When a banker offers you a hybrid security and a 156-page prospectus, hold on to your wallet. We’ve long preached a ‘no hybrid’ philosophy (see here, here, here, here, here or here). Macquarie Group’s (ASX: MQG) Capital Notes 2 aren’t about to change that.
The 5.14% margin the Notes offer above the bank bill rate (currently 2.36%) looks appealing relative to term deposits and is better than the 4.2% margin offered by Westpac’s (ASX: WBC) recent hybrid issue (see Avoid Westpac Capital Notes 3).
Nonetheless, it’s still inadequate compensation for the risk, which is nicely summarised in the fine print on Page 4: The Notes are 'subject to payment conditions including MGL’s absolute discretion to determine whether or not to pay distributions'.
Make no mistake, Macquarie is trying to reduce its own financing cost and risk, not doing its best to make you rich.
Unlike deposits, the hybrids aren’t guaranteed by the government so shouldn’t be thought of as cash equivalents. The prospectus isn’t joking when it says ‘none of MGL, MBL or any other member of the Macquarie Group in any way guarantees or stands behind the capital value or performance of MCN2’.
Another shortcoming is that, unlike senior bonds, the Notes are perpetual and don’t have a fixed maturity date. Macquarie is under no obligation to ever give you your capital back or convert your loan into ordinary shares, which would allow you to participate in any increase in the bank’s profitability.
What’s more, Macquarie has the option to redeem the securities after five or so years if it happens to find more attractive financing – though that seems unlikely given the only reason the banks are tripping over themselves to sell the hybrids today is because they’re such a one-sided bet.
You don’t even get to rest easy in times of crisis. True, the Notes rank ahead of shares should Macquarie be wound up. But the Notes have specifically been created to behave like equity for Macquarie to draw on in an emergency.
If a ‘Non-Viability Event’ occurs, the Notes immediately convert to Macquarie shares. Broadly, a Non-Viability Event occurs if APRA tells Macquarie it doesn’t have enough capital. The trouble with this clause is that ‘APRA has not provided guidance as to how it would determine non-viability.’
As our Research Director, James Carlisle, recently put it, ‘The root problem with hybrids, as opposed to a combination of shares and cash, is that companies have to act in their shareholders' interests. Everything is done to make shareholders richer – including the issuance of all other securities, which must therefore, almost by definition, be unattractive. Sure shares are (slightly) riskier, but that can be offset by holding cash (how much will of course depend on the individual), to provide a better blend of risk and return and vastly more transparency.’ (For more on this strategy, see Don’t bank on hybrids)
So what are we left with? Another set of hybrids that act like fixed income securities (minimal capital gains) in good times and act like stocks (large capital losses) in bad times, all to gain an extra percentage point or so of yield ... ’at Macquarie’s absolute discretion’. AVOID
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