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. 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 www.brsecuritiesaustralia.com.au
Frequently Asked Questions about this Article…
ANZ Capital Notes 3 are a type of Alternative Tier 1 equity, similar to other recent Alt T1 issues. They are not low-risk investments due to their long term, which is valued using March 2023 as the maturity date. The base interest rate is floating, but the credit margin is fixed, impacting capital value based on secondary credit margin movements.
ANZ Capital Notes 3 are considered high-risk primarily because of their long term, which makes capital prices sensitive to yield movements. Additionally, they are equity-like investments, and the fixed credit margin adds to the risk. APRA's options to convert or write off these securities in certain circumstances also contribute to the risk.
The floating base interest rate, which is the BBSW part, affects your income as it gets reset regularly. However, it does not impact the capital value of ANZ Capital Notes 3, which is influenced by the fixed credit margin and its secondary movements.
APRA has the option to convert ANZ Capital Notes 3 to equity or write them off in certain circumstances, even without ANZ defaulting. This potential action increases the risk, as markets may anticipate these options being exercised, especially during a crisis, affecting the price of the securities.
BR Securities suggests that a margin between 450 and 550 basis points is more appropriate, although individual investors might consider buying at 360 to 380 basis points as an alternative to buying ANZ equity. However, they do not see great value at the current margin.
The value of ANZ Capital Notes 3 is affected by market conditions, particularly adverse systemic scenarios. If the ANZ share price sells off, the Alt T1 securities might also sell off. The potential for APRA to exercise its options can increase the number of sellers during a crisis, pushing prices lower.
Investors should consider the long-term nature and associated risks of ANZ Capital Notes 3, including the fixed credit margin and APRA's options to convert or write off the securities. Understanding these risks allows investors to act accordingly as market events unfold.
ANZ Capital Notes 3 can be considered an alternative to ANZ equity, especially if purchased at a margin between 360 to 380 basis points. However, investors should be aware of the risks and potential lack of value at the current margin, as suggested by BR Securities.
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