Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 161

Hybrids: the good, the bad and the ugly

Hybrids are the cane toads of the financial markets, and just as cane toads have evolved to survive in a range of climates, hybrids have adapted to changing regulatory and interest rate environments. The similarities do not end there because like cane toads, hybrids have good, bad and ugly characteristics.

The good

Hybrid margins (the difference between the interest earned and the benchmark interest rate) are higher than what has been offered historically and are attractive, especially in a very low interest rate environment (the bank bill benchmark rate is currently about 2%). Interest is calculated quarterly and all ASX-listed bank hybrids are floating rate. Back when interest rates were high, hybrid margins were relatively skinny. NAB’s National Income Securities (ASX: NABHA) were issued in financial ‘pre Jurassic times’ in 1999 with a margin over the bank bill benchmark of just 1.25% pa and investors were happy to invest at that level.

Figure 1: Paying better returns – hybrid spreads widen

Screen Shot 2016-06-22 at 10.11.42 pm

Screen Shot 2016-06-22 at 10.11.42 pm

Source: Bond Adviser

In more recent times, margins have increased. All of ANZ’s five listed hybrids were issued in the 3% range. But returns hit a low point in October 2014 with the CBA Perls VII issue offering a margin of just 2.8% over the benchmark. This issue was a big one with CBA raising $3 billion. Since then investors have sold down hybrids and the price of Perls VII trades well below its $100 par value and is often in the high $80s to low $90s, pushing the margin up for new investors to over 5%.

While CBA wins the prize for the lowest margin hybrid on issue, Perls VIII issued in February 2016 was at the other end of the scale with a 5.2% pa margin, perhaps rewarding tolerant investors for past mispricing. This issue has tended to trade above par, implying investors would be satisfied with a lower rate.

The most recent Westpac issue, Capital Notes 4 (ASX: WBCPG), settled at a 4.9% margin and raised $1.45 billion, well over the targeted $750 million, a good result for investors and the bank. Next horse out of the gates was NAB with margin set at 4.95%, a small sweetener over the Westpac issue.

Separately, ANZ has announced a USD hybrid, a first for any Australian bank. Considerable work would have gone into marketing the issue, but they will reap the benefits of expanding their investor base and having issuance in another currency. The fixed coupon in USD is 6.5% and the cost of the issuance is rumoured to be higher once swapped back into Australian dollars as a premium for a new market is fairly typical.

The success of the heavily-oversubscribed ANZ deal will open another market for the majors and could mean reduced issuance here. Depending on demand, this could push hybrid prices higher. The issue will provide an international comparison of margins and terms for our own insular, domestic market.

The bad

The complexity and range of terms and conditions in hybrids makes them hard to assess. Comparing older hybrids that were more debt-like with new ones is extremely difficult. For example, the ANZPC and WBCPC were issued soon after Basel III was implemented and contain capital trigger clauses but not a non-viability clause that was mandatory from early 2013. So what extra return do you require over and above the margins on those securities to compensate for the additional risk?

The non-viability clause is important for investors to understand, and we have prepared this fact sheet for those requiring more information.

The ugly

The conversion terms and conditions especially those following a ‘loss absorption’ event are ugly. Practically every hybrid has variations to these terms and percentage conversion rates can differ, even if issued by the same bank. It’s part of the evolution of hybrids.

Investors should be aware of multiple possible outcomes, and follow the share price of the bank as it determines conversion or not. For example the NABPD requires that “The VWAP (volume-weighted average price) of ordinary shares on 25th business day immediately preceding (but not including) a potential mandatory conversion date must be greater than 56% of the issue date VWAP”. All new hybrids have similar clauses. It means hybrids aren’t set and forget investments and you need to keep track of share price movements. Those hybrids issued when share prices are high are at greater risk of non-conversion. For an example of the complexity, consider the terms of the NABPD conversion.

