAL PORTFOLIO ** 97,365,004.35 100% 4.53 364,708.12 4.53 364,708.12BENCHMARK 2.74 2.74

North Sydney Council Investment Portfolio as at 31 July 2014Term Amount Invested % Wgt. Avg Performance Council UBS BBI OutperformanceWorking Capital (0-3 Months) $17,361,342 18% 3.82% FYTD 4.53% 2.74% 1.79%Short-Term (3-12 Months) $15,685,600 16% 4.17% 1 year 4.61% 2.66% 1.95%Short-Medium Term (1-2 Years) $36,067,742 37% 4.39% 2 years 5.24% 2.95% 2.30%Medium Term (2-5 Years) $28,250,320 29% 4.65% 3 years 5.49% 3.49% 2.00%Long Term (+5 Years) $0 0% 0.00% 4 years 5.83% 3.86% 1.97%Total $97,365,004 100% 5 years 6.01% 3.90% 2.12%

BenchmarkUBS Bank Bill Index AAA 0%

AA+ 0%Investment Horizon AA 0%Working Capital (0-3 Months) At-Call Accounts, Term Deposits AA- 40%Short-Term (3-12 Months) Term Deposits A+ 7%Short-Medium Term (1-2 Years) Senior Bonds, Term Deposits A 2%Medium Term (2-5 Years) Senior Bonds, Term Deposits A- 23%Long Term (+5 Years) N/A BBB+ 13%

BBB 0%BBB- 10%NR 6%

100%

North Sydney Council Investment Portfolio as at 31 July 2014

Investments Summary by Credit Rating #

Cash, Term Deposits, Senior Fixed and Senior FRN's

Investments


Quarterly Investment Report 30th June 2014

North Sydney Council

Report Prepared by Andrew Vallner, Managing Director (02) 8246 8805 or [email protected] Michael Chandra, Advisor – Fixed Interest (02) 8246 8812 or [email protected]


mailto:[email protected]

Quarterly Report – 30th June 2014

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TABLE OF CONTENTS

Portfolio Review ......................................................................................................................... 3

Overview ................................................................................................................................ 3

Maturity / Cash Flow .............................................................................................................. 9

Fixed Interest Markets ......................................................................................................... 10

Australian Economy and the Reserve Bank ...................................................................... 10

Long Bonds ....................................................................................................................... 13

Term Deposits & Basel III ..................................................................................................... 15

Bonds and FRNs .................................................................................................................... 18

Portfolio Holding Summary .................................................................................................. 23

Counterparty Exposure ........................................................................................................ 24

Credit Quality of Portfolio .................................................................................................... 26

Term to Maturity .................................................................................................................. 27

Asset Allocation .................................................................................................................... 28

Credit Fund Performance (reference only) ...................................................................... 29

Appendix: Global Economic Background ............................................................................. 30

US and the Federal Reserve .............................................................................................. 30

Europe ............................................................................................................................... 32

Other ................................................................................................................................. 34

Summary and Outlook ...................................................................................................... 35

Disclaimer ................................................................................................................................. 36



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PORTFOLIO REVIEW

Overview

This quarterly report provides an analysis of Council’s investment portfolio as at 30th June

2014, and should be read in conjunction with our Market and Economic Review. At this

date, Council’s investment portfolio was $95.9mn at face values.

Table 1 provides an assessment of Council’s portfolio allocation in relation to the limits set

out in its Investment Policy. An explanation of the three indicators is provided below:

The portfolio is in accordance with recommendations for this aspect.

The portfolio is materially consistent with Policy, with a clear path to rectification.

The portfolio is inconsistent with the Investment Policy and CPG recommends

Council take action to reweight the portfolio.

Table 1 – Policy Scorecard

Policy Aspect Indicator Details

Credit Quality

The portfolio is of high quality with approximately 72% of total assets rated

“A” or higher. The remaining 28% is predominately invested in various

attractive deposit and FRNs with the lower regional and unrated ADIs. Several

of the deposits were invested above 6% p.a. yield and are now showing

significant embedded gains.

Counterparty

As at the review date, Council did not have an overweight position to any

single ADI. Overall the deposit portfolio is highly diversified across the entire

credit spectrum.

Term to Maturity

Council’s deposit portfolio remains highly liquid, with around 17% of assets

maturing within 3 months and an additional 14% of assets maturing within 12

months. Overall the portfolio is well diversified from a maturity perspective.

A spread of maturities into medium-term investments has been effective in

dealing with the low interest rate environment.

Term deposits have a weighted average maturity of approximately 1.8 years.

The longer-dated deposits in the portfolio continue to be the main

contributor to outperformance against benchmark and are providing strong

income protection in a low interest environment.

Asset Class

Council’s investment portfolio is mainly directed to deposits, which accounts

for approximately 71% of total assets. With deposit margins narrowing, some

primary issued senior bonds, particularly those of the lower rated regional

ADIs are becoming more attractive. This could support a shift to more liquid

assets from the beginning of FY15.

The composition of Council’s investment portfolio as at 30th June 2014 follows:



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Figure 1: Allocation by Product Type

Term deposits (fixed and floating) dominate, at around 71% of the total investment

portfolio - supplemented by cash and credit securities.

