On 24 May, Liberty Financial’s senior unsecured bonds began trading on the secondary market. Last week we DirectBonded the issue, making it available to wholesale investors from $10,000 per bond
Many clients are familiar with Liberty as one of our preferred originators of RMBS transactions. The non bank lender has been in operation since 1997, providing a wide range of loan products – from mortgages, to auto, personal, and business loans.
In FY16 Liberty originated AUD2.5bn of loans, of which 80% were residential mortgages, and currently has assets in excess of AUD6bn. Although Liberty is a private company, it has a strong position in the Australian marketplace and is well capitalised with total equity of AUD413.6m and an S&P Risk Adjusted Capital Ratio of 18.1%, according to an update provided by the issuer.
The three year bonds were originally marketed by Liberty at a spread to benchmark of +275bps, however the issuer was caught up in Standard & Poor’s downgrade of 23 financials. As a result, the bond issue repriced higher to +325bps, while the rest of the market did not move.
Forced selling of bonds that moved to sub investment grade appears to have been limited in the short term, although some now have split investment and sub investment grade ratings between credit rating agencies.
Even now, weeks later, the movement in credit spreads for other bonds affected by the downgrade has been negligible.
We believe that Liberty’s senior unsecured line remains very cheap, particularly when compared to the subordinated debt that makes up much of the exposure to financials within many portfolios. Bank subdebt has a number of features imposed by APRA that, although better than those on hybrids, are still less attractive than the conditions for senior debt. These include call dates with longer terms until final maturity and a point of non viability conversion.
In addition, Liberty offers investors a certain level of diversification in portfolios, away from bank subordinated debt.
Figure 1 displays the trading margin for many of these bonds. The Liberty bond maturing on 1 June 2020 is displayed in bold.
Figure 1
Source: FIIG Securities
Indicative ask pricing, accurate as at 5 June 2017
The trading margin is essentially the additional yield on offer for taking risk over and above the benchmark with a matching term. Given that trading margins for other financials did not increase with their downgrades – but Liberty’s did – we believe that investors are being compensated for the additional risk. In our view, the trading margin should contract over time, which may lead to higher capital values for holders.
Investors looking for high yielding investment grade bonds should consider Liberty’s June 2020 senior unsecured line, and current holders of bank senior and subordinated debt should evaluate switching at least some of their exposure.
The bonds are offered at a yield to call of around 4.50%, but this is subject to change. Please call your dealer for up to date pricing and others switch opportunities.
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Glossary
APRA
APRA is charged with the prudential supervision of Authorised Deposit-taking Institutions (ADIs). Its ultimate aim is to ensure financial promises made by the bodies it regulates are met within a stable, efficient and competitive financial market. It oversees, banks, credit unions, building societies, genenral insurance and reinsurance companies, life insurance, friendly societies and most members of the superannuation industry.
Call date
The date prior to maturity on which a callable bond may be redeemed by the issuer. If the issuer determines there is a benefit to refinancing the issue, the bond may be redeemed on the call date, at par, or at a small premium to par depending on the terms of the call option.
PONV
Point of non viability, the point at which regulators decide a bank is no longer able to function. To count towards regulatory capital ratios under Basel III, subordinated bonds must be written down to zero or converted to equity when the trigger is hit.
Subordinated debt
A bond or loan that ranks below senior debt, loans and creditors. In the event of a wind up (insolvency) of an issuer, subordinated debt is not paid until all senior debt and unsecured creditors are paid first.