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:
- National Bank Income Securities (NABHA);
- Macquarie Income Securities (MBLHB);
- Multiplex Sites (MXUPA).
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.
Forecast 12 month distributions $3.40 to $3.50
Dividend Yield: 5.4%
Forecast 12 month distribution $3.90 to $4.00
Dividend Yield: 5.8%
Forecast 12 month distribution $5.90 to $6.00
Dividend Yield: 8.8%