Credit securities (including senior bank bonds and FRNs) were significantly tighter during the

quarter. Credit indices set new post-GFC tights in calmer 2014 environment:

Figure 2: Global Credit Indices



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Deposit margins followed traded credit tighter. Under 6 months, peak T/D spreads are

below +100bp from a range of issuers (from major banks, to unrated ADIs). Even at longer

terms, margins have generally contracted to under +120bp – barring occasional specials.

Bank securities were not a standout sector, in part due to supply. Sub-debt performed well;

senior debt was stronger but on a smaller range. However, with isolated exceptions like the

Chinese banks’ ADI branches, credit was firmer almost across the board.

Fixed rate bonds traded stronger – with both lower government yields, and tighter credit

margins, helping to deliver gains. Government bonds rallied strongly through the quarter,

taking yields to levels last seen in June-July a year earlier. 10-year bonds traded around

3½%, having touched 4% at the end of 2013.

Senior bonds and FRNs of the lower rated regional ADIs are competitive with longer-dated

deposits – providing a trade-off between seniority and liquidity. As yields fell throughout the

quarter, long deposits dipped to the mid-4%’s at the time of writing – with tighter margins

dragging deposit yields to cyclical lows probably not seen in term deposits since 2001.

Economic fundamentals have guided bond and credit markets in 2014. While there had

been concerns around the US Federal Reserve exiting from bond markets, the “taper” of

bond purchases (now just 40% of December’s monthly level) has been well flagged, and

asset markets have been resilient. The major drivers of bond yields have been:

Repeated revisions of the US Q1 GDP figure, from a weak +0.1% p.a. at the first

estimate down to a disastrous -2.9% p.a. final;

A dip as Australia reported an upside surprise for Q1 GDP (at +1.1%, for a trailing

+3.5% year-on-year), before plunging commodity prices slashed Q2 estimates.

The Fed should complete its “quantitative easing” late in 2014, with speculation about

which central banks may lead the interest rate cycle higher. For Australia, a currency far

stronger than commodity prices implies the RBA will tend to be “behind the curve.”

Retail securities have generally tightened as they approach maturity and typically trade in a

volatile range during their ex-interest period. We periodically see relative value in CBA

Retail FRN given the short term to maturity - trading up to double the spread of its

wholesale senior equivalents. Crossing against another client selling for liquidity needs could

periodically see concessional brokerage offered.



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As at the end of June, Council’s deposits were averaging an excellent yield of 4.60% p.a.;

around +210bp above the cash rate and significantly higher than all prevailing deposit rates

today. Some longer-dated deposits were placed ahead of the declining swap rates and

contracting margins – anchoring the portfolio for years in advance.

While Council’s running yield remains well above bank bills, this will continue to drop as

existing deposits mature and are reinvested at lower prevailing rates. Cash continues to be

a drag to overall performance and in the absence of unexpected rate rises by the RBA, the

term deposit portfolio will drop through 4½% as we progress into FY15 with a number of

5%+deposits maturing in 2014.

Banks are highly capitalised heading into Basel III implementation in January 2015, which

itself penalises short-dated term deposits. Banks have attempted to use Basel III as a

“Trojan Horse” to talk down deposit margins, but margins have been consistent with long-

term trends in broader credit markets in 2014, and not outliers. Still, we expect shorter T/D

margins to tighten faster than the longer end.

The longer-term outlook still appear to us consistent with a low interest rate environment

– last quarter’s concerns about upside risks have faded as the terms of trade have collapsed

towards GFC levels. Other indicators (retail sales, consumer sentiment, and possibly even

apartment construction approvals) hit a wall after the shock of the Budget.

Given the RBA’s neutral stance, we expect ongoing reductions in FY15 income as older

assets mature and are rolled over at decade lows. Even 4% yields are now the exception

rather than the norm, requiring longer-dated investments of at least 3 years in most cases.

At quarter end, the weighted average duration of Council’s deposit portfolio stood at 1.8

years – providing strong protection to income in FY15.

For FY14, the total portfolio returned +4.71% p.a., outperforming its benchmark by 203bp.

Council’s deposit investments up to 5 years, supplemented by bank securities, have been

the backbone of strong outperformance over recent years. It has consistently

outperformed benchmark by around 200bp over 1-5 year time periods:



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Table 2: Council’s Performance as at 30/06/2014

Going forward, our core strategy remains to be opportunistically invested in medium and

longer-dated assets; supplementing deposits with bank credit in periods of weakness where

relativities show compelling value.

In our central view, the potential to gross up credit spreads by capital gains from a traded

credit strategy will tend to support allocations away from deposits over FY15. However,

this is highly dependent on how markets actually evolve, and the relative values in each.

Our current investment points are:

Just before quarter end, BoQ affirmed in their management presentation that the

Investec ADI was still being acquired. Management also confirmed directly to us

that they expect the merger to complete during Q3.

As a result, this would see ~6% of assets upgraded from BBB- to A-, but also require

further investments with BoQ to be halted as counterparty capacity limits are

breached.

The potential sale of a BoQ FRN as well as an Investec deposit maturing in Q3 readily

addr

Long T/D rates have dipped to 4½% for a rated issuer, at best. This does not

completely invalidate the thesis for longer investments, but the case is strongest if

Q1’s GDP is interpreted as an outlier. Subsequent trade data suggests Q2 will be

markedly slower.

Regional bank spreads have participated in the trend to tighter spreads, but there is

still enough in new issue spreads at above +100bp to imply an exit at a premium

part way through the term (all things being equal on the outright level of markets).

