Call date and final maturity date- beware of the price cliff
An example is the PCAPA, the CBA issued (non compliant with Basel 3) hybrid, which has a call / conversion date of April 2016 but is a perpetual otherwise. The contractual coupon is BBSW 1.05% (fully franked (ff)), so it is quite low meaning it is more likely not to be called given rates look like being above that level. It would be in CBA's interest to leave it out there as they cannot borrow more cheaply. However there is a coupon stepup of 1% on April 2016 if the hybrid isn't called so that is a positive for an investor.
From April 2016 the contracted coupon thus would become BBSW 2.05% (ff). The PCAPA will be priced to April 2016 if spreads between April 2016 and perpetuity look like staying below BBSW 2.05% (ff). In this case CBA will call or convert and reissue another security. The PCAPA will be priced as a perpetual if spreads between April 2016 and perpetuity look like being above BSW 2.05% (ff). When priced with a longer maturity date the capital volatility is higher for a given widening in spread.
Having said all that banks have traditionally always called /converted such securites. History may not repeat of course. The PCAPA are one of the lower risk hybrids on offer. They have a face value of $200, and can't be written off or converted to equity at a loss. If you are looking to park some money after selling some CBA shares perhaps then they are offering near 6% fully franked to April 2016 (less if priced as a perpetual), so that is a fair return.
If you are really bearish on markets just park your money in bank deposits or buy some CBAHA. Lower return but much lower risk.
Frequently Asked Questions about this Article…
The call date is when the issuer can choose to repay or convert the hybrid security, while the final maturity date is when the security must be repaid if not called earlier. Understanding these dates is crucial as they can affect the pricing and risk of the investment.
Price cliffs occur when the difference between the call date and the final maturity date causes a significant price drop if credit spreads widen. This can impact the value of your investment, making it important to understand these dynamics.
If secondary market credit spreads widen relative to the contracted coupon credit margin, investors may start pricing the security to the final maturity date instead of the call date, potentially leading to a price drop.
If an issuer decides not to call a hybrid security, it may remain on issue until the final maturity date. This decision is often based on whether the issuer can reissue at a lower yield. If not, they might prefer to leave the security outstanding.
An example is the PCAPA issued by CBA, which has a call date of April 2016 but is perpetual otherwise. It has a contractual coupon of BBSW 1.05% (fully franked), with a step-up to BBSW 2.05% if not called.
PCAPA hybrids are considered lower risk as they cannot be written off or converted to equity at a loss. They offer a fair return, especially if you are looking to park money after selling CBA shares.
If you are bearish on the market, consider parking your money in bank deposits or buying CBAHA for a lower return but much lower risk compared to hybrid securities.
An issuer might call or convert a hybrid security if the spreads between the call date and perpetuity are below the contracted coupon rate, allowing them to reissue at a more favorable rate.
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