New hybrids issued by three of the major Australian banks have been snapped up by investors at attractive yields. Initial yields for CBAPE’s, NABPD’s and WBCPG’s (Westpac) were the bank bill rate plus 5.10%, 4.95% and 4.90% respectively. Issue volumes were all significantly increased due to demand and all three issues are trading well above their $100 issue price, effectively pushing the yields lower post-issue.
As often happens, new hybrid issues spark increased investor interest in the sector as investors revisit existing hybrid issues and search for value. With global bonds hitting record lows, the yields on hybrids have been seen as attractive. Investors have been pushing down trading margins in general but have they gone too far?
One analyst who thinks they might have in the short term is Michael Saba, Head of Income Products at Evans and Partners. He recently looked at the relationship between trading margins of bank hybrid securities and the dividend yields on banks’ ordinary shares. The chart below shows that relationship over the past year.
There are similar characteristics between investing for bank dividends and investing in hybrids but significant differences in risks as the two securities are in a different part of the company’s capital structure. Hybrids carry less risk than pure equity and the question investors should always be asking is “Am I being compensated enough for the risk I am taking?”
The chart below shows that the gap between dividend yields and trading margins on hybrids has been widening and what Mr Saba found was that is that hybrid securities of most banks appear to be expensive relative to the ordinary shares. This suggests that hybrid yields are too low or that dividend yields are too high. “Either the stock price must rise or ordinary dividends be cut to reduce the share price yield, or hybrid prices fall to increase the hybrid yield to in turn reduce the yield gap.” Whilst he acknowledged the variance over time of the relationship and says the yield gap itself is not a reliable indicator of hybrid prices or yields it is an interesting observation and reflects on the risk choices that investors appear comfortable making.