Retail credit is very much a daily proposition, as they have tended to trade over a

wide range but with a gradual tightening bias underlying them. CBA Retail FRNs are

cheap relative to wholesale peers, but has a wide trading range. Heritage Bank’s

retail bond is consistently around 100bp cheap, on low volumes.



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The market is currently factoring the possibility of a rate cut again – it would be

risky to rule this out, given both economic data and sentiment. The RBA would be

reluctant to stimulate a housing bubble; but they again have a strong focus on the

$A, which they regard as overly high. We are assuming the same easing bias as the

futures market, although it is a disincentive for investment in the 6-12 month terms.

The first domestic rate increase is factored in for 2016 – the first time in some

months that the market has not priced in a 2015 increase. We believe that rates

should ideally begin to normalise when commodity prices stabilise and falling mining

construction is no longer a detractor from GDP. Either speculative housing activity,

or overly rapid fall in the $A would tend to force the RBA’s hand earlier.

Regional bank bonds are now being issued wider than deposits, so there is no

longer a trade-off between liquidity and yield (at the longer end).



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Maturity / Cash Flow

Over the next quarter, along with the moderate cash balance, approximately $10.5m of

deposits will mature. The maturity profile of Council’s investment portfolio follows:

Figure 3: Maturity Profile of Portfolio

The portfolio is highly diversified from a maturity perspective, with the largest maturities

in 2016. Income protection remains the primary challenge, as it appears likely that income

will gradually fall over the second half of FY15 at least.

Short-term assets are now pricing quite expensively, on the expectation that there could be

a further cut.

This has made the yield curve quite steep in the middle durations, encouraging investment

there - even in a lower absolute rate environment.

At the shorter-end, Basel III phasing in has seen ADIs cut short deposit rates. At 1-3 months,

the penalty is so heavy that spreads have fallen well below BBSW+100bp. (Banks are given

no “committed funding” credit in the last month of a deposit, as APRA requires protection

this against a 1-month run.)



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Fixed Interest Markets

Australian Economy and the Reserve Bank

The RBA kept the official cash unchanged at a half-century low of 2.5% in Q2, unchanged

since August 2013. Reiterating a “period of stability” over the calls of many economists for

rate hikes, the RBA has (if anything) an unspoken easing bias now. There has been some

positive economic data - a surprise GDP figure of +1.1% for Q1 taking the annual growth

rate to +3.5%. Employment growth also resumed, and outperformed forecasts from the

2013 Budget.

But the outlook is dramatically different a quarter later. Trade data mirrors the terms of

trade (dominated by commodity prices) – with the deficit detracting severely from Q2:

Figure 4: Trade and Commodity Prices

While the budget did little to near-term spending, any cuts received the same anguished

response – including a proposal to index fuel excise by just 1c a litre. In any case, the new

Senate appears likely to block all fiscal repair, so the Budget has effectively zero economic

impact. The “budget implied a more substantial fiscal consolidation than had earlier been

projected” – but over the medium term, with less immediate impact.

Much of what were reported as “cuts” are actually much more interesting – we will know

only in a few years what the fiscal policy outlook actually is. Meanwhile, the Federal

government has only guaranteed real value preservation of health, education and pension

spending – any real growth is discretionary. (Not that it won’t happen.)



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Governor Stevens actually indicated that fiscal contraction was quite modest compared to

past periods. (This is true – the immediate shift from transfers to infrastructure construction

was largely spending neutral.)

Part of the impact was the shock of revealing that on current settings, deficits would persist

for around 15 years. Blunt by central banker standards, Stevens said the medium term

finances “looked like they were going to start going more seriously off course.”

But consumer confidence plunged to near post-GFC lows –levels touched only briefly at the

depths of the US downgrade / EU breakup crisis of late 2011.

The RBA also stated that Chinese growth slowed somewhat, with other emerging markets,

in 2014 – something that the official statistics have not yet acknowledged. As mining

construction slumps, this was identified as a more significant impact than the Budget.

Business investment fell -4.2% in the March quarter, led by a -8.7% fall in mining

investment. Property construction had been strong, but unit approvals have recently

weakened. RP Data property prices fell -1.9% in May – declining in most capitals. It is too

early to extrapolate a single month’s data. Stevens felt it necessary to warn households

that prices can and do fall.

Employment has been highly volatile, but better than expectations of 2013.

Unemployment did not approach the 6¼% forecast for June 2014 in the previous Budget –

but very low participation (64.6%) helped the headline statistic. One month accounted for

much of the gains, suggesting a statistical quirk. There has been no clear trend to or from

part-time employment (unlike in the US).

Figure 5: Employed Persons

The RBA sees a “fair level of spare capacity” in the labour

market, with real private sector wage growth turning

negative. Substantial currency depreciation (20%, of which

over 10% stuck after the retracement of Q2) has not

brought broad-based inflation. Mining and mining services

salaries have seen disinflation as the boom ends.

We believe the RBA has been over-optimistic since at least

2010 – they have consistently over-read the positives.

“Slightly below trend” in the short-term sees them liable to

disappointment; we see downside risks after the Q2 GDP.



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As such, we are siding with the bond market against the RBA on future outlook. Futures

are factoring a material risk of a cut – nothing since quarter end has helped convince us

they’re wrong:

Figure 6: ASX Futures Cash Rate

Source: ASX/SFE

On a medium term view, the futures market sees rates:

Possibly cut one more time

Very likely at the current level in mid 2015

Not rising in 2015

Very slowly normalising in 2016 and beyond

Moving towards a neutral 4% over the very long term.

