Are bank hybrids oversold?

PORTFOLIO POINT: The repricing of bank hybrids has been overdone and value is re-emerging, creating some attractive opportunities across the sector.

Over the last two years, Eureka Report has pointed investors towards a more diversified portfolio with a particular emphasis on less weighting in equities – particularly blue chips. In exchange, we have suggested investors examine traditional and non-traditional 'fixed income’ options, such as bonds and hybrid notes.

Among the most popular options in this area have been bank-based hybrid notes. However, the market for these notes experienced something of a tremor in recent months, after Commonwealth Bank priced its covered bonds – a security that sits far higher in the capital structure than hybrids – very similarly to the existing range of bank notes. In the weeks following that offering, prices readjusted across the market, especially among hybrids from bigger banks such as CBA, Westpac and ANZ. However, James Lawrence, a specialist analyst in this area at RBS Morgans, released a note this week which suggested the sell-off in bank hybrids has been overdone and his brokerage, at least, has now put a 'buy’ on virtually the entire sector. If you have – or intend to have – hybrids in your portfolio, it’s worth considering the note below. One last thing – remember this is a broker’s note, and RBS Morgans may hold an interest in any of the securities mentioned. - Eureka Report managing editor James Kirby

Raising indigestion creates opportunities

Given the significant number of new raisings currently underway in the space (particularly by financial issuers), there has been selling in all the existing bank issued hybrid securities. We had previously warned investors that hybrid security pricing had not readjusted, following movements in wholesale spreads, and suggested more active investors should reassess their positions. We believe the correction in prices has now occurred and the RBSM financial issuers hybrid index has fallen 4% this calendar year. Opportunities abound!

The RBSM financial issuers hybrid index so far this year has fallen 4% on a capital basis. In our view, this correction in prices is now overdone and we have moved overweight the sector, given the attractive yields now on offer.

In addition to the attractive Colonial Group Subordinated Notes (CNGHA) and Westpac Convertible Preference Shares (WBCPC) opportunities, investors who are looking to build positions in a number of bank hybrid securities as part of a diversified portfolio may wish to consider the securities outlined below. The proposed portfolio will generate gross income for investors of 7.77% and a yield to maturity of 8.42% based on current pricing.

We view these returns as very attractive, especially given where cash rates currently sit and compared to the returns available on other asset classes. We are buyers of all the securities outlined below at current prices.