Three securities for yield-seeking retirees

Wednesday, February 17th, 2016

John Abernethy, Chief Investment Officer

The spike in “perceived risk” that has engulfed asset markets in 2016 has resulted in a sharp decline in the prices of various good quality listed income securities.

We highlight three securities for yield-seeking retirees:

  1. National Bank Income Securities (NABHA);
  2. Macquarie Income Securities (MBLHB);
  3. Multiplex Sites (MXUPA).

Risk assessment - Clime

All three securities have fallen significantly in price since 31 December in response to debt market moves in the US and Europe. In recent months, as oil prices have contracted, the fear of credit problems in US and European banks has lifted credit margins in the corporate markets. The cost of wholesale funding for Australian banks has also risen in recent weeks.

In contrast to higher interest rate margins for corporations, we have seen a strong rally in government bond yields across the world. This rally is partly driven by concerns regarding Chinese banks and the realisation that Japan is slipping back into its endless recession. Long term inflation projections have been lowered in response to lower oil prices, and this has added to concerns and pushed government debt yields ever lower.

This year has started with a “ducking for cover” approach, where multi asset managers are attempting to maintain capital (through bonds), with little regard for a return on capital. It appears that asset markets are pricing in a heightened risk of default somewhere in the world, and are assuming that Central Banks would let such a default occur without intervention.

Without doubt, general economic conditions globally have deteriorated over recent months and are looking flat at best. That said, we observe from history that markets tend to overshoot – they fall on fear and generally recover on confirmation that a worrisome event either did or didn’t occur. The event itself would have to be much worse than expected to be a significant negative price mover (eg. a rerun of the GFC).

With the market now pricing in a very negative year ahead, the hybrids noted above should be on the shopping lists of income-oriented investors that understand investment risk and are prepared to buy against poor sentiment.

There are a number of good reasons for accumulating NABHA, MBLHB and MXUPA:

  • Their running yields have significantly increased and are well above 90 day term deposit rates;
  • They pay quarterly distributions;
  • These distributions are floating rate and reset each 90 days;
  • The quality of each issuer is good and supported by solid business cash flows; and
  • The securities have embedded in them various protective clauses for investors that include dividend stoppers on ordinary shares (ie. the dividend on the ordinary shares of the issuer cannot be paid unless the distribution on the hybrid security has been paid).

Every significant market correction throws up opportunity in various market segments. Often the opportunity in the lower risk segments of the market is ignored, and this is what appears to be happening with the income securities noted above.

Both NABHA and MBLHB are issued by Australian banks that have substantial APRA regulated capital buffers. These securities rank ahead of ordinary equity and (importantly) they are not convertible into equity at the option of either bank. Both securities are strong hybrids with excellent yields relative to the market, and they have never missed a distribution – even during the GFC.

MXUPA (SITES) is effectively issued by Brookfield International Inc. through its Australian subsidiary. The SITES are high yielding securities supported by a strong Australian construction and engineering business. Again, it is worth noting that MXUPA did not miss a distribution during the GFC and Brookfield is a strong ultimate owner of Multiplex, with more than $100 billion of property assets under management globally.

While each security is perpetual, we expect that each will be bought back by the issuer at some point. Indeed, NABHA and MBLHB have become non-complying tier 1 capital and their “dividend stopping” default clause is regarded as poisonous in each bank’s capital structure.

With these securities trading well below their issue price of $100, investors may contemplate the returns should they be bought back. However, the primary focus today should be on the quarterly paid but annual running yields and these look attractive at current prices.

NABHA
Price: $63.50
Forecast 12 month distributions $3.40 to $3.50
Dividend Yield: 5.4%

MBLHB
Price: $68.00
Forecast 12 month distribution $3.90 to $4.00
Dividend Yield: 5.8%

MXUPA
Price: $68.00
Forecast 12 month distribution $5.90 to $6.00
Dividend Yield: 8.8%

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22 Responses to “Three securities for yield-seeking retirees”

  1. Roy Lawrence says:

    My concern is that each of these have been falling in price- offsetting the value of the return

  2. Sceptical Sam says:

    Roy’s point resonates.