What would derail this base case? To the upside, another commodity boom or inflation

appears unlikely – currency depreciation has already passed through the system. While the

more bearish commentators are still talking about Japan-style stagnation, or another GFC,

the conditions for these do not appear to be in place.

The ideal time to start interest rate normalisation (unless derailed by other factors) is

when the wind-down of mining construction is no longer detracting – possibly 2016. It is

currently stripping as much as 2% p.a. from GDP, coupled with falling commodity prices

affecting export values. We see no way that the RBA can tighten while this persists.



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Long Bonds

Global bond yields fell over the quarter, accepting the tapering of bond purchases by the

US “Fed” (Federal Reserve) and soft guidance of rising rates during 2015. Yellen is

considered a “dove” - and has become more dovish since appointment as Fed chair.

US 10-year bonds closed near 2½%, having opened the year at 3%.

Meanwhile, Europe has a negative ECB deposit rate to encourage lending, and Abenomics

has underperformed (for which the solution is, of course, longer and larger Abenomics!).

European bond yields fell to record lows, under 1% on EFSF bonds, coupled with recovery

in the debt markets of formerly – and arguably currently – distressed countries.

While stronger data helped Australia resist global trends in Q1, there was little newsflow

that would support bonds yields in Q2, and longer swaps rallied towards 2012 lows:

Figure 7

10-year bonds ended up rallying 60bp, outperforming global markets in Q2:



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Figure 8: Domestic Yield Curve

The longer end of the curve remains steep beyond 12 months, factoring some chance of

another rate cut but more likely rate stability in 2015. 3-year bonds are almost flat to the

cash rate - as even 10’s factor low rates effectively forever:

Figure 9: Australia Government Bond Yields

Long bonds look over-valued to us, especially globally – even US Fed economists are

struggling with current levels. We see no reason to own government bonds here.



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Term Deposits & Basel III

Wholesale funding spreads continued to ease during the quarter, highlighted amongst the

majors. The local banking industry continues to be well capitalised and highly profitable.

Competition for deposits has softened for over 2 years and the headline deposit rate has

fallen without any further movements in the official cash rate since Q3 2013.

With the implementation of Basel III, ADIs have stronger imperatives for longer-term

funding, which may benefit depositors who favour longer-dated deposits.

Figure 10: Term Deposit Premium

The bond market has continued to rally during the quarter (as discussed previously). This

has tended to compress yields further at the short end, to new record lows. We anticipate

that short dated deposits will contact more sharply than longer-dated deposits as we

approach the Basel III accords in January 2015.

Banks are clearly signalling that margins are on their way down. Basel III will significantly

impact the ability to pay high margins on deposits (short deposits, in particular) as more and

more conditions are applied – as well as greater requirements for expensive capital.



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For those investors that require high levels of liquidity to meet irregular expenditures (e.g.

emergency liquidity, or infrequent major capex projects), with 1-2 month deposits now well

under 100bp margin, we believe it is now time to look at structured deposit accounts such

as AMP’s Notice Account. The AMP Bank (A+) Notice Account pays a minimum fixed margin

of +100bp (plus rebate) above the official cash rate but requires a minimum 31 day notice

period for withdrawals. A maximum limit of $10M applies on this account.

This deposit now materially exceeds 30 and 60 day T/D rates and a $10m allocation would

be of benefit (it does not substitute for at-call money). Please contact CPG’s office to discuss

the procedure to ensure that any inbuilt brokerage of 10bp per annum is rebated.

The “deposit war” has continued to ease, where most longer-term deposits would be

attainable at up to +130bp in Q1, this margin contracted to as low as +115bp in Q2 in a

falling bond yield environment.

At the time of writing, peak deposit margins were around +120bp over 1-5 year terms with

the unrated ADIs – through broker specials. It has been some time since the deposit curve is

dominated by the lower end of the credit spectrum. Previously, A or AA banks tended to

overpay relative to peers, providing a “free lunch” for yield and credit quality.

Taking either deposit or bond rates as equivalent, longer T/Ds no longer have a large kink in

the 5th year, and so factor in a more linear increase – implied rates no longer reach 5½%:



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Figure 11

These levels represent excellent value in the out-years relative to a severely constrained

outlook both globally and domestically - but we caution that they are not achievable in

the highest rated bank deposits currently.



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Bonds and FRNs

We refer to our recent updated Fixed Interest Analysis Report for monthly analysis and

strategy of FRNs as background – in addition to further deposit analysis.

Credit spreads in Q2 continued to trade tighter, following cash and global index credit

spreads which also tightened. Bank bonds were also firmer, with the retail market

sometimes mispriced during the ex-interest period.

Figure 12

Heritage retail bonds (“HBSHB”) continue to offer value over their wholesale equivalents,

trading up to yields of 4.9% p.a., but can be difficult to trade in volume.

CBA’s retail FRN (ASX: CBAHA), now less than 1½ years to maturity, tightened to +98bp at

quarter-end - slightly above par value. The ex-interest period for the current coupon was

more orderly that the extreme swings that accompanied previous periods. We have no

current trading view – it is saleable more quickly than (for example) the AMP Notice

Account, but with trading costs, and disposals are more likely to result from client needs

than a firm recommendation.



