Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 316

Is it time to sell bank hybrids?

Over the past five years, we have used a simple rule of thumb to assess the value of the new style/Basel III compliant Australian major bank hybrids:

  • Excellent value at a five-year credit margin approaching +500bps
  • Expensive when the five-year margin is +300bps or lower

This simple rule is based on the tightest and widest issues we have seen from the major banks since Basel III Additional Tier 1 (AT1) hybrids were first issued in January 2013. The two ‘book-ends’ were both issued by CBA and only 18 months apart, which shows how quickly the market can move:

  • CBA Perls VII (CBAPD) – issued in October 2014 at a credit margin of +280bps to call in 8.2 years
  • CBA Perls VIII (CBAPE) – issued in March 2016 at a credit margin of +520bps to call in 5.5 years

Significant tightening of margins

Australian bank and insurance AT1 hybrid spreads have been tightening for some time but that trend has picked up since the May 2019 election win by the Coalition which removed the risk that Labor’s franking policy posed, as the black line in the chart below demonstrates.


Source: Bell Potter

With demand increasing following the election, supply has been constrained with a dearth of new issues and little replacement funding expected in the near term. Issues approaching call/maturity dates in the next 12 months include just one major bank:

  • IANG (IAG) 16 December 2019 ($550 million)
  • NABPC (NAB) 23 March 2020 ($1,343 million)
  • MBLPA (Macquarie Bank) 24 March 2020 ($430 million)
  • CGFPA (Challenger) 25 May 2020 ($345 million)
  • SUNPE (Suncorp) 24 June 202 ($400 million)

Against this backdrop and the market’s search for value, AT1 hybrid spreads are now the tightest we have seen since the new breed of Basel III compliant hybrids first hit the market in early 2013. The widest margin of any of the major bank hybrids (as at 22 July 23019) was the NABPF June 2026 call AT1 with a trading margin of just +288bps.

Inadequate reward for hybrid risks

Margins for the AT1s with a first call in five years are closer to +270bps. This is in contrast to last week’s ANZ 10-year subordinated bond issue with a margin of +200bps. We argue that a differential of just 70bps is too low for the additional risks that AT1 hybrids present, including extension/non-call risk, no maturity date, automatic conversion to equity if Core Equity Tier 1 ratio falls below 5.125% and potential for coupons to be cancelled.

We believe it is time to take profits on bank and insurance company AT1 hybrids. We still see value in the legacy hybrids such as NABHA and MBLHB which are still trading at a discount to par, but those too have rallied strongly in recent times.

Whilst there is no immediate threat or trigger point to cause hybrid spreads to widen, history tells us that spreads are tight.

An opportunity to re-enter the market might be seen in the coming 12 months if the banks use the retail ASX-listed market to help raise the additional $50 billion Tier 2 capital required over the next four years, following APRA’s clarification of capital requirements earlier this month. We suspect we will see a number of large, well-priced listed Tier 2 issues with margins in the low-200bps. There is also the potential for some out of cycle/non-rollover AT1 issues which could present good new issue margins.

One further impact of the tight major bank credit spreads was the recent BNP AT1 in AUD. It was initially launched with a margin of 412bps but priced 75bps tighter at a margin of 337bps. Despite the tightening in issue spread, the size of the order book (demand) and the relatively small issue size (supply) provided a pathway for the strong secondary performance which we have seen to date.

 

** Justin will be hosting the ASA webinar 'Bonds, hybrids and inverse yield curve effect on equity markets' on 8 August 2019, outlining how in a low-interest environment you can maximise yield through the use of bonds and hybrids. **

 

Justin McCarthy is Head of Research at BGC Fixed Income Solutions, a division of BGC Brokers, and a sponsor of Cuffelinks. The views expressed herein are the personal views of the author and not the views of the BGC Group. This article does not consider the circumstances of any individual investor.

For more articles from Mint Partners and BGC, click here.

RELATED ARTICLES

Why bank hybrids are far too expensive

NAB hybrid: one says buy, one says sell, you decide

Understanding the extra return from hybrids

banner

Most viewed in recent weeks

Which generation had it toughest?

Each generation believes its economic challenges were uniquely tough - but what does the data say? A closer look reveals a more nuanced, complex story behind the generational hardship debate. 

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

The best way to get rich and retire early

This goes through the different options including shares, property and business ownership and declares a winner, as well as outlining the mindset needed to earn enough to never have to work again.

A perfect storm for housing affordability in Australia

Everyone has a theory as to why housing in Australia is so expensive. There are a lot of different factors at play, from skewed migration patterns to banking trends and housing's status as a national obsession.

Chinese steel - building a Sydney Harbour Bridge every 10 minutes

China's steel production, equivalent to building one Sydney Harbour Bridge every 10 minutes, has driven Australia's economic growth. With China's slowdown, what does this mean for Australia's economy and investments?

Latest Updates

Retirement

Supercharging the ‘4% rule’ to ensure a richer retirement

The creator of the 4% rule for retirement withdrawals, Bill Bengen, has written a new book outlining fresh strategies to outlive your money, including holding fewer stocks in early retirement before increasing allocations.

Shares

Are franking credits worth pursuing?

Are franking credits factored into share prices? The data suggests they're probably not, and there are certain types of stocks that offer higher franking credits as well as the prospect for higher returns.

Retirement

Inflation cruels a comfortable retirement

ASFA’s latest estimates reveal that home-owning couples need at least $690,000 in super for a ‘comfortable’ retirement, yet only around 30% of people meet these thresholds, and the shortfall may deepen.

Australia’s sleepwalk into a damaged society

The role of family and community as foundations of a healthy society have been allowed to weaken. This has brought about Australia's spiritual decline and a thirst for dopamine that explains our high debt levels.

Investment strategies

The simplicity of this investing method hides its power

Despite the perception that successful investors nimbly navigate each zig and zag in the market, the evidence suggests otherwise. This approach can help an investor avoid self-harming their returns.

Investment strategies

Four ways that global investors are reshaping their US exposure

It wasn't long ago that investors were asking if US exceptionalism could continue. They now appear to be diversifying away from dollar assets and shifting to a more active US equity allocation.

Investment strategies

The case for high yield bonds

This is a primer on high yield bonds - their risk and returns compared to investment grade securities, diversification benefits, and strategies for selecting high yield investments for enhanced portfolio yields.

Sponsors

Alliances

© 2025 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. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. 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.