• Australian (ASX) Stock Market Forum

Hello and welcome to Aussie Stock Forums!

To gain full access you must register. Registration is free and takes only a few seconds to complete.

Already a member? Log in here.

Hybrids - eyes wide shut in the chase for yield?

Discussion in 'Business, Investment and Economics' started by sydboy007, Aug 27, 2014.

sentifi.com

Aussie Stock Forum Sentifi Top themes and market attention on:

  1. sydboy007

    sydboy007

    Posts:
    3,632
    Likes Received:
    2
    Joined:
    Dec 10, 2012
    I'm posting this because I'm not sure if those piling into the new bank issues hybrids are fully aware of the much higher risk they carry when compared to the pre basel III hybrids.

    FIIG has a good article today on the potential loses if APRA decided to enforce the non viability clause in all the new basel III complian hybrids, and even the fear of this occurring could see large falls in value. It's also intresting to note that in the EU and UK they've banned these type of hybrids from being sold to retail investors.

    https://www.fiig.com.au/news-and-re...ampaign=The Wire - 27 August 2014 - Issue 315

    FIIG Securities says new “bail-in” hybrids are equity risk, not fixed income
    26 August 2014
    by Craig Swanger
    Key points:

    1. The new breed of hybrid is not traditional fixed income, and in a downturn they will perform just like equities and not protect investors like fixed income should.
    2. Regulators are happy that these hybrids are “equity” because of their ability to force a conversion in a crisis; and investors, particularly private investors, price them like debt.
    3. The biggest risk is what happens when markets sense that a bank’s financial position is deteriorating toward a point where non-viability may be called by the regulator and investors start a sell down of the hybrids, which will occur well before any actual crisis triggering a non-viability clause.
    4. The UK’s financial services watchdog, the Financial Conduct Authority, this month banned the issue of bail-in hybrids to retail investors. The EU’s equivalent, the European Securities and Markets Authority, has flagged it is likely to follow.
    Leading fixed income investment specialist FIIG Securities is warning investors that the new breed of hybrid is not traditional fixed income, and in a downturn they will perform just like equities and not protect investors like fixed income should.

    FIIG Head of Markets, Craig Swanger, said “The problem with these hybrids is that they were specifically designed to provide financial support to banks if they have another financial crisis like the 2008/09 GFC. That is, they will convert to equity, without investor choice, at precisely the wrong time for investors. Many in the market believe the hybrids will only convert when the bank becomes bankrupt but this is not how the regulator views it, they see this capital converting when the bank is in trouble but still “a going concern” and investors in these new securities will likely take a significant haircut on their capital when they convert.”

    “It is important to understand that these securities are designed to be equity in the eyes of the banking regulators. During the GFC, several European banks were bailed out by governments which in effect saved the banks failing but laid the burden of loss at both the equity holders’ door and taxpayers. Bond investors were protected (as they should be) because they ranked higher in the capital structure. In Australia the taxpayer was burdened with having to provide a deposit guarantee. If the same scenario played out today, the banking regulator would have the option of declaring non-viability and forcing a conversion of these hybrids to equity – good for the taxpayer but not so good for the hybrid investors.”

    Now banking regulators are encouraging banks to issue more “Tier one” capital, i.e. “equity” to avoid a repeat of this scenario. But rather than issue expensive equity diluting existing equity holders, the banking sector designed these hybrids to take advantage of a market arbitrage. Regulators are happy that these hybrids are “equity” because of their ability to force a conversion in a crisis, and investors, particularly private investors, price them like debt.

    Ironically, it is now the same regulators that are warning that the risks of these securities are not being properly priced. The Bank of England recently warned, “There is a risk that investors are underestimating the probability that [these] instruments will be required to absorb losses”. Then UK regulator, the Financial Conduct Authority, this month banned their issue to retail investors while the EU equivalent, the European Securities and Markets Authority, has flagged it is likely to follow.

    “FIIG believes that the regulators’ proactive role is appropriate and timely. In Australia, where ASIC issued a similar warning over a year ago, the market is still focussed on the relatively minor risk of one of the Australian banks becoming “non-viable”. That is not the biggest risk facing holders of these hybrids.”

    “The biggest risk is what happens when markets sense that a bank’s financial position is deteriorating toward a point where non-viability may be called by the regulator and investors start a sell down of the hybrids, which will occur well before any actual crisis triggering a non-viability clause.” Such a sell down occurred in 2008/09, when even the major banks’ hybrids dropped by more than 30% without any question of default of the banks. “What we don’t know yet is what will happen in the next financial crisis when these new bail-in hybrids are put to the test,” Swanger says. These new hybrids could fall much further than 30%, and potentially even more than equities if investors dump the hybrids ahead of conversion.

