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How hybrids would fare under dividend franking shift

Glenn Freeman  |  04 Apr 2018Text size  Decrease  Increase  |  
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As many as 20 per cent of investors holding additional Tier 1 (AT1) securities would be negatively affected by the Australian Labor Party's proposal to end cash refunds of excess imputation credits, says Morningstar's John Likos.

The proposed change would bring an abrupt end to a key advantage of the hybrid securities, according to Likos, Morningstar's director of equity and credit research, Australia. He addressed the topic in a recent report, which is available to Premium subscribers.

"Labor's proposed policy burden falls largely on the end investor, not the issuer.

"Some investors stand to lose a significant proportion of their total return on their hybrid investments by having the cash rebate removed," he says.

Likos also believes the change could create broader market changes by causing issuers to increase pricing and adjust the size of issuances.

"Unlike hybrids, the impact on equity investments is mitigated by capital upside potential as well as a higher dividend yield to start with.

"Nevertheless, while many investors have much to lose from this proposal, most hybrid investors will continue to benefit from fully franked dividends, up to the point where their franked returns offset their tax liabilities," Likos says.

Not killed, just limited

He reminds investors that dividend imputation would still remain--a point that has been confused or under-emphasised in some commentary.

"Franked dividends will continue to have a franking credit attached to them, but the refund provided by the Australian Taxation Office for any excess credits over tax payable will be scrapped.

"It does not mean franking will come to an end. The ability to use franking credits to offset tax liabilities will be retained."

Despite the "furious public backlash" which saw Opposition Leader Bill Shorten soften the original proposition, Likos emphasises that only a small proportion of the total group of investors that receive cash refunds or buy hybrids would be affected.

Even so, he says his watchlist of AT1 securities "has largely been a sea of red" since the proposal was floated.

This has been priced into the securities, creating attractive buying opportunities--which has seen Morningstar recently increase its ratings of several notes, including the ANZ Capital Notes 4 (ANZPG).

Not a fait accompli

"Of course, beyond Labor winning the next election, there remain further hurdles for this policy to be enacted. In particular, the proposed legislation must get through both houses of parliament.

"Given the last Federal election and the way that played out with regards to the high number of independent candidates winning seats, this is no certainty," Likos says.

However, he suggests there is a good chance such a policy would be passed, a scenario that would affect the medium-term dynamics of the AT1 market.

"We believe the recent AT1 sell-off has been overdone, presenting attractive opportunities for medium- to high-risk investors with the tolerance to invest in AT1s."

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Glenn Freeman is a senior editor at Morningstar.

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

is senior editor for Morningstar Australia

© 2020 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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