Observations on Bank Hybrids

Generally I am skeptical of hybrids, particularly the highly structured preference shares issued by financials (mainly the big 4 banks).

I would never participate in a new issue as the are typically overpriced and trade poorly in the secondary market. They are sold in general to in a fairly unsophisticated manner based on yield, despite being complex securities.

It's important to note that while they may look like a fixed interest product (the holder receives regular payments and if all goes well a return of capital at a specified future date) they are more akin to equity. In periods of market distress (now) fixed interest securities as a group generally rise while equity-like hybrids fall. This is possibly due to investors switching From the hybrids into ordinary equity to capture the higher yields on offer. This is quite a disadvantage as they are not providing any diversification benefit to a portfolio. To verify this for yourself, check out WBC vs WBCPE (hybrid) and WBCHB (bond).

WBC

WBCPE (hybrid)

WBCHB (bond)

All three securities have declined over the last 12 months. The bond has done best and importantly has exhibited the lowest volatility and greatest degree of capital stability.

Having said all this there are some opportunities from time to time.

ANZPA will mandatorily convert in Dec 16 at a 1% discount if not redeemed. Currently they are trading at a margin of about 3.9% to bills (i.e. based on a bill rate of 2.1% the yield to maturity is c.6.0% – note this will fluctuate as bills move). I like it under $99 and like it more under $98. I would reassess these levels if ANZ trades below c.$25. It is a very liquid issue having $1.7bn of securities outstanding.

If there is interest I will write about another opportunity. Let me know in the comments.

Good luck

Ed