Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 316

Is it time to sell bank hybrids?

Over the past five years, we have used a simple rule of thumb to assess the value of the new style/Basel III compliant Australian major bank hybrids:

  • Excellent value at a five-year credit margin approaching +500bps
  • Expensive when the five-year margin is +300bps or lower

This simple rule is based on the tightest and widest issues we have seen from the major banks since Basel III Additional Tier 1 (AT1) hybrids were first issued in January 2013. The two ‘book-ends’ were both issued by CBA and only 18 months apart, which shows how quickly the market can move:

  • CBA Perls VII (CBAPD) – issued in October 2014 at a credit margin of +280bps to call in 8.2 years
  • CBA Perls VIII (CBAPE) – issued in March 2016 at a credit margin of +520bps to call in 5.5 years

Significant tightening of margins

Australian bank and insurance AT1 hybrid spreads have been tightening for some time but that trend has picked up since the May 2019 election win by the Coalition which removed the risk that Labor’s franking policy posed, as the black line in the chart below demonstrates.


Source: Bell Potter

With demand increasing following the election, supply has been constrained with a dearth of new issues and little replacement funding expected in the near term. Issues approaching call/maturity dates in the next 12 months include just one major bank:

  • IANG (IAG) 16 December 2019 ($550 million)
  • NABPC (NAB) 23 March 2020 ($1,343 million)
  • MBLPA (Macquarie Bank) 24 March 2020 ($430 million)
  • CGFPA (Challenger) 25 May 2020 ($345 million)
  • SUNPE (Suncorp) 24 June 202 ($400 million)

Against this backdrop and the market’s search for value, AT1 hybrid spreads are now the tightest we have seen since the new breed of Basel III compliant hybrids first hit the market in early 2013. The widest margin of any of the major bank hybrids (as at 22 July 23019) was the NABPF June 2026 call AT1 with a trading margin of just +288bps.

Inadequate reward for hybrid risks

Margins for the AT1s with a first call in five years are closer to +270bps. This is in contrast to last week’s ANZ 10-year subordinated bond issue with a margin of +200bps. We argue that a differential of just 70bps is too low for the additional risks that AT1 hybrids present, including extension/non-call risk, no maturity date, automatic conversion to equity if Core Equity Tier 1 ratio falls below 5.125% and potential for coupons to be cancelled.

We believe it is time to take profits on bank and insurance company AT1 hybrids. We still see value in the legacy hybrids such as NABHA and MBLHB which are still trading at a discount to par, but those too have rallied strongly in recent times.

Whilst there is no immediate threat or trigger point to cause hybrid spreads to widen, history tells us that spreads are tight.

An opportunity to re-enter the market might be seen in the coming 12 months if the banks use the retail ASX-listed market to help raise the additional $50 billion Tier 2 capital required over the next four years, following APRA’s clarification of capital requirements earlier this month. We suspect we will see a number of large, well-priced listed Tier 2 issues with margins in the low-200bps. There is also the potential for some out of cycle/non-rollover AT1 issues which could present good new issue margins.

One further impact of the tight major bank credit spreads was the recent BNP AT1 in AUD. It was initially launched with a margin of 412bps but priced 75bps tighter at a margin of 337bps. Despite the tightening in issue spread, the size of the order book (demand) and the relatively small issue size (supply) provided a pathway for the strong secondary performance which we have seen to date.

 

** Justin will be hosting the ASA webinar 'Bonds, hybrids and inverse yield curve effect on equity markets' on 8 August 2019, outlining how in a low-interest environment you can maximise yield through the use of bonds and hybrids. **

 

Justin McCarthy is Head of Research at BGC Fixed Income Solutions, a division of BGC Brokers, and a sponsor of Cuffelinks. The views expressed herein are the personal views of the author and not the views of the BGC Group. This article does not consider the circumstances of any individual investor.

For more articles from Mint Partners and BGC, click here.

RELATED ARTICLES

Why bank hybrids are far too expensive

NAB hybrid: one says buy, one says sell, you decide

Understanding the extra return from hybrids

banner

Most viewed in recent weeks

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

The 2025 Australian Federal election – implications for investors

With an election due by 17 May, we are effectively in campaign mode with the Government announcing numerous spending promises since January and the Coalition often matching them. Here's what the election means for investors.

Finding the best income-yielding assets

With fixed term deposit rates declining and bank hybrids being phased out, what are the best options for investors seeking income? This goes through the choices, and the opportunities and risks involved.

What history reveals about market corrections and crashes

The S&P 500's recent correction raises concerns about a bear market. History shows corrections are driven by high rates, unemployment, or global shocks, and that there's reason for optimism for nervous investors today. 

Howard Marks: the investing game has changed

The famed investor says the rapid switch from globalisation to trade wars is the biggest upheaval in the investing environment since World War Two. And a new world requires a different investment approach.

Welcome to Firstlinks Edition 605 with weekend update

Trump's tariffs and China's retaliatory strike have sent the Nasdaq into a bear market with the S&P 500 not far behind. What are the implications for the economy and markets, and what should investors do now? 

  • 3 April 2025

Latest Updates

Investment strategies

4 ways to take advantage of the market turmoil

Every crisis throws up opportunities. Here are ideas to capitalise on this one, including ‘overbalancing’ your portfolio in stocks, buying heavily discounted LICs, and cherry picking bombed out sectors like oil and gas.

Shares

Why the ASX needs dual-class shares

The ASX is exploring the introduction of dual class share structures for listed companies. Opposition is building to the plan but the ASX should ignore the naysayers and bring Australia into line with its global peers.

The state of women's wealth in Australia

New research shows the average Australian woman has $428,000 in net wealth, 40% less than the average man. This takes a deep dive into what the gender wealth gap looks like across different life stages.

Investing

The two most dangerous words in investing

Market extremes are where the biggest investment risks and opportunities lie. While events like this are usually only obvious in hindsight, learning to watch out for these two words can alert you to them in real time.

Shares

Investing in the backbone of the digital age

Semiconductors are used to make microchips and are essential to a vast range of technology and devices. This looks at what’s driving demand for chips, how the industry is evolving, and favoured stocks to play the theme.

Gold

Why gold’s record highs in 2025 differ from prior peaks

Gold prices hit new recent highs, driven by a stronger euro, tariff concerns, and steady ETF buying – all while the precious metal’s fundamental backdrop remains solid amid a shifting global economic landscape.

Now might be the best time to switch out of bank hybrids

In this interview, Schroders' Helen Mason discusses investing in corporate and financial credit securities, market impacts of tariffs, opportunities for cash investments, and views on tier two and hybrid bonds.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.