The following real example from February 2015 written by Carlo Queddeng – Providence Portfolio Analyst, demonstrates Providence’s ongoing approach to thorough review of investment opportunities as they arise.
The Opportunity
February 2015 – National Australia Bank have recently offered a new $750m IPO of capital note securities (ASX code: NABPC) which falls in line with preference share securities.
NABPC Capital Note offers:
- A bookbuild margin of 3.50% – 3.70% above 90 day BBSW (currently 2.33%).
- With investors chase for yield in a low interest rate environment, we expect the margin to be set at the lower end of the range at 3.50%.
- On behalf of our clients, Providence has been able to negotiate a 1% rebate, which boosts the initial gross running yield for the first year.
- 3.50% expected book build margin + 2.33% 90 day BBSW + 1.00% rebate = 6.83% gross running yield for the first year.
- Shorter duration as the instrument will have a first call date March 2020. We believe this is quite positive as it reduces duration risk versus similar preference shares with longer dated maturities (eg ANZPE Mar-22, CBAPD Dec-22, WBCPE Sep-22).
- Income will be payable quarterly for NABPC, which is preferable over half yearly income distributions such as the recent ANZPF offer.
- The size of the offer provides sufficient scale to clients being able to participate in the market, unlike trying to do so in the secondary market.
Being preference shares, the risks remain:
- Common equity trigger event (the hybrids will convert to stock if NABs common equity tier 1 capital ratio is equal to or less than 5.125%). As at Dec-14, CET1 stood at 8.74% providing a buffer of $13.7bn.
- Non viability trigger event (APRA can convert the hybrids to stock if they determine NAB to being non-viable due to significant capital losses, prolonged difficulties raising funding or maintaining liquidity).
- Inability event (if NAB is not able to issue ordinary shares from conversion within 5 business days of trigger event conversion date).
A comparison between NAB equity and preference shares:
- The forecast grossed up yield on NAB ordinary shares is currently 7.7%.
- In comparison, the grossed up running yield of NABPC offers 6.83% for the first year (inclusive of 1% rebate) with the same underlying bank risk but with considerably less risk of capital downside.
Conclusion:
Overall, we believe NABPC adequately provides investors enough compensation for the risks as mentioned above. For clients overweight in cash and underweight in fixed income, we have recommended participating in this float with the additional 1% rebate Providence has negotiated.
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