    This sell down could occur sooner than many expect if ASIC were to follow the UK example and ban retail distribution. ASX data shows that large institutional involvement has fallen dramatically over recent years. Hybrid participation prior to 2008 was 60-70% institutional, but by 2013 this figure had fallen to 20%, meaning the participation of smaller investors would have made up the difference. SMSF industry data confirms this, showing that SMSFs are holding around $30bn in hybrids, up from less than $10bn in 2008.

    “Fixed income is supposed to protect investors in a downturn and provide regular, reliable income throughout the cycle. Hybrids failed to offer protection in 2008/09, but the major banks’ bonds (without the bail-in provisions) fell just 2-3% and recovered immediately. Bank equities fell by 40% on average, but you accept that risk because you also have the chance for upside, as investors that held on to their bank stocks have now found. With these hybrids, you get neither the protection of bonds nor the upside of equities.”

    “Since the global financial crisis, hybrid products have become more complex, more like equity and more popular than ever with SMSF investors. They are not fixed income in any traditional sense – they have no set maturity date, have optional interest payments and can be converted to shares by the banking regulator.”

    “Furthermore, there are clear signs globally that professional investors are sceptical about the value these new hybrids offer. However private investors are still chasing yield, and without access to other investments offering security and high yield, will continue to support these hybrids. More transparency of the global debate and education is urgently needed.”

    For its part in this, FIIG has issued a research paper on the topic titled “New style Basel III-compliant bank subordinated debt and Additional Tier 1 securities/hybrids are higher risk”.

    ENDS: Media enquiries to Duncan Macfarlane on 0435 092 936

    About bail-in hybrids

    Bail-in hybrids (also known as Contingent Convertible securities or “CoCos”) were created in 2009 in the UK, when Lloyds Group issued a new type of hybrid. The securities would be automatically converted into shares in Lloyds in the event that Lloyds’s capital fell to crisis levels.

    Rather than the government being forced into further bail outs, these new securities would convert from high-yielding hybrids into shares without the investor or even Lloyds itself having any choice in the matter. In other words, the hybrid investors would be “bailed-in” to prop up the bank’s balance sheet.

    Since then, European banks have issued around $110 billion (€75billion) in these hybrids. Banks, and until recently regulators, have been pleased at the success of this financial innovation as it means bondholders and government bodies are far less likely to need to bail out banks in the event of a liquidity crisis like that seen in 2008.

    Banks are particularly keen to issue more of these securities because they are a cheap source of funding. In a crisis, these securities act as a loss-absorber as banks don’t have to pay interest or repay the capital. For this reason, European banks are expected to issue a further $240 billion (€170billion) in the next two years. Yield hungry investors are expected to scramble for an allocation, with Deutsche Bank’s recent €1.5billion issue receiving €25billion in orders.

    However, the tide is turning, with the UK’s financial services watchdog, the Financial Conduct Authority, this month banning the issue of CoCos to retail investors. The EU’s equivalent, the European Securities and Markets Authority, has flagged it is likely to follow.
     
  2. qldfrog

    qldfrog

    Posts:
    2,976
    Likes Received:
    1,282
    Joined:
    Jun 8, 2008
    Agree Sydboy,
    A good point:
    I was very heavy hybrids a year or so ago and today a stoploss on my MBLHB saw me exit the last ones, I even prefer cash to staying in these;

    I hope a fair amount of owner will read and understand what you wrote:
    hybrids have been very good for me in the past and probably for many people as well with yield well above 5% based on when these were purchased and a nice capital gain for most in my case but seeing the attitude of the usual punter in real estate and the banks, it seems people tend to replay nice projection of the past into the future.That is a very dangerous game
    i agree with you that hybrids nowaday have nearly no risk premium on what is now a bigger than before risk.
    much better to put your $ in TLS or even bank shares:eek: than hybrids with more risk, less yield and the potential of having a final value of basically 0;
    of course Telstra could go bankrupt too but I am ready to take that risk.:D
    TLS being used here as an example but you can replace by any decent serious blue chip with rteal asset (excludes banks)

    Disclaimer; I do not own hybrids anymore since today, I own TLS but no bank shares and I am not pushing TLS
    DIYR
     
  3. Vixs

    Vixs

    Posts:
    235
    Likes Received:
    0
    Joined:
    Nov 16, 2011
    It is also important to note that they aren't all the same. Some hybrids convert to shares at a ratio based on the pre-issue/listing share price, meaning you got to participate in equity upside while getting 'fixed-interest-like' yield. Most of the recent offerings don't have this and instead convert at the share price at the time of conversion - meaning no capital gain because you just get less shares per $100 face value. This makes them significantly less attractive, obviously.