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Figure 13

But what is the “big picture” premise behind credit investing? The black arrow shows the

fundamentals of bond investing in a “normal” yield curve. Critically, credit spreads are

almost always normal, and the blue arrow shows how this grosses up bond investing:

Figure 14



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(Figure 13 shows the credit spread curve for major banks, and for their more senior Covered

Bonds.) We seek a single exit opportunity where the exit yield is significantly lower than the

purchase yield, exiting at a premium to cost.

Our analytic tools help identify the point of maximum “tailwind” in capital prices, but of

course prices are also influenced by macro factors affecting the overall levels for credit.

We continue to recommend selling any senior major bank FRNs maturing on or before

2016, marked less than +40bp. Even the 2017 major bank senior FRNs are saleable at short

notice, particularly for those early 2017’s that are now within 3 years to maturity.

Senior regional bank FRNs maturing in 2015 are also usually saleable, as are some 2016’s.

Primary issues continue to be favoured over secondary market offers in the wholesale

market - although this may change if spreads widen. For new issues, we currently favour the

regional ADIs (rated A or BBB) as they are offering a more attractive spread compared to the

major banks. Private placement FRNs or secondary market ‘taps’ can sometimes be offered,

usually at a premium yield to the wholesale secondary market.

Although bank spreads have continued to narrow, the gap between securities and deposits

has also contracted to a level which may see a more prominent role for senior bank

securities going forward. In a sense, this is a welcome development for investors, as they

do not have to sacrifice liquidity for margins. However, bonds are somewhat variable in

quoted price (which creates discomfort amongst some investors, even if the difference is an

illusion caused by daily quoting of a price). They also lack the seniority and legislative

protection that applies to deposits. Margins for the higher rated banks’ tradeable

instruments are significantly lower, and so they will not suit all investors.

At the time of writing, Heritage retail bonds (around 4.85% / 200bp over swap) are in the

middle of its trading range. Now a little under 3 years from its June 2017 maturity, the

spread as a 3-year bond cannot be compared to near its issue, as a 5 year.

The spread remains around 100bp above regional banks’ wholesale products of equivalent

seniority – which range from BoQ around +95bp to ME Bank around +115bp.

For investors with BBB appetite, we recommend patient bidding with a disciplined spread

limit – history suggests orders will fill eventually at a level which remains good value as

swap rates have fallen through CY14.



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Credit spreads are significantly tighter over CY14:

Figure 15

The monthly Fixed Interest Analysis report provides up to date information on spreads, as

well as more detailed forward-looking outlook.

Council’s bank security portfolio continues to embed significant capital profits at current

trading levels:

Senior Fixed Bonds

Heritage fixed paying 7.25% p.a. quarterly maturing 20/06/2017 – yielding 4.80%

p.a. or capital price ~$106.73. Unrealised capital gain ~$50,500 on $0.75m face

value.



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Senior FRNs

AMP senior FRN paying 3m BBSW+1.08% p.a. maturing 14/03/2016 – trading margin

+50bp / capital price ~$100.94. Unrealised gain ~$9,000 on $1.0m face value.

BoQ senior FRN paying 3m BBSW+1.60% p.a. maturing 02/12/2015 – trading margin


ING senior FRN paying 3m BBSW+1.20% p.a. maturing 23/08/2016 – trading margin

+64bp / capital price ~$101.13. Unrealised gain ~$11,000 on $1.0m face value

(purchased at par).

Bendigo-Adelaide senior FRN paying 3m BBSW+1.20% p.a. maturing 17/05/2017 –

trading margin +84bp / capital price ~$100.97. Unrealised gain ~$22,000 on $2.0m

face value (purchased at discounted capital price ~$99.86).

BoQ senior FRN paying 3m BBSW+1.00% p.a. maturing 12/06/2018 – trading margin


Bendigo-Adelaide senior FRN paying 3m BBSW+1.27% p.a. maturing 14/11/2018 –

trading margin +95bp / capital price ~$101.27. Unrealised gain ~$12,500 on $1.0m

face value.

CBAHA senior FRN paying 3m BBSW+1.05% p.a. maturing 24/12/2015 – trading

margin +98bp / capital price ~$100.13. Unrealised gain ~$94,000 on $6.6m face

value (purchased at discounted weighted average capital price ~$98.72).

Suncorp senior FRN paying 3m BBSW+1.10% p.a. maturing 23/04/2019 – trading


value.

ME Bank senior FRN paying 3m BBSW+1.30% p.a. maturing 17/04/2018 – trading


value.

At quarter end, we recommend the sales of:

$1.0m AMP Mar 2016 FRN (subsequently sold in early July 2014)

$1.0m BoQ Dec 2015 FRN

$1.0m ING Aug 2016 FRN (subsequently sold in early July 2014)

Conversely, Heritage Bank bonds remain excellent value.



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Portfolio Holding Summary

Council’s investment portfolio of $95.9mn is predominately invested in fixed and floating

rate term deposits (71%). The remaining portfolio is invested in FRNs (22%), various at-call

accounts (6%) and fixed bonds (1%). Overall, the portfolio is highly liquid, highly rated and

diversified from a counterparty and maturity perspective.

Table 3: Investment Portfolio by Product Type



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Counterparty Exposure

In the following section we compare existing exposure to individual counterparties with

typical Investment Policy limits. The aim is to ensure that Council’s investment portfolio is

appropriately diversified across individual institutions / counterparties.

