The ASX listed hybrid market has had another year of positive performance driven by no ALP franking policy / Coalition election win, and the RBA cutting the official cash rate by 0.25% in June, July and October.

This has resulted in the average trading margin on major bank hybrids firming from 3.34% at 31 December 2018 to 2.74% on 11 December 2019. In the 6 weeks post the Federal Election which included the RBA rate cuts in June and July, the hybrid market margins slipped to the lowest level since January 2012, with the average trading margin on major bank hybrids firming 1.01% from 3.32% on 17 May to 2.31% on 2 July. The market has subsequently eased with $2.9bn of issuance since September, spanning ASX listed debt and hybrid issues from Australian Unity ($322m), CBA ($1,650m), Virgin Australia ($325m), Suncorp (>$300m) and AMP (>$250m).

Post the broker firm new issue settlement on SUNPH on 13 December and AMPPB on 20 December, we see the potential for buying strength to emerge for the ASX listed hybrid market, supported by over $1bn of redemptions from hybrids issued by IAG ($550m), NAOS ($26.5m) and Multiplex ($450m). In addition, December has 29 ASX listed debt / hybrid securities paying a total of $271m of cash coupons ($369m grossed up), where the flow of funds has the potential to once again result in a repeat of the Christmas rally in hybrids witnessed over this decade. Since 2011, the average trading margin on major bank hybrids has firmed 0.39% from the high in mid-December to the low in early January.

NAB SUBORDINATED NOTES 2 (NABPE)

As the only remaining ASX listed bank subordinated debt security, NABPE offers value on a 1.88% trading margin at $101.10. For moving one notch lower down the bank capital structure from senior debt to subordinated debt, NABPE currently offers an additional margin of 1.19% when compared with NAB September 2023 wholesale senior debt (0.69% trading margin), and a margin uplift of 0.25% when compared with WBC wholesale subordinated debt (June 2023 call) on a trading margin of 1.63%. The rally in the hybrid market over 2019 has seen the spread from moving one ranking notch lower from NABPE to 5 year major bank hybrids narrow from ~2.00% at the start of 2019 to currently ~1.00%. NABPE is worthy of consideration to cornerstone a low risk fixed income portfolio.

ANZ CAPITAL NOTES 2 (ANZPE)

ANZ has moved to partial franking of dividends, reflecting the change to the geographical earnings mix. With ANZ declaring 70% franking on its final ordinary dividend, issue terms of ANZ listed hybrids provides for a cash top-up if the distribution is not fully franked. This has resulted in a 9.9% increase to the cash income on ANZ hybrids from the decline in franking from 100% to 70%. ANZPE currently offers value on a trading margin of 2.77% at $101.97, reflecting an attractive spread of 2.25% above ANZ March 2022 wholesale senior debt (0.52% trading margin). The higher cash component of income has the potential to result in a modest re-rating of partially franked ANZ hybrids versus other major bank fully franked hybrids.

MACQUARIE GROUP CAPITAL NOTES 3 (MQGPC)

MQGPC is worthy of consideration for investors seeking to increase income levels. At $105.30, the capital price premium reduces the 4.00% issue margin to a trading margin of 2.83%. The cash top up required for MQGPC distributions being 40% partially franked results in our 12 month income forecast of $4.17 cash, plus $0.72 franking (issue margin 4.00% + 3 month bank bill of 0.89%). If MQGPC was 100% franked, cash income would decline 18% to $3.42, while franking would increase to $1.47.

Authored by Damien Williamson – Research Analyst at Bell Potter Securities, 17 December 2019
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Disclosures
Macquarie Group Capital Notes 3 (MQGPC):
Bell Potter Securities acted as Co-Manager in MQG’s Capital Notes 4 (MQGPD) offer (February 2019)  and received fees for that service.
ANZ Capital Notes 2 (ANZPE):
Bell Potter Securities acted as Co Manager on both ANZPE launched in February 2014 and MQGPC launched in May 2018.
T S Lim holds long positions in IAG, MQG, MQGPC, MQGPD and SUN.