Strategy
Income
Australia

General update on Income Strategy and Hybrids

24 Mar 2020
By
The listed hybrid market, despite being seen as a safe haven by many investors, has seen a hefty hit in recent weeks as echoes of the GFC lead to heavy selling in the sector.

The listed hybrid market, despite being seen as a safe haven by many investors, has seen a hefty hit in recent weeks as echoes of the GFC lead to heavy selling in the sector. Given the unknowns in the market right now – how effective the government’s response has been and when the world will return to normal – I think that some selling is appropriate, but it is time to begin stress-testing our holdings. Ultimately, we feel the bank hybrids are the safest bet and, as we saw during the GFC, their debt will be guaranteed by the Federal government which is an important safety valve for hybrid holders. Assuming all hybrids will redeem at their call dates is misguided however and depending on the individual company it may be wise for the company to let them lapse even though the damage to the balance sheet would be significant. Hybrids are useful as they are debt-like but are classified as equity, and the short summary is that if hybrids are not redeemed at their call date they will be reclassified as debt, thus impacting a company’s credit rating.

So, for the most part, holding hybrids that redeem in the short-term could be problematic. The only two hybrids in our portfolio that redeem in the next 18 months are the CWNHBs and the MQGPBs. We’re not overly concerned with the MQGPBs as Macquarie Group’s business is diversified and they can withstand a downturn. Crown’s (CWN) position is more problematic as the company is likely to endure closures of its casinos, and Asian tourists aren’t likely to be flying in anytime soon either. But CWN has a solid balance sheet after selling its Macau investments, and ultimately, I think an equity raising for the company would be well-supported given the likely return to normal trading once the pandemic passes.

We should remember that during the GFC we saw all hybrids sold off on insolvency fears, but ultimately the majority returned to their highs once the crisis abated. We do not intend to panic knowing that the survival of a company will ultimately return its hybrids to previous trading levels, and we remain comfortable with the solvency of the underlying issuers. This is a fluid situation so we will continue to monitor our holdings, but for the time being, all hybrids remain holds for the long