As at the review date, Council did not have an overweight position to any single ADI.

Overall the deposit portfolio is diversified amongst the entire credit spectrum.

Table 4: Counterparty Exposure

Investec (Australia) is currently a split BBB credit, based on the Fitch rating of BBB-.

In Q2, Bank of Qld announced the purchase of most of Investec’s Australian business –

critically, this includes the ADI licence and therefore all of the existing deposits.

While the transaction remains subject to regulatory approvals, on completion it is likely that

a substantial ratings upgrade will take place.

After completion, the group exposure to BoQ would reflect the merged entity. This would,

as a result of the merger, breach capacity limits for the BoQ group – requiring new

investments in the group to be briefly halted until rebalanced (although $1.0m of the BoQ

Dec 15 FRN could be sold immediately to reduce the overall exposure).

Counterparty AAA AA- A+ A A- BBB+ BBB- NR Grand Total Maximum CapacityCompliance

Check

Federal Government 3% 3% 100% 97% OK

Rabobank 9% 9% 30% 21% OK

CBA 12% 12% 30% 18% OK

NAB 12% 12% 30% 18% OK

Westpac 5% 5% 30% 25% OK

Suncorp 1% 1% 15% 14% OK

AMP 7% 7% 15% 8% OK

ING Bank NV 1% 1% 15% 14% OK

ING Bank 6% 6% 15% 9% OK

BoQ 13% 13% 15% 2% OK

Bendigo Adelaide 3% 3% 15% 12% OK

Heritage 2% 2% 10% 8% OK

ME Bank 10% 10% 10% 0% OK

Investec 6% 6% 10% 4% OK

Arab Bank 4% 4% 10% 6% OK

Quay CU 2% 2% 5% 3% OK

Police CU 4% 4% 5% 1% OK

Collective Investment 0% 0% 0% 0% OK

Grand Total 3% 38% 8% 1% 22% 12% 10% 6% 100%



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Figure 16



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Credit Quality of Portfolio

The credit quality of the portfolio is high with approximately 72% of assets rated ‘A’ or

better. The AAA assets represent the deposit investments covered by the Federal

Government’s Financial Claims Scheme (FCS).

The remaining 28% is predominately invested in various attractive deposits with the lower

regional and unrated ADIs. Several of the deposits were invested above 6% p.a. yield, and

are now showing significant embedded gains.

Table 5: Credit Quality

Figure 17

Should the acquisition of Investec Bank (Australia) Ltd by BoQ complete, 6% of the

portfolio is expected to be reassigned from BBB category to A, leaving further BBB range

capacity.

This of course assumes that IBAL is re-rated to the same rating as the parent, as has been

the case with recent bank takeovers.



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Term to Maturity

In the following section we analyse the investment portfolio from a term-to-maturity

perspective with the limits contained within Council’s Investment Policy. This seeks to

ensure that the current maturity profile is appropriate given Council’s liquidity

requirements. This exposure is shown in Table 6 with the following points to note:

o Council’s portfolio has high levels of liquidity, with 17% of assets maturing within 3

months and an additional 14% maturing within 12 months.

o There is substantial capacity to invest terms between 1-5 years, particularly if liquid

FRNs are sold.

o As existing assets mature or where surplus funds are available, medium-term assets

should continue to play a prominent role as part of Council’s portfolio.

Table 6: Term to Maturity Allocation

For several years, we have encouraged long-dated fixed deposits in preference to securities

(except as required to support a liquid allocation). The case for credit has been strong, but

as the cash rate has fallen, and with it the medium-term outlook for interest rates, the fixed

deposit case has been stronger.

This is starting to turn around, as deposit margins contract through bond margins, and as

the bond market more fully factors in a “lower for longer” outlook – at least out through

CY2015.



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Asset Allocation

The following analysis looks at the investment portfolio’s allocation across various sub-asset

classes of fixed interest. It is not Council’s intent to hold other asset classes at this time.

As at the review date, Council’s investment portfolio is predominately invested in fixed

assets. With deposit margins narrowing, credit securities may take a more prominent role

again going forward.

Table 7: Other Investment Allocation

One immediate example is the Heritage Bank bond. Still yielding around 4.8%, it commands

a substantial premium to other medium-term investments. We expect it would be highly

liquid on sale, as it is in strong demand from the sector – however, it can be quite illiquid on

the buy side and take time to accumulate a parcel.



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Credit Fund Performance (reference only)



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Appendix: Global Economic Background

US and the Federal Reserve

Fed Chair Janet Yellen has watched inflation rise to almost 2%, unemployment decline

almost uninterrupted to 6.1% (the Fed had once flagged 6.5% as a turning point for the

interest rate cycle) and has generally held a positive view on the forward-looking outlook.

None of this good news pressured her to “taper” the quantitative easing program any faster

than Bernanke planned in December - $10bn a month reduction each meeting. Currently

$35bn p.m., QE3 should finish by year end. Short-term rates are guided to remain near zero

“for a considerable time” after QE3, pushing bond rates lower. However, we believe this

path will be difficult to execute, if unemployment is 5½% and CPI above its 2% target.

The worst GDP reading since the GFC in 2009 (-2.9% annualised in Q1) had no effect either –

our June Economic Commentary explored the Fed’s baffling silence on this news. More jobs

with less production arithmetically implies falling productivity.

