Helen Mason
Despite a final phase out date of 2032, a number of large bank hybrids have already matured, which means investors need to start looking for alternative investments sooner rather than later, according to Schroders portfolio manager, fixed income, Helen Mason.
Ms Mason says a CBA and ANZ hybrid have already been called and matured with a Westpac hybrid to mature this month.
“About 76 per cent of current hybrid securities will be called within the next 5 years. That’s a lot of money that needs a new home. The other thing to consider is pricing pressure. Every single retail hybrid security is currently trading above par. It is important to remember if investors wait until the call date, they will not receive the current trading price, which could be $106, as the price will pull towards the par value of $100 as these securities get closer to call,” Ms Mason says.
“Investors should therefore start considering other options to replace their hybrid exposure whist the price remains high and to avoid the potential for capital losses into the future.”
Bank hybrids, also known as Additional Tier 1, have been attractive to retail investors for a variety of reasons including their perceived safety, the yield and their franking credits. Retail investors comprise a large percentage of the $40 billion bank hybrid market in Australia, Ms Mason says.
“Because hybrids are issued by the Australian major banks, retail investors have been less concerned over the risk of bank failure. But although unlikely, a loss of confidence in the banking system can occur for a number of reasons. In terms of the risk, hybrids were put in place to provide an additional source loss provision to help shore-up the capital stack and avoid the Government having to step-in to support depositors in the event of a crisis. Given hybrids sit just below equity in the capital stack, means hybrid holders were taking far more risk than they were possibly aware of.
“Hybrids are volatile. They actually trade like equities. For instance, in 2023 when Credit Suisse and Silicon Valley Bank failed, the contagion effects to Australia were not insignificant. The PERLS XIII, a CBA bank hybrid, had a drawdown of 2.5 per cent which was over 6 times greater than the draw down on the Schroder Australia High Yielding Credit Fund at the time,” Ms Mason says.
She adds that bank hybrids are complicated products. “They were originally established to manage liquidity and the contagion shortcomings revealed by the global financial crisis (GFC).
“In fact, the decision to phase out bank hybrids itself is indicative of how APRA and ASIC do not believe they are fit for purpose or a suitable investment for retail investors.
“Clearly it is time to think about transitioning from those hybrids and looking at other opportunities in the market, and there are some very compelling alternatives,” Ms Mason says.
For instance, she says that Australian public debt is very attractive.
“The Australian credit index versus the credit indices of the likes of the US and the Europe is about two ratings notches higher.
“Our index is very high quality. The reason for that is partly our highly regulated and high-quality banking system, as well as other high-quality businesses which have highly regulated cash flows but are also inflation linked. We have very low exposure to cyclical companies in our credit market”
“Furthermore, around 60 per cent of issuance in the Australian public credit universe is unlisted, meaning investors cannot access these companies via equity markets. So, it provides an element of diversification,” she says.
Examples of the kinds of businesses issuing debt are Sydney Airport, the Port of Brisbane, the Port of Newcastle, and Transgrid. Ms Mason says these businesses have high quality monopoly-like characteristics but need to take on debt to fund projects they are working on.
“The energy transition has meant increased capex for many companies to support the roll-off of traditional energy sources into renewables, which means they have to issue more debt,” Ms Mason says.
Some large infrastructure companies are using corporate hybrids to support their capex pipeline, which are available to wholesale investors only. Melbourne airport recently listed such an instrument.
“They’re building a third runway, and so they require capital up front. Issuing a corporate hybrid helps to protect the senior debt credit rating without compromising business requirements.,” Mason says.
The corporate hybrid market is a growing market in Australia and, according to Ms Mason, an increasingly attractive one for wholesale and institutional investors.
For retail investors to be able to access these types of investments, they may need to look to look at investing via funds or ETFs – such as the Schroder Australian High Yielding Credit Fund and Active ETF, Cboe: HIGH.