NABPD conversion conditions

Screen Shot 2016-06-22 at 10.12.31 pm

Source: National Australia Bank, NABPD prospectus, page 24

The success of all the recent hybrid issues shows investors are willing to accept these ‘ugly’ terms and conditions as they search for yield, but in financial markets, there’s no reward without risk. Remember that cane toads were originally introduced to Australia to control a major pest, the sugar cane beetle, and many decades later, that has turned very ugly indeed.

 

Elizabeth Moran is Director of Client Education and Research at FIIG Securities. Click on this link for a free copy of FIIG’s 2016 Smart Income Report designed for income-seeking investors. This article is general information and does not consider the circumstances of any individual.

RELATED ARTICLES

The fascinating bank hybrid journey of the last year

A simple method compares hybrids with term deposits

Should you buy CBA PERLS XII Capital Notes?

banner

Most viewed in recent weeks

Stop treating the family home as a retirement sacred cow

The way home ownership relates to retirement income is rated a 'D', as in Distortion, Decumulation and Denial. For many, their home is their largest asset but it's least likely to be used for retirement income.

Two strong themes and companies that will benefit

There are reasons to believe inflation will stay under control, and although we may see a slowing in the global economy, two companies should benefit from the themes of 'Stable Compounders' and 'Structural Winners'.

Welcome to Firstlinks Edition 433 with weekend update

There’s this story about a group of US Air Force generals in World War II who try to figure out ways to protect fighter bombers (and their crew) by examining the location of bullet holes on returning planes. Mapping the location of these holes, the generals quickly come to the conclusion that the areas with the most holes should be prioritised for additional armour.

  • 11 November 2021

Reducing the $5,300 upfront cost of financial advice

Many financial advisers have left the industry because it costs more to produce advice than is charged as an up-front fee. Advisers are valued by those who use them while the unadvised don’t see the need to pay.

Welcome to Firstlinks Edition 431 with weekend update

House prices have risen at the fastest pace for 33 years, but what actually happened in 1988, and why is 2021 different? Here's a clue: the stockmarket crashed 50% between September and November 1987. Looking ahead, where did house prices head in the following years, 1989 to 1991?

  • 28 October 2021

Why has Australia slipped down the global super ranks?

Australia appears to be slipping from the pantheon of global superstar pension systems, with a recent report placing us sixth. A review of an earlier report, which had Australia in bronze position, points to some reasons why, and what might need to happen to regain our former glory.

Latest Updates

Investment strategies

Maybe not the four most-costly words in investing

A surprisingly high percentage of respondents believe 'This Time is Different'. They may be in for a tough time if history repeats as we have seen plenty of asset bubbles before. Do we have new rules for investing?

Investment strategies

Firstlinks survey: the first 100 tips for young investors

From the hundreds of survey responses, we have compiled a sample of 100 and will publish more next week. There are consistent themes in here from decades of mistakes and successes.

Strategy

What should the next generation's Australia look like?

An unwanted fiscal drain will fall on generations of Australians who have seen their incomes and wealth stagnate, having missed the property boom and entered the workforce during a period of flatlining real wages.

Shares

Bank results scorecard: who deserves the gold stars?

The forecasts were wrong. In COVID, banks were expected to face falling house prices, high unemployment and a lending downturn. In the recovery, which banks are awarded gold stars based on the better performance?

Exchange traded products

In the beginning, there were LICs. Where are they now?

While the competing structure, ETFs, has increased in size far quicker in recent years, LICs remain an important part of the listed trust sector. There are differences between Traditional and Trading LICs.

Shares

Should you bank on the Westpac buy-back?

Westpac has sent out details of its buy-back and readers have asked for an explanation. It is not beneficial for all investors and whether this one works for some depends on where the bank sets the final price.

Investment strategies

Understanding the benefits of rebalancing

Whether they know it or not, most investors use of version of a Strategic Asset Allocation (SAA) to create an efficient portfolio mix of different asset classes, but the benefits of rebalancing are often overlooked.

Shares

Six stocks positioned well for a solid but volatile recovery

The rotation to economic recovery favouring value stocks continues but risks loom on the horizon. What lessons can be drawn from reporting season and what are the trends as inflation appears in parts of business?

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
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.