The Fed has been quietly drifting to a “dovish” tone – reinforcing the downside risks to rate

guidance, and pointing to 2016 milestones rather than 2015. Yellen has also spoken against

using interest rates against asset price bubbles – tolerance of inflation and stockmarket

booms implies low rates in the near term, but is unfriendly to bondholders long-term.

Not even the Fed is convinced by its own guidance – there is a wide range of views:

Figure 18



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The Fed economists appear clustered near a 4% equilibrium interest rate, long-term –

implying bondholder losses as yields retrace up to 2%.

US GDP has averaged +2.1% since the GFC ended – by far the worst recovery in history,

albeit facing tighter fiscal policy for some of that period. But unemployment has declined

over 4 points. Each worker is working fewer hours, in part a “feature, not a bug” of

Obamacare which imposes healthcare costs after a 29 hour week.

However, manufacturing and cheap energy production is recovering strongly enough for the

current account to narrow to -2.3% of GDP – the smallest deficit since 1998.

Yellen had been softening up markets for a weak number, talking all year about the very

cold winter – but this was well out of line with (for example) Canada.

The Fed continued to expect faster growth during the rest of the year, and most economists

agree that Q2 will see some rebound as activity is shifted a few weeks later (job vacancies

jumped around 20% in May – there is work to be one). Bankruptcies fell – forward indicators

are holding up well However, we find the Fed’s estimates consistently overstated – covered

in the June Economic Commentary:

Figure 19

Yellen showed declining conviction, with two new warnings and a GDP downgrade to 2.1-

2.3% for CY14 (still highly improbable, with 5% p.a. for 3 straight quarters needed). She

indicated that the renewed weakness of the housing market was once again a cause for

concern (more so volumes than prices, which remain firm), and she added that “heightened

geopolitical tensions” could undermine the recovery:

The Iraqi (Shi’ite) government collapsing under insurgency from primarily Sunni ISIS, Russia

intruding in Ukraine beyond the Crimean secession, Israel, Egyptian chaos, the rest of North

and West Africa....



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Europe

The Ukraine crisis represents two significant issues for the global economy:

Full sanctions against Russia would cause massive economic disruption in Western

Europe – they are very dependent on Gazprom supplies for heating and industry.

Sanctions on Bank Rossiya prevented dealings with US companies Visa and

MasterCard. This could also cause other countries to hypothesis about how future

dispute with the US would impact them, and fear joining payment systems.

We tend to assume that political leaders are more rational than they appear, not least

Putin. He now has Crimea back – including Sevastopol port. In reality, few Crimeans are

likely to be disappointed. Why did Russia use almost identical rhetoric in describing NATO

member Estonia: oppression of the Russian-speaking minority (24% of Estonia’s population)

and suppression of the Russian language by official policy?

Either Putin is planning on invading in support of any Russian minority population with a

grievance (including NATO countries), or he’s warning off the EU by reminding them that it

could get much worse than a tiny peninsula smaller than Greater London.

Estonia is not Crimea – the Russian population of Narva has no desire to live in Ivangorod, or

they would have simply walked 50 metres and done so. Estonia is likely to react with further

democratic reforms and assistance for the Russian minority, without an invasion required.

In our April Economic Commentary, we explored the Russian stance, and took the view that

Putin was a rational actor and not reproducing the Stalinist model. (CPG visited Moscow

and St Petersburg in September; meeting with a Minister, business leaders and fund

managers as part of an emerging markets tour.)

The Russian crisis has since de-escalated, with a recovery in financial assets and the rouble.

In June, the European Central Bank (ECB) cut its benchmark interest rate from 0.25% to

0.15%, and its deposit rate from 0% to -0.10%. It is lending up to €400 billion to European

banks under “Targeted LTRO” – cheap loans contingent on on-lending to the real economy,

with credit still declining in a 1930’s style credit contraction. Quantitative easing through

purchases of structured credit is mooted – 5 years after the successful US TALF.

Europe fears deflation even after GDP turned positive. Gross domestic product across the

28-country EU was +0.3% in the March quarter and +1.4% in the year to March. In the 18-

country Eurozone, GDP grew by +0.2% in the March quarter (the fourth straight positive)

and by +0.9% in the year to March. Unemployment is 11.6% (a record 6.2% being long-



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term) – almost double the US rate. Inflation is just +0.5%, uncomfortably near zero.

Producer prices fell –1.1%.

The good news is that distressed Europe (the “PIIGS”) is largely through its financial crisis.

Greece has a B range credit rating from S&P and Fitch. All but Greece now borrow cheaper

than Australia - almost 1% cheaper, in the case of Italy and a record low 2.26% for Ireland:

Figure 20

Restoring Ireland’s 123% debt : GDP, after first balancing a 7% of GDP budget deficit, will

require decades – and probably inflation. It seems a good time to take some contrarian

positions on European inflation – believing the bond market on deflation requires

disbelieving it on credit quality, and vice versa.

To paraphrase Churchill, Europe is doing the right thing – having first tried everything else.

When the US did it, the policies were experimental: Nationalise / recapitalise banks to

strong levels so they can lend, buy the misnamed “toxic assets” from weak holders (and

make enormous profits on the recovery), deal with “zombie banks” quickly, cut interest

rates to zero and undertake massive monetary stimulus.