    I don't know what's the chicken and what's the egg in this scenario, but I doubt it is coincidence that less institutional involvement over the last few years is related to the decreasing attractiveness of the offerings being issued.
     
  4. Ferret

    Ferret

    Posts:
    410
    Likes Received:
    45
    Joined:
    Aug 13, 2006
    I've never owned a hybrid, but have started looking into them as a home for some of my cash holdings since bank interest rates are so low.

    This thread gives me plenty of pause for thought, but the last post was 5 years ago so I wonder if the situation has changed at all?

    What are people's opinions on the bank hybrids currently trading on the ASX?

    I thought there were some that only redeemed for cash at the end of their term and didn't convert into shares, but I need to research further.
     
    barney likes this.
  5. Bill M

    Bill M Self Funded Retiree

    Posts:
    1,954
    Likes Received:
    320
    Joined:
    Jan 4, 2008
    Hi Ferret, I have held and currently hold hybrids, preference shares and convertible notes. As someone mentioned they are all different. Some do get bought out by the parent company for cash. I will give you 2 good examples. I held SUNHB, Suncorp decided to buy it out for cash. This is guessing (can't remember exactly) but the value of SUNHB slipped to around $73 and Suncorp made the offer to buy them back for around $80. It would have been silly not to accept an offer that was quite a bit more than market price so I sold out for a tiny profit. The people who bought at face value at $100 would have lost money if they sold it back.

    Then there was Seven Groups TELYS4, same situation. Face value was $100, but it slipped out of flavour and the price slid to under $80 at one stage. I thought it was very good value so accumulated at around $85 as the dividends were great for that risk. Knowing there was a slim chance of a buy back I held on and kept getting nice dividends for years and then Seven Group wanted to buy them back. The offer made was around $98 (not exactly sure) but trading under $89 this was a good offer. I sold out for cash and made a tidy sum.

    The point made about bank hybrids are fair. They are there for Tier 1 Banks Capital should the bank run into trouble they got funds backing them. Those funds are yours that they are using and are not guaranteed. They rank in front of ordinary shareholders however in reality you probably wouldn't get any money back should the bank collapse. I personally do not think such a collapse will happen so I invest in a few. My best is NABPF which pays 4% above the 90 day BBSW. At the moment that = about 4.75% in distributions. I am not sure if it is better or safer than ordinary shares. Many people say they would rather just buy the ordinary shares, they could be right. They do go up in value too, right now NABPF is trading at $106. 68 which is not bad considering face value in $100 per share. Good luck anyway.
     
  6. qldfrog

    qldfrog

    Posts:
    2,976
    Likes Received:
    1,282
    Joined:
    Jun 8, 2008
    I am not an expert but all hybrids are not the same if facing a crisis
    Some can have interest unpaid ..ever, some could get transformed i to worthless bank shares
    And it is not a matter of:
    take cba not anz, every issue is different, just buy wisely, research the codes
     
    Ferret, Bill M and barney like this.
  7. Ferret

    Ferret

    Posts:
    410
    Likes Received:
    45
    Joined:
    Aug 13, 2006
    Thanks for the replies Bill M and qldfrog.

    They seem to be a little more complex than I imagined and it does appear that the issuer holds all the cards.

    The bank web sites seem to have plenty of information on their offerings and I'll research further.
     
  8. qldfrog

    qldfrog

    Posts:
    2,976
    Likes Received:
    1,282
    Joined:
    Jun 8, 2008
    a journo at AFR (sorry I forgot his name, anyone?) swear by hybrids but highlights the difference and it is a very instructive read,I do not subscribe anymore to the AFR as their price is now over the roof but I own hybrids
     
    sptrawler likes this.
  9. So_Cynical

    So_Cynical The Contrarian Averager

    Posts:
    6,871
    Likes Received:
    461
    Joined:
    Aug 31, 2007
    HBRD - BETASHARES ACTIVE AUSTRALIAN HYBRIDS FUND (MANAGED FUND)

    HBRD is an ETF of Hybrids, high yield and risk is spread across 15 or so hybrids, about 85% franked, Hybrids made easy.
     

Share This Page