Thursday 11 June 2015 by Craig Swanger Opinion

A word of warning about hybrids

Despite repeated warnings from ASIC, fund managers and fixed income specialists such as FIIG, new style “bail-in” hybrids like CBA’s PERLS VII continue to be promoted as fixed income.  They are not fixed income in our view

warning signs nature

The new breed of bank issued hybrids such as CBA’s PERLS VII, are not fixed income.  The problem is that’s the view of some of the investment industry, but not all.  Fund managers won’t include them in fixed interest funds and most simply won’t invest in them at all.  Australia’s corporate regulator, ASIC issued a specific warning highlighting that they would investigate “misleading promotion of hybrid securities as fixed income products”.  But there are still a lot of promoters of bank hybrids that continue to present them as fixed income products in recommended lists and other research. 

Tuesday’s AFR did a great job providing much needed education on the under-represented bonds asset class.  In interviewing the various parts of the industry, it highlighted the polarised views of these new hybrids.  Senior fund managers were clearly opposed to the hybrids, with one bank owned fund manager stating: “…with hybrids being the worst as they…look like bonds in the good times and equities in the bad times.” This is very similar to our view. But on the facing page, one financial advice firm posts its “fixed income portfolio” that includes PERLS VII and several other new style hybrids, despite ASIC’s warning. 

We continue to hold our view on this topic – these hybrids are not fixed income.  In 2014, we ran a series of articles on hybrids (see the article, FIIG Securities says new "bail-in" hybrids are equity risk, not fixed income and others in the related articles section.)

The point of the series was to highlight:

  1. That new style bank hybrids are not fixed income, but equity as return of capital and the “interest” payments are not legally required to be repaid. Further, the banking regulator (APRA) insists that distributions are purely at the issuer’s discretion and not legal liabilities.
  2. That these “bail-in hybrids” were being sold to retail investors in Australia, despite bans in Europe and the UK.
  3. That the income offered on Australian hybrids at the time, such as on CBA PERLS VII, was far lower than equivalent hybrids offered by European banks, and that because of this PERLS VII was likely to fall to $95-96 after the IPO, and that several of the other hybrids were likely to struggle to stay above their $100 issue prices.

CBA Perls VII (CBAPD) Share Price since IPO (to 10 June 2015)
cba perls since IPO
Source: FIIG Securities, ASX

By the time of the PERLS VII listing date, the other major banks’ “new style” hybrids, were below their issue price. PERLS VII came on to the market at $97 and never recovered to its $100 issue price, falling by more than 6% since its IPO. 

Several of the promoters of the PERLS VII issue were quoted in the media around the time of PERLS VII’s IPO saying that “the recent price falls were liquidity driven”; “window is closing soon – prices will rebound” and “the recent fall in hybrid prices presents clients with a buying opportunity”.  However, sellers continued to dump their stock and now, despite far lower yields on other shares compared to that time, PERLS VII is trading at $93.00. While that is far better than CBA shares have fared in 2015, the point is that CBA shares aren’t sold as “fixed income” and they have the potential to rise dramatically in good times as we’ve seen in the last few years.

Repeating our warning of August 2014, prior to the PERLS VII IPO:

“We do not believe that there is a large risk of one of Australia’s major banks requiring a bail out. The issue is that we don’t consider these securities to be bonds, but instead far more like equities. History has shown us that they won’t rise as much as shares in the good times, but will fall in line with equities in the bad times. Investors are getting the worst of both worlds, and should consider shifting their money to either pure bonds or equities instead.”

Investors seeking yield have choices and do not have to accept poor value securities simply because they are popular.  If you are going to take on the price volatility risk of hybrids, you need to be rewarded for that risk.  If you want genuine fixed income in which the issuer is obliged to pay you your income and to repay a fixed capital amount at a fixed date, use bonds or term deposits.  

Please note, pricing accurate as at 11 June 2015 and subject to change.