Major bank hybrids – how do they really stack up?

Big Australian banks recently priced new debt issues. Portfolio Manager of the Enhanced Yield Fund, Jarod Dawson, discusses what investors may want to consider.

Macquarie Bank and National Australia Bank recently priced franked hybrid debt issues at yields of Bills + 290bp, and Bills + 295bp respectively (yields of ~3.90%). Excluding franking, the yield on Macquarie’s bond falls below 3.50% and NAB’s bond dips below 3.00%.   

These securities sit just one notch above equity in the bank’s capital structure, have no final maturity date (although they are potentially redeemable in around 6-7 years) and are convertible into equity if the banks’ common equity falls below 5.125% or the bank is deemed non-viable by regulators. It can even be written off before the banks’ equity under certain circumstances. How is that for a deal!

All the while, for the privilege of copping the above terms, investors receive a fairly low nominal yield, and in the case of NAB for example, are backed by a business that is highly geared, with significant exposure to residential property should the housing market’s day of reckoning befall it at some point. Also,  post the Royal Commission, banks now face increased  regulatory headwinds, as well as an environment of weaker credit growth, and  low interest rates that can potentially  impact their margins.

When faced with the above combination of low yields, poor security structures and a difficult earnings environment, we have chosen to look elsewhere to what we believe are for more attractive risk/ reward opportunities!

A good example of one of the Enhanced Yield Fund’s (EYF) investments are  the senior secured bonds issued by Spanish commercial property company Lar Espana. Think of Lar Espana like Stockland Property Trust in Australia, but with property assets that are far more attractively valued. It is sensibly geared, against good quality commercial property assets in key capital cities, with a capable management team at the helm.

The bond that EYF owns is a 2-year bond, with a known fixed maturity date (unlike the above bank hybrids which may be redeemed in 6-7 years at best) and which is secured against the company’s properties. I.e., so if there ever was a problem, the bond has the first call over the company's considerable assets.

The best part is that the current yield on the bond is Bills + 350bp – a cash yield of ~4.40% (ie no franking). 

Another example of what we consider to be an anomaly in debt markets that is owned in the EYF is online job advertisement company Seek Ltd’s 6-year bond (likely to be redeemed after 3 years) that was recently issued at a yield of Bills + 370bp (~4.60% yield – again pure cash - no franking). Seek is an impressively managed Australian company, with strong cashflow, and a good track record of investing shareholder capital. It also has a sensible balance sheet.

So as you can see, if you look in the right places, you can uncover attractive cash yields, in well run businesses, and investment structures that in our eyes favour the investor – not the issuer. The EYF's wide-ranging mandate gives us the flexibility to scour the globe so we can uncover the true anomalies in debt markets. Importantly, it also means that we are not forced into investments like the recently issued bank hybrids –   with low  cash yields relative to their risk, and investment structures that are made to favour the issuer – not the investor.  

We prefer it when the risk reward equation is in our favour. This is just another way that the PM Capital Enhanced Yield Fund is different – genuinely different – and why it has held ‘Recommended’ ratings from a number of the major rating agencies for over 15 years!

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This Insight is issued by PM Capital Limited ABN 69 083 644 731 AFSL 230222 as responsible entity for the PM Capital Enhanced Yield Fund (ARSN 099 581 558). It contains summary information only to provide an insight into how we make our investment decisions. The securities named, while held as at the time of issue of this insight, may be sold without notice. This information does not constitute advice or a recommendation, and is subject to change without notice. It does not take into account the objectives, financial situation or needs of any investor which should be considered before investing. Investors should consider a copy of the Product Disclosure Statement which is available from us, and seek their own financial advice prior to investing. Past performance is not a reliable guide to future performance and the capital and income of any investment may go down as well as up.

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