But watching the economy normalise and unemployment nearly halve, even during massive

Budget repair should have given Europe some clues during the past 4 years. Instead, Trichet

repeatedly raised interest rates to fight inflation, and QE is coming 5 years too late.

Still, markets ascribe effectively zero risk to a major financial crisis from Europe, with banks

and peripheral countries trading at normal credit spreads.



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Other

The Middle East is also deteriorating, although with less immediate economic effect than

the Ukraine. Investors have wearied of the oil price jumping $20 at every Middle East event,

and sits just above $100 – marginally lower over a year.

Even if the US declines to intervene (having already been talked down from intervening in

Syria), we could even see Iraq take action to prop up its newly Shi’ite friend – the last thing

they need is two Sunni-led civil war on each border.

Still, Iran has more economic impact if at war with the Western world than if engaged within

the region – far from closing the Strait of Hormuz, their incentive would be to open the taps

and maximise oil production and revenue.

China's economy grew an annual 7.4% in Q1 2014, slowing from a 7.7% increase in Q4

2013 - back to 1990 levels. The industrialisation of China at 10% p.a. was a one-off, and

effectively complete. China's reported CPI rose by 2.6% in 2013, unchanged from 2012 and

well below the official 3.5% target. At this stage, inflation does not threaten further small

stimulus programmes of the Chinese government, but food prices (+4.1%) are rising faster

and are more feared by the government due to the threat to stability they represent.

Chinese data is questioned by many (not all) Western commentators – we are in the camp

of disbelievers. We are happy to agree with RBA Governor Stevens that the Chinese

economy is slowing – even if every piece of official data disagrees and shows them on

target for the Five Year Plan objectives of 7%+. (Even if Premier Li insisted that the target is

“non-negotiable” and even if they announce a stimulus package to achieve it.)

If we’re wrong, then growth is coming from services and high-value added product – great

for the Chinese, but with the same practical effect for commodity prices as if we’re right.

Property sales in China fell sharply (-6.9% by area / -7.8% by value) in April quarter. Annual

growth in average new home prices slowed to an 11-month low in April. Existing home

prices dropped from a month earlier in 22 of 70 cities in April.

Targeting a property boom, slowing credit growth, introducing bond defaults, tackling

corruption, filling vacant cities, introducing environmental standards, reducing energy

intensity and lowering inflation – while propping up GDP, during a trading partner recession.

It is an impossible policy objective, and the Chinese must relax some while saving face. At



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5½-6% GDP, most aims are achievable. Figure 4 appears to show which “non-negotiable”

they have compromised on.

Finally, Japan – firing the “third arrow” of Abenomics.

First, Abe announced a modest fiscal stimulus ($US100bn, in an economy 4 times

Australia’s) – although the existing deficit of 9% of GDP did not really increase, and has

actually fallen to 7.6% of GDP in 2013. The first “arrow” has been mostly talk.

Second was massive monetary stimulus under a new central banker to “create inflation”

and inflation expectations of 2% p.a. – but more likely targeting a trashing of the currency

(inflation nudged up to 1.3% excluding the GST increase).

Currency depreciation increased the competitiveness of Japanese industry by a third.

The actual inflation rate is distorted by the third arrow: Pro-growth reform. Some reforms

are confusing and contradictory – following stimulus with a 3% increase in the VAT (GST) at

April 1st. Naturally, spending was brought forward into Q1 with a +1.6% YoY increase, but Q2

is expected to see shrinkage. (The 1997 recession followed a VAT hike.)

Abe is trying low-tax / free trade economic zones, deregulation, encouragement of higher

wages (wage rises unheard-of after 20 years of no inflation), and boosting female workforce

participation (partially offsetting declining population).

Japan is rolling the dice. The second arrow is by far the largest; any fiscal stimulus is

undetectable noise, and few outside Japan think rapid and major reforms are probable. But

the lower currency has seen stock prices double as investors back companies to capture

market share and boost margins. This depreciation has translated to just the tiniest blip in

inflation, to around 1½% underlying, but has driven strong GDP than most of the OECD over

the same period.

Summary and Outlook

Globally, the BoJ and ECB replaced the Fed as the providers of liquidity, with financial

markets unaffected by the much-feared “taper” and by economic bad news – we see

conditions as “mid-cycle” but markets running ahead to price for perfection in some areas.

The Emerging Markets crisis bottomed in Q1, with markets anticipating a rebound (ex-

China) and rewarding more prudent macro policy.

Inflation risks were dismissed by central banks, and by bond investors, ahead of ECB QE.



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DISCLAIMER

Much of the information provided in this document is written for the general interests of clients of CPG Research &

Advisory only. This report does not constitute a recommendation or an offer to invest. This market review sector of the

document is intended as background material does not take into account the investment objectives, financial situation or

particular needs of any particular investor. Before making an investment decision or acting on any of the information or

recommendations contained in this report, the investor should consider whether such recommendation is appropriate

given the investor’s particular investment needs, objectives and financial circumstances. We recommend you consult your

CPG adviser for updated advice that addresses your specific needs and situation before making investment decisions. All

information and recommendations expressed herein constitute judgements as of the date of this report and may change

without notice. Staff or associates may own positions in the investments mentioned – directly or indirectly.


Documents

NO RTH SYD N E Y COUN CI L R E POR T S · 2018-06-22 · ITEM G05 REPORTS 18/08/14 NO RTH SYD N E Y COUN CI L R E POR T S Report to General Manager Attachments: 1. Investment Portfolio