ANZ Capital Notes 3 - not quite there yet

The term is too long for a low risk investment. Capital prices are more sensitive to movements in yield the longer the term. It belongs in your return seeking portfolio but the reward for risk is not quite there yet.

The current ANZ Capital Notes 3 issue qualifies as Alternative Tier 1 equity and is similar to other recent Alt T1 issues.  The discussion applies to all like investments.  It is not a low risk investment primarily because of its term.  It will be valued using March 2023 as the maturity.  That is 8 years away. 

The term is too long for a low risk investment.  Capital prices are more sensitive to movements in yield the longer the term.  While the base interest rate (the BBSW part) is floating, the credit margin isn't.  It is fixed.  The movement of BBSW will impact your income not your capital value as it gets reset regularly.  The movement of secondary credit margins, however, will impact your capital value as the credit margin will not be reset regularly.  It is the movement of secondary credit margins and the long term that presents the risk. 

Adding to the risk, this security is also an equity like investment so, for us, fits within a return seeking portfolio on this criteria as well.  However, we (BR Securities) don't think it offers any great value even if the margin is set at 380 bp.  While the odds of ANZ defaulting are low, APRA has the option to convert the securities to equity in certain circumstances with investors potentially receiving less than their investment.  APRA also has the option to write off these securities if conversion isn't possible and without ANZ defaulting.  The odds of APRA exercising these options via directors depends on how often you think adverse scenarios play out requiring action. 

Even if APRA never exercises the options, the potential to act will increase the number of sellers in a crisis pushing the price lower than for non Basel 3 compliant hybrids.  Markets will anticipate the exercise of the options, sometimes wrongly.  You have to remember that APRA specifically requested these options as they didn't like organising government guarantees for bank debt a few years ago while letting preference share investors benefit.  They want the triggers, so presumably they will use them.      

We (BR Securities) think a margin between 450 and 550 bp is closer to the mark.  Having said that, however, indivdual investors may wish to buy some at 360 to 380 bp as an alternative to buyng ANZ equity at the moment.  The Alt T1 securities won't sell off too much unless the ANZ share price sells off as well, usually in an adverse systemic scenario.  There is no right answer but if you know the risks you can act accordingly as events unfold.  We  (BR Securities) would wait for wider spreads.

General Advice Only; FSG

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