Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 473

Is the best value for Australian credit not in Australia?

While Australian major bank hybrids (sometimes called T1s reflecting their position in the capital structure) are rightly held in high regard, their USD-issued equivalents now trade at a substantial premium and offer much higher risk-adjusted returns. Investors able to access Australian credit in offshore markets remain at a distinct advantage to those constrained to local shores.

(Editor's note: access to these securities is generally available via fixed interest brokers for investors who qualify as 'wholesale' - which is not a difficult test - or through funds which invest in them. In Australia, we commonly refer to T1 securities as 'hybrids' and T2 as 'subordinated' and T1 ranks below T2 in the capital structure. That is, T1 carries more risk because it would be paid out after T2 in an event of default).

Small yield gain for lesser credit quality 

In May 2022, we were surprised when major bank BBB-rated Tier 1 (T1) hybrid securities in Australia were trading just ~40bps (0.4%) higher in yield than the lower risk major bank BBB+ rated Tier 2s (T2) despite being two notches lower in credit quality. Incredibly, that gap has narrowed further to just ~20bps following the recent T2 (subordinated) issuance from NAB and ANZ which priced at very attractive margins of BBSW+280bps and BBSW+270bps respectively (refer Chart 1).

Based on historical averages, T1s currently look incredibly expensive and should be trading ~200bps wider of current valuations.

Moreover, based on offshore hybrid pricing, it seems this disconnect in bank hybrid capital pricing is more of an Australian phenomenon.

After diverging in late 2021, there is now a dramatic gap between the two, with US T1s now trading ~200bps wider than their Australian comparatives (refer Chart 2).

Looking at T1 curves in Chart 3 - the US (dark blue line) and Australia (light blue line) - there are several opportunities for domestic investors to extract a significant premia by choosing the US dollar denominated Australian T1s. Australian investors either need to accept the foreign currency exposure or hedging out the currency and interest rate risk.

We recently purchased the 2027 Westpac USD T1s. The security swapped back to a credit margin of BBSW+480bps, ~200bps wider than the equivalent ASX-listed security, with all currency and interest rate risk hedged throughout the life of the security.

By comparison, given their more attractive pricing domestically compared to T1, the same pick-ups in credit margins offshore are not currently available in bank senior or T2 segments. However, there are similar opportunities in Australian corporate credit with both the single A and triple B rated curves for Australian issuers significantly wider in USD than in AUD (refer Chart 4 and 5).

Benefits of taking a global perspective

This approach is enabling us to harvest higher risk adjusted returns across most sectors of Australian credit, while maintaining diversity across the spectrum of household Australian names which are a mainstay of most equity portfolios but typically do not issue debt in AUD. This long list includes major corporates such as BHP, Rio Tinto, Brambles, Bluescope and CSL, to name only a few.

Where it makes sense to do so, the Yarra Higher Income Fund is investing in Australian issuers across major currencies and hedging out currency and interest rate risk to optimise risk adjusted returns. With a current yield at ~5% which we expect will increase alongside rising interest rates, the Fund remains well placed to continue delivering consistent monthly income to its investors.


Phil Strano is a Portfolio Manager, Higher Income Fund at Yarra Capital Management. The information provided contains general financial product advice only. The advice has been prepared without taking into account your personal objectives, financial situation or particular needs.



Market turbulence shows strength of Australian bank T2 bonds

Credit trumps residential property for headache-free income

What's next for bank hybrids?


Most viewed in recent weeks

Meg on SMSFs: Clearing up confusion on the $3 million super tax

There seems to be more confusion than clarity about the mechanics of how the new $3 million super tax is supposed to work. Here is an attempt to answer some of the questions from my previous work on the issue. 

Welcome to Firstlinks Edition 566 with weekend update

Here are 10 rules for staying happy and sharp as we age, including socialise a lot, never retire, learn a demanding skill, practice gratitude, play video games (specific ones), and be sure to reminisce.

  • 27 June 2024

Australian housing is twice as expensive as the US

A new report suggests Australian housing is twice as expensive as that of the US and UK on a price-to-income basis. It also reveals that it’s cheaper to live in New York than most of our capital cities.

The catalyst for a LICs rebound

The discounts on listed investment vehicles are at historically wide levels. There are lots of reasons given, including size and liquidity, yet there's a better explanation for the discounts, and why a rebound may be near.

How not to run out of money in retirement

The life expectancy tables used throughout the financial advice and retirement industry have issues and you need to prepare for the possibility of living a lot longer than you might have thought. Plan accordingly.

The iron law of building wealth

The best way to lose money in markets is to chase the latest stock fad. Conversely, the best way to build wealth is by pursuing a timeless investment strategy that won’t be swayed by short-term market gyrations.

Latest Updates

Financial planning

Our finances should enable and not dictate our lives

Most people would prefer to have more money than less of it. But at what point do the trappings of wealth and success start to outweigh the benefits of striving for more?


This vital yet "forgotten" indicator of inflation holds good news

Financial commentators seem to have forgotten the leading cause of inflation: growth in the supply of money. Warren Bird explains the link and explores where it suggests inflation is headed.


Emerging market equities are ripe with opportunity

Emerging markets offer compelling value compared to history and the stretched valuations of developed market equities. Investors can benefit from three big tailwinds, but only if they are selective.


Tomorrow's taxpayers pay for today's policy mistakes

Less affordable housing isn't the only thing set to weigh on Australia's younger generations. If new solutions for pension deficits and the use of resource revenue aren't found quickly, tomorrow's taxpayer will foot the bill.

How would a switch to nuclear affect electricity prices?

The Coalition's plan to build seven nuclear power stations in 15 years faces scrutiny due to high costs and slow construction. And it is unlikely the investment would yield cheaper energy for Australian households and industry.


Reader feedback from our 2024 survey

Articles that are easy to understand, quick to read, and credible; being able to engage via the comments section; and keeping Firstlinks free and independent are just some of the features valued by our readers.


Have your say on Firstlinks and the topics we cover

We’d love to hear your thoughts on Firstlinks and how we can make it better for you. If you’d like to help us out in a just a couple of minutes, please take our short survey.



© 2024 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. 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.