Tips For Assessing A New Hybrid
Last week, Westpac brought a new listed hybrid to the market. I’m expecting it to be joined by an avalanche of new issues to meet higher APRA capital requirements, so I think it is timely to suggest some tips on assessing them.
8 tips for assessing a new hybrid:
1. Understand the structure. Is the hybrid issued by a company or a bank? New company hybrids are rare these days but the structure is driven by the credit ratings agencies. If the company is trying to satisfy two or more agencies, its hybrid structure can get very complicated.
Bank hybrids are structured to satisfy the Australian Prudential Regulation Authority’s capital requirements to be loss absorbing in times of distress. At the worst possible time they convert to shares to support bondholders that sit higher in the structure.
2. Work out how you are going to be repaid and when. Hybrids typically have call dates when most investors expect to be repaid but this is not always the case, they can be extended and in the case of bank hybrids, they can be perpetual and never have to be repaid. Use a best case scenario of the first call date, but keep in mind the worst case – you have to sell to get your money back. Remember the longer the time until first call the more uncertainty there is and you should be rewarded with a higher return.
3. Check the distribution payment terms. Interest can be “cumulative” meaning the entity can miss a payment but it has to be made up at a later date or “non-cumulative” meaning interest can be forgone – not so attractive if you are buying the hybrid for its cashflow. All bank hybrids must be non-cumulative to meet APRA requirements.
4. Assuming repayment at first call, compare this hybrid to others issued by the same company. Are there any advantages of owning other hybrids by the same company? In the case of the banks, some of the older style hybrids don’t have the non-viability or capital trigger clauses, meaning they are lower risk. If those hybrids are paying similar returns the market isn’t pricing in the risk differential.
It’s also worth comparing returns of other investments in the same company. For example, term deposits, bonds and shares. It is a matter of assessing the risk and return throughout the capital structure, to make sure you are getting the best deal.
5. Compare the new hybrid to existing ones from other banks or companies. Is there any benefit in the new hybrid over other similar companies or banks? In regards to bank hybrids, if my prediction of more issues to come transpires, there should be a saturation point and as more supply enters the market, the banks should be offering higher returns. It may pay to wait for a few issues before you buy in if you share my view, to increase your return.
6. Check the performance of recently listed hybrids. Some, like CBA Perls VII have been quite volatile trading below their face value.
7. Will the new hybrid be upsized to fill demand? The significant need for more capital by the four major banks and Macquarie mean they are likely to issue enough to meet market demand, taking away possible secondary market buying support and reducing the chance of the hybrids increasing in value when listed.
8. What’s your existing exposure to the sector and individual bank or company? Recent research by Investment Trends suggests investors are over-exposed to the banking sector with average exposure over 50% when you consider term deposits, hybrids, equities and other bank securities.
If you are interested in the new hybrids, setting up your own spreadsheet to keep track of the various options is a good idea, as they are all different. My final suggestion - make sure you read the health warning on the pack!
Elizabeth Moran is a director of education and fixed income at Sydney-based bond broker, FIIG Securities.
She is a specialist on the bond market and regularly presents at conferences across Australia. Elizabeth is the editor of FIIG's weekly newsletter The Wire and is the is the author of "The Australian Guide to Fixed Income".