On 1 January 2023, the Aged Care Interest Rate (commonly referred to as the Maximum Permissable Interest Rate or MPIR) increased from 6.31% to 7.06%. This new rate is applicable to individuals who enter aged care from 1 January 2023 and existing residents who move to another aged care facility. The MPIR is used to determine the Daily Accommodation Payment (DAP) rate for market price residents and the lump sum rate for low means residents.The change in the MPIR can materially impact the level of the DAP. The table below illustrates the DAP equivalent for a Refundable Accommodation Deposit (RAD) of A$400,000 based on the MPIR rate over the last seven quarters.
The change in the MPIR can materially impact the level of the DAP. The table below illustrates the DAP equivalent for a Refundable Accommodation Deposit (RAD) of A$400,000 based on the MPIR rate over the last seven quarters.
MPIR trends over time
Source: SimplyRetirement.com.au
With interest rate rises likely to continue over the coming year, DAPs are becoming more expensive for residents paying the market price. If we assume the MPIR reaches 9%, the market price resident above paying A$400,000 by RAD will pay $36,000 annually or $98.63 per day. Since RADs and DAPs are impacted by changes in interest rates, the MPIR for an Aged Care provider really reflects their cost of capital. As cost of capital rises, there is a need for Aged Care providers (many of which are not-for-profit organisations) to effectively earn a ‘more commensurate’ return on that capital.
Many Aged Care providers have been heavily invested in bespoke cash management solutions, whether that be via negotiable certificates of deposit (NCDs) or term deposits (TDs). While this low-risk low-return, asset allocation has worked well in the past, a more flexible investment strategy is needed as other costs (mainly those linked to inflation) within the Aged Care sector have also risen exponentially. Additionally, real returns on bespoke cash management solutions are considerably lower than those available in investment grade credit.
With inflation accelerating well beyond initial expectations and proving stubbornly elevated, central banks have embarked on an aggressive tightening cycle over 2022. A consequence of the upwards adjustment in interest rates is that investors now have a realistic alternative to generate returns without having to resort to higher risk assets or compromising liquidity to add incremental yield.
And this is where investment grade credit fits in.
Growth dynamics are likely to be challenged in the pursuit of reducing inflation to a rate close to central bank targets. A contractionary growth regime would indicate a defensive bias is warranted provided stubborn inflation and slower growth paints a challenging environment for most traditional assets like equities and property. At some point in 2023, conditions may become more beneficial, but we are not there yet.
A combination of rising government bond yields and widening credit spreads has created a perfect storm for credit investors over 2022, driving absolute yields back to levels like those seen before the global financial crisis (GFC). Investment grade credit now offers a way to achieve long-term return objectives via income alone, without the drawdown risk inherent in equity markets. Despite the rise in yields, many corporate issuers are insulated from the interest rate shock. Through the period of low interest rates, corporates extended their bond maturity profiles, taking advantage of excellent funding conditions. Furthermore, many corporates who pass on rising costs (mainly those linked to inflation) and have long maturity fixed-rate debt will effectively be naturally deleveraging.
Absolute yields offer meaning long-term returns
Source: Bloomberg and Bank of America, October 2022. The global investment grade universe is represented by ICE BAML Global Corporate Index (G0BC).
It’s important at this stage to predicate that we see investment grade credit as another appropriate asset allocation for Aged Care providers alongside bespoke cash management solutions. We are not recommending a high-yield asset allocation. In accordance with the Aged Care Act, investment grade bonds offer protection of capital and meet cash flow requirements, including repaying RADs as and when they fall due. Because investment grade bonds can be staggered to meet various maturity profiles, they also fulfil an important requirement in managing the DAP for market price residents and the lump sum for low means residents.
IAM has a long history of working with not-for-profits, currently administering assets for over 45 such organisations. IAM was awarded a A$160 million mandate in May 2022 to provide execution services for a large not-for-profit organisation.
Source: Bloomberg