    In addition if, as you say, “we expect that each will be bought back by the issuer at some point” because they are “poisonous in each bank’s capital structure”. That provides all the more motivation for the issuer to do what they can to drive down the price before buying them back.

  3. manzur says:

    It is not clear whether these are “perpetuals” in that they have no set maturity date or fixed term securities? Could someone clarify?

    • john Abernethy says:

      Hi Manzur

      They are issued as perpetual securities meaning they have no fixed termination or redemption date. However, the obligation to pay interest on the securities is also enduring.

      JA

  4. Thomas says:

    I don’t think this is a suitable investment category for retail investors. These instruments are complex – and so, difficult to value even if you know what you are doing. They tend to perform very badly when markets turn down.

    NABHA is perpetual – as in, NAB can leave them out there forever. You can see a summary of the terms and conditions on australianratings.com. Note how the instrument can produce a number of different outcomes over time, most at the option of the bank. So, there is no means to predict what your investment will look like over time. Investors will often argue that the issuer will be forced into choosing a particular outcome (eg. buying back the securities) by a combination of the terms of the instrument and market forces – but there have been cases in the past where bank issuers have not done the expected and left investors in the lurch.

    Who knows, they may go up. But unless you can read and understand the terms and conditions and know a bit about credit analysis, I would not be anxious to buy them.

  5. tim says:

    Driving down the price is irrelevant unless they are buying back. They still have to pay $100/security

    • David King says:

      Sorry Tim but this is EXACTLY where you are wrong. The obligation to buy back these securities is non-existent. Therefore they are free at virtually any time (let’s not argue about the exact timing but usually about quarterly) to offer to buy back securities at any price they choose to offer. Bendigo Bank bought some of their $100 hybrids at $80. No-one was forced to sell, but many will, to get rid of these dreadfully company- benefit- skewed securities. I sold all mine before prices fell, and am so glad I did.

  6. Graeme says:

    I have held NABHA for a number of years and frequently buy more when the price is extra weak. The capital is about as secure as one can find and If you analyse the price over longer periods it becomes obvious there are excellent opportunities to enter and exit – while waiting, you have an excellent return on your investment.

  7. Des says:

    Where can these be purchased

  8. brian says:

    The MBLHB and NABHA are unlikely ever to be redeemed as there is no way either of these banks could borrow at the floating rates offered. I suspect the fact that they are not tier one assets will have little concern for either institution

    • john Abernethy says:

      Brian

      You could be right re funding costs but you have not taken into the “dividend stopping clause” if interest is missed. That is the point about these hybrids that makes them toxic and it is why APRA does not approve hybrids with similar clauses today.

      JA

  9. Kevin says:

    Tim hits the nail on the head. In NAB’s annual report last year it was specified that the bank is required to pay the securities back at par ($100) if and when it decides to buy them back

  10. James Hanna says:

    In the event of the banks failing, god forbid, would our investment in NABHA or MBLHB be secured by the government for the first $250K.

    • David King says:

      The answer has to be “no.” Banks and all other approved deposit taking institutions have only their depositors’ funds covered by the government guarantee. Not even their senior debt is guaranteed and these securities are a long way down the line from senior debt.

    • Don Glasson says:

      No, they are NOT secured by the Governments $250k guarantee.

  11. Paul says:

    Maybe this is a silly question but why wouldn’t NAB just buy these income securities back on-market at lower than $100 if they ever wanted to call them in? They could get them cheaply now!

    • Clime Asset Management says:

      Not silly at all and quite probably what they would attempt to do at that point.

  12. Wayne says:

    John – Why not Seven hybrids (SVWPA)? Yield is Much better than your three picks.

    • Gerry Dutton says:

      I bought many preference shares in the GFC under face value and did well especially with the terminating ones. I hold MBLHB and SVWPA, both of which have dropped in value since the recent drop in the market. SVWPA has dropped 25% below my purchase price although the return in my super is exceptional. Why are these doing so badly when they are returning well above cash rate and presumably have the protection above share dividends?

      • Keith Berry says:

        As reported by AFR, down-rated because of concerns that SVW will be completely swallowed up by Kerry Stokes and when no longer publicly listed, it becomes a private debt

  13. Colin Duncan says:

    Are MBLHB and NABHA dividends Fully Franked?

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