Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 340

A simple method compares hybrids with term deposits

The extra return paid to investors for taking risk has been heavily influenced by the reach for yield. It affects many spread margins (or excess returns) such as on high-yielding corporate bonds and (even) ordinary equity.

With cash and bond rates set to remain ‘lower for longer’, the transfer mechanism from 'risk free' with almost zero return to 'risk on' becomes self-fulfilling. This is the situation that Australia now finds itself in. Low interest rates, predicted by the 10-year bond rate to remain so for an extended period, assist with benign corporate and household default conditions.

Breakeven analysis: term deposit versus hybrid

As the reach for yield intensifies, do investors know if the return on invested capital at risk is sufficient compensation versus the risk-free rate to justify the investment? This is the question investors should always ask themselves before making any investment.

There is no right or wrong answer because individual investor risk tolerances vary. For example, we might assess hybrid capital instruments to have little risk at present arguing that the improved credit health of the issuers justifies pricing closer to more senior instruments of the same issuer. However, other investors will rank them only marginally ahead of ordinary equity perceiving them to be highly risky.

We use a number of methods to assess the risks inherent in individual securities and in aggregate terms, in our portfolios. One method, breakeven analysis, provides us with a relatively simple method of assessing whether the excess return over a prescribed benchmark index or even the risk-free rate provides sufficient compensation for the additional risk. It helps to compare assets of differing seniority, term and credit quality.

Using an example of a major Australian bank term deposit returning approximately 1% on an annual basis and the PERLS VII hybrid capital instrument (ASX:CBAPD), currently yielding approximately 3.5% per annum, puts the excess return in perspective.

Assume $100 is invested in a term deposit for 2 years (a reasonable time frame) at 1% per annum. Ignoring compound interest, investors earn $2 or 2% over the 2-year period.

Now, investing in CBAPD, we can assume the floating benchmark reference rate will be 1% (i.e. BBSW), the return over the same period, including the value of franking, will be 3.5% in year 1 followed by 3.5% in year 2, a total of $7 or 7%.

While the return is 3.5 times the risk-free term deposit rate, the investment is in a ‘risk’ asset where there is some probability, albeit a very low, of a capital loss over the period. Using breakeven analysis, it is possible to make a value judgement on the return versus the risk.

Making sense of the numbers

Let’s assume there is an ‘event’ and the capital value of the hybrid CBAPD declines. The question you should ask is:

How far does the capital value of CBAPD have to fall by the end of the period (i.e 2 years) before an investor would have been better off investing in the term deposit?

The capital loss on CBAPD would have to be greater than $5 (i.e the difference between earnings on CBAPD and the term deposit) before you would have been better off in the term deposit.

That is, if you buy CBAPD at $100 today you could sell it for $95 at the end of the period (year 2) and be no worse off than investing in the term deposit at 1% p.a. for 2 years. The table below summarises this information.


Income (annual rate)

Return @ end 2 years

Amount Invested

Income earned on $100 over 2 years

At end year 2 ($100 + income)

Breakeven CBAPD price @ end year 2 to = 2-year TD income

2-year TD














What does this tell us?

The interesting fact is that at a price of $95 in 2 years’ time (in January 2022), the yield-to-maturity to the first call in December 2022 of CBAPD would approximate to 9% per annum. That is, the change in capital value plus the  coupon and franking. At 9%, the spread margin represents an excess margin of 800 basis points or 8% over the risk-free rate which would be amazing value, everything being equal, for an asset of that credit quality (CBA risk) and term (one year).

While CBAPD has traded at a price below $95 in its life since its 2014 issuance, as shown below, it was only for a 12-month period in 2015 and 2016 when the term to maturity (first call) was in excess of five years. Since then it has traded at a price in excess of $95 and more recently above $100 (the security’s par value) reflecting a rerating of the risks associated with major bank hybrids and a shortening term to maturity or first call specific to the CBAPD security.

CBAPD Price Daily October 2014 to December 15, 2019

… but diversification is still key

While our portfolios are of similar term and similar average weighted credit quality to the example above, the important difference is that our portfolios contain 35 securities spread across a range of sectors and sub sectors, including banking, insurance, building and construction and infrastructure. The risks associated with investing in a single individual security are significantly reduced. Even with a credit of the quality of CBA, it's worth spreading the risk to other quality names. It is also possible that CBA will not call the hybrid at its first call date, although banks are reluctant to do this as it affects their subsequent visits to the market.


Norman Derham is Executive Director of Elstree Investment Management, a boutique fixed income fund manager. This article is general information and does not consider the circumstances of any individual investor.



The dramatic tale of two hybrids, CBA VII versus VIII

Should you buy CBA PERLS XII Capital Notes?

Why bank hybrids are far too expensive


Most viewed in recent weeks

Too many retirees miss out on this valuable super fund benefit

With 700 Australians retiring every day, retirement income solutions are more important than ever. Why do millions of retirees eligible for a more tax-efficient pension account hold money in accumulation?

Is the fossil fuel narrative simply too convenient?

A fund manager argues it is immoral to deny poor countries access to relatively cheap energy from fossil fuels. Wealthy countries must recognise the transition is a multi-decade challenge and continue to invest.

Reece Birtles on selecting stocks for income in retirement

Equity investing comes with volatility that makes many retirees uncomfortable. A focus on income which is less volatile than share prices, and quality companies delivering robust earnings, offers more reassurance.

Welcome to Firstlinks Election Edition 458

At around 10.30pm on Saturday night, Scott Morrison called Anthony Albanese to concede defeat in the 2022 election. As voting continued the next day, it became likely that Labor would reach the magic number of 76 seats to form a majority government.   

  • 19 May 2022

Is it better to rent or own a home under the age pension?

With 62% of Australians aged 65 and over relying at least partially on the age pension, are they better off owning their home or renting? There is an extra pension asset allowance for those not owning a home.

Keep mandatory super pension drawdowns halved

The Transfer Balance Cap limits the tax concessions available in super pension funds, removing the need for large, compulsory drawdowns. Plus there are no requirements to draw money out of an accumulation fund.

Latest Updates

SMSF strategies

30 years on, five charts show SMSF progress

On 1 July 1992, the Superannuation Guarantee created mandatory 3% contributions into super for employees. SMSFs were an after-thought but they are now the second-largest segment. How have they changed?

Investment strategies

Anton in 2006 v 2022, it's deja vu (all over again)

What was bothering markets in 2006? Try the end of cheap money, bond yields rising, high energy prices and record high commodity prices feeding inflation. Who says these are 'unprecedented' times? It's 2006 v 2022.


Tips and traps: a final check for your tax return this year

The end of the 2022 financial year is fast approaching and there are choices available to ensure you pay the right amount of tax. Watch for some pandemic-related changes worth understanding.

Financial planning

Is it better to rent or own a home under the age pension?

With 62% of Australians aged 65 and over relying at least partially on the age pension, are they better off owning their home or renting? There is an extra pension asset allowance for those not owning a home.


Listed infrastructure: finding a port in a storm of rising prices

Given the current environment it’s easy to wonder if there are any safe ports in the investment storm. Investments in infrastructure assets show their worth in such times.

Financial planning

Power of attorney: six things you need to know

Whether you are appointing an attorney or have been appointed as an attorney, the full extent of this legal framework should be understood as more people will need to act in this capacity in future.

Interest rates

Rising interest rates and the impact on banks

One of the major questions confronting investors is the portfolio weighting towards Australian banks in an environment of rising rates. Do the recent price falls represent value or are too many bad debts coming?



© 2022 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.