Possible $2.5bn tailwind to drive hybrid demand in 2017

Glenn Freeman  |  22/02/2017Text size  Decrease  Increase  |  

Glenn Freeman: I'm Glenn Freeman for Morningstar and I'm joined today by Morningstar senior credit analyst, John Likos.

John, thanks for joining us today.

John Likos: It's good to be here.

Freeman: Just firstly John, what's your outlook for Australia's hybrid sector for 2017?

Likos: Yeah sure. Look I think this year we have a range of technical factors which should support hybrid pricing. By technical factors I'm largely referring to supply issues.

We've already seen a couple of issuers come to market and not replace their hybrids in the last few months. So we've seen Woolworths, we've seen Origin and we believe we're probably going to see some other issuers do the same thing through this year and they include companies such as Caltex, possibly Goodman as well.

There is a possibility that one of the major banks might not replace their listed security with another listed security they might replace it in the wholesale market and I'm referring to the ANZ HA there. So, if that’s the case than we are going to see a significant amount of money on the sidelines waiting for opportunities in this space.

So, we've calculated approximately $2.5 billion worth of money might be sitting on the sidelines after issuers called their notes without replacing them. And the ANZ note lifts that up to just over $4 billion.

We think that will be strong technical tailwind of course that won’t count for much if the market and the economic backdrop fall away and offset that.

But that’s not our base case scenario we continue to think the economy will continue to perform at a reasonable rate of growth. Which should, in line of the supply issues as well, provide a reasonable backdrop for hybrids. However, saying that I don’t think we're going to see the rapid price appreciation as we witnessed in late 2016.

Freeman: Can you talk a little about National Australia Bank's recent hybrid issue and why we supported this?

Likos: Yeah, absolutely. NAB came to market and issued the NAB subordinated notes too.

Now, they are a Tier 2 product. So, they are not like the Tier 1 hybrids that the market is generally more familiar with. The Tier 2 has more bond like features. For example, it doesn’t have a capital trigger whereas the Tier 1 securities do have a capital trigger.

And what a capital trigger is, basically, should the common equity Tier 1 ratio drop below a certain level, then they effectively have to be converted into equity and these don’t have that. They do have however the non-viability trigger as the new AT1s do.

However, in saying that, they also have event of default provisions which is much more bond like, meaning that you can't miss a payment without that, meaning a default for the issuer.

Whereas the AT1s, the more common ones, you can defer your distributions if you like even though there's a dividend stopper. There are, more bond like features we believe adds significantly to the quality of investor's portfolios by stabilizing a large part of it. It is far less volatile in a down market then what we'll find the AT1s will be.

So, look, we really like the product and we thought the price was fair, you'd always like a little bit more, but we still thought the price was fair where it was and we had no hesitation in recommending that for our investors.

Freeman: And John, do you expect some of the other major Australian banks will follow suit with issues this year. What are some of the risks that investors need to be mindful of if this is the case?

Likos: We do expect further issuance this year. When there is a note that’s due to be called or maturing, generally speaking, you'll expect the issuer to reissue.

So, we do have a couple of notes that are due to be called this year and that includes the Colonial notes, also some of the ANZ notes as well. So we think there will be replacement trades in that space.

The interesting one of course is the ANZ HA, that is a Tier 2 product. Now whether or not ANZ opts to come back into the list of market with that, or whether they opt to go into the wholesale market, I really think that’s a 50-50 play at the moment, which goes back to the supply driver that I mentioned before. But nevertheless, we do expect to continue to see the banks tap into this hybrid market.

In terms of risks, look there is always risk, and the biggest risk with hybrids is not understanding what you are buying.

So, we need to always ensure that investors are aware of what they are buying and they are aware of key terms such as the non-viability trigger and the capital trigger.

So, that’s critical now those triggers go back to the capital levels of the banks and therefore for hybrid owners you find that the greatest risks are related to issues surrounding capital levels.
Banks are very well capitalised at the moment, and we believe they'll continue to be well capitalised. But should there be any shock to the system whether it’s a housing related shock, whether it's a US-influenced shock in funding costs. It could well impact some of their bottom line capital numbers, which could then flow onto the pricing in the hybrid products.

Again, that’s not a base case scenario but these are issues that investors must continuously be on top of.

Freeman: John, thanks very much for your time today.

Likos: Thank you.

Freeman: I'm Glenn Freeman for Morningstar. Thanks for watching.

Video Archive...

CBA's impressive FY17 result marred by AUSTRAC case
11/08/2017  A typically clean, solid and big $9.8 billion result from Commonwealth Bank of Australia was somewhat overshadowed by ongoing coverage of its alleged role in money laundering
Rio Tinto posts mixed result for 1H17
10/08/2017  An interim result of US$3.9 billion in net profits after tax for one of the world's largest mining companies was positive but slightly weaker than expected, even alongside a record dividend, explains Morningstar's Mat Hodge.
Kerr Neilson on why global investment exposure is key
07/08/2017  There are two types of investors, regardless of market noise, imputation credits, diversification approaches and market indices, says the managing director of Platinum Asset Management.
Finding fixed income opportunities in new paradigm
02/08/2017  Slowing economic growth in the US and parts of Europe emphasises the need to carefully select credit opportunities, says Vincent Reinhart, chief economist, Standish Mellon Asset Management.
Exclusive: An interview with Westpac CEO, Brian Hartzer - Part 3
20/07/2017  Insights on Australia's housing market, China's effect on domestic banks, and cyber-security readiness, in the final instalment of Brian Hartzer's interview with Morningstar's David Ellis.
Telstra won't be blown away by headwinds
17/07/2017  While it faces what Morningstar equity analyst Brian Han describes as a whirlwind of negatives, he suggests investors shouldn’t hang up on Telstra.
Exclusive: An interview with Westpac CEO, Brian Hartzer - Part 2
13/07/2017  Westpac CEO Brian Hartzer joins Morningstar banking analyst David Ellis to discuss digital disruption, regulatory change and Australian banks' social license.
The home-truths of investing
12/07/2017  Look for companies that sit outside the cycle; heed the lessons of history; and remember the power of compounding, says Bennelong's Neale Goldston-Morris.
Exclusive: An interview with Westpac CEO, Brian Hartzer - Part 1
06/07/2017  Brian Hartzer, CEO, Westpac joins Morningstar senior analyst David Ellis to discuss his role leading Australia's oldest bank, how Westpac can continue to grow value, and its commitment to sustainability.
Self-managed super is not Do-it-yourself
03/07/2017  There are a few common pitfalls in running a self-managed super fund that mean trustees shouldn't go it alone entirely, says BT Financial Group's head of financial literacy, Bryan Ashenden.
Investing to protect on the downside
30/06/2017  There are investment strategies you can adopt to mitigate volatility-linked fear and uncertainty in markets, explains Roy Maslen, chief investment officer – Australian equities, AllianceBernstein.
Don’t overdo benchmark consideration
28/06/2017  Being benchmark agnostic is the most effective approach to fixed income investing, according to Anujeet Sareen, portfolio manager, Brandywine Global.
Factor-based investing using ETFs
26/06/2017  Investors should consider style-exposures--such as value, defensive or yield-- they would like in their portfolios, explains Jonathan Shead, head of portfolio strategists – Asia Pacific, State Street Global Advisors
Volatility plays to active manager strengths
--  The climate of political volatility in the US holds important implications for investors and the funds they invest in, particularly around Donald Trump's ability to pass legislation through Congress, says Pimco's Libby Cantrill.
Is the FTSE 100 Facing Another Market Crash?
16/06/2017  Ten years on from the pre-crisis FTSE 100 high, Morningstar UK's Emma Wall examines how UK stocks have fared
How to guard against retirement threats
16/06/2017  As retirement approaches, even the best-laid plans can go awry, as Tim Steffen tells Christine Benz, Morningstar US.
PIMCO Global Credit Fund
07/06/2017  The PIMCO Global Credit strategy receives a Morningstar Analyst Rating of Silver due to its sizeable and highly capable credit research team.
PIMCO Income Fund
07/06/2017  Morningstar's Tim Wong looks at the strengths and competitive advantages of this Silver-rated strategy.
3 pockets of opportunity in fixed income
07/06/2017  The head of PIMCO Australia portfolio management explains his views on active management in fixed income and outlines where he sees most value in this space.
Trump administration biggest macro threat for investors
05/06/2017  Even as European political volatility subsides, the US Government remains a considerable threat to financial markets, says Colleen Barbeau, director of equity portfolio management, Franklin Templeton.