Credit spreads reversed direction in October, with domestic physical spreads widening 0.75 basis points (bps) over the month. The synthetic indices had a mixed performance with the US CDX Index tightening by 0.55 bps, the European iTraxx widening by 2.51 bps and the Australian iTraxx widening by 7.74 bps. Corporate and asset-backed debt issuance (excluding supranational/sovereign/agency) reached AUD 4.26 billion this month compared with AUD 5.75 billion in September.

Australian banks continued to report strong profitability, except for National Australia Bank (NAB) whose results were dragged down by its UK subsidiary, with additional charges totalling AUD 1.5 billion after tax. NAB reported FY14 cash earnings of AUD 5.2 billion, down 9.8% year-on-year (YoY), although its domestic business performance remains satisfactory and the improving UK economy is helping its run off book. Capital, asset quality and liquidity remain steady. ANZ Bank reported FY14 cash earnings of AUD 7.1 billion, up 10% YoY. The Australian business reports another strong half recording 5% pre-provision profit growth and expanding margins and its capital and liquidity position remains steady. Bank of Queensland reported FY14 results with cash earnings of AUD 301.2 million, marginally ahead of guidance. The earnings growth was driven by a combination of margin expansion and further improvement in asset quality.

The Australian real estate investment trust (A-REIT) sector showed a turnaround for the retail segment with strong results, while the office segment remains challenged in terms of occupancy and the upcoming supply in Barangaroo. GPT Group successfully launched its Metro Office Fund (GMOF), raising AUD 225 million as part of its strategy to increase earnings from its funds management business. GMOF holds six A-grade office buildings totalling AUD 367 million, all of which are fully tenanted. GPT's Q3 FY14 update showed increased earningsper- share (EPS) growth guidance to at least 4% from at least 3% on the back improvements in its retail and office portfolios. Dexus Property Group has announced a 5% buy back, which will take place over the coming 12 months. The approximate value of the buyback is AUD 272 million, which is within capabilities. Stockland released its Q1 FY15 quarterly update with strongest start to a financial year since 2010, particularly in residential.

Coles continues to deliver for Wesfarmers with Q1 FY15 like-forlike sales of 4.3%. Wesfarmers noted that all key trading regions and categories performed well. BHP Billiton released its quarterly operational review, with a 9% increase in group wide production and production guidance on track to deliver group production growth of 16% over the two years to the end of FYE 2015. Metallurgical coal production rose 25% to 13 million tonnes as Queensland Coal achieved record quarterly production and sales volumes. Iron ore production increased 15% to 62 million tonnes as the ramp up of new productive capacity continued ahead of schedule and supply chain improvements.

Moody's revised its outlook on Australian Rail Track Corporation's (ARTC) Aa2 rating to Stable from Negative. The change reflects the expectation "that ARTC's financial metrics will strengthen over the next 3-4 years and revert to levels that are more consistent with the Aa2 rating". The announcement also comes after a deferral of capex, which was due mainly to a lower need for network expansion as coal demand tapers off. Standard & Poor's (S&P) upgraded Asciano to BBB+ from BBB due to S&P's expectation that "Asciano's future capital expenditure is to moderate, resulting in strong free cash flow and thereby consolidating the company's financial risk metrics at a level consistent with an improved credit profile".

Financial issuance this month included Suncorp, Bank of Queensland, AGL Energy, Newcastle Building Permanent Society and Toronto-Dominion Bank. In the securitisation market, Pepper Residential Securities Trust issued AUD 400 million, Sapphire XIII Series issued AUD 209 million and Widebay Trust issued AUD 300 million of RMBS.

Credit Outlook

Physical credit spreads have remained at reasonably tight levels due to the ongoing search for yield, although global uncertainty in the Middle East along with recent fears about Ebola and re-emerging concerns about Europe have generated negative sentiment. Credit markets still benefit from positive factors, such as a technical bid for credit due to the search for yield in a low-yield environment, supportive policies of most central banks, strong corporate balance sheets, a low likelihood of major bank failure and relatively solid economic fundamentals. Despite the considerable tightening over the last few years, spreads still seem to have more of a bias to tighten than to widen, although the pace of tightening will be slower and less consistent.

The excess supply of senior debt from the financial sector seems to be less of a threat than previously (due to slower growth in lending) and markets appear more sanguine about regulatory risk. Our view, therefore, is that high quality corporate paper is now priced fairly against bank issues due to continued spread tightening and high demand. Financials should outperform if the market becomes more optimistic, although they will remain more challenged in the longer term until regulatory issues are more completely settled and in particular there are more clearcut resolution regimes for failing banks. Given their strong credit profiles, paper from the major Australian banks appears attractive and should be relatively stable in the longer term. However, its higher liquidity has resulted in more volatility in the shorter term when some investors have tried to trim their credit exposure.

Supply continues to be a key issue for the Australian market, especially outside the financial sector. Despite record levels of lower rated corporate paper, the corporate market remains supply-hungry and allocations to new deals are often being severely scaled. Future supply is uncertain given many investment-grade issuers tend to be lowly geared and so require less debt. In addition, many Australian issuers are attracted to the bank loan market for shorter maturities and are still drawn offshore or to the bank market where very competitive pricing can be achieved for long-term debt.