AMP issue to test risk appetite

Investors will need to check their risk profile before buying into the AMP offering.

In a move to take advantage of investors’ insatiable appetite for yield, AMP Ltd has announced an unsecured subordinated debt offering.

For investors, the question is going to be about risk. AMP is offering a margin between 2.65 and 2.85 percentage points over the current 90-day Bank Bill Swap Rate. If it is priced at the lower end, on today’s numbers it comes in at a forward running yield of 5.24 per cent.

The current dividend yield on AMP ordinary shares comes in at 5.1 per cent. With a decision on the final dividend to be made next year, there is scope for this number to be much less. Someone is not getting rewarded for the risk they are taking.

AMP plans to use a substantial portion of funds raised to contribute to Tier 2 capital. A similar offering already trading on the market issued by the National Australia Bank, also for the purpose of Tier 2 capital, is paying a margin of 2.75 per cent over the same benchmark.

If we take the margin as a proxy for assigning a measure to risk, on the face of it the National Australia Bank issue and AMP offering conclude similar risk profiles. With this offering, AMP is essentially trying to raise funds at a lower margin than any Big Four bank is paying – a somewhat dubious strategy.  

While the Australian banking sector is facing changes as the regulator Australian Prudential Regulation Authority (APRA) looks set to enforce increased capital requirements, the impact on ordinary shareholders would likely be in the form of lower dividends. At present there is little threat to underlying cash flows.

Unfortunately the story doesn’t look as compelling for AMP, which faces a myriad of issues, led by the life insurance sector as it faces continued structural changes. It shouldn’t be a surprise to the market if there are further downgrades, coming from the life insurance business of AMP. Cash flows and gearing ratios could feasibly be negatively impacted resulting in lower dividends and in an extreme circumstance, missed coupon payments on the subordinated notes.

There has previously been talk that retail investors don’t understand the risks with hybrids and subordinated note offerings, which could very well be the case. However perhaps the real issue is the compensation investors are signing up for against the actual risk assumed. 

Given the amount of cash self-managed super funds alone are sitting on, AMP should easily be able to raise the required funds at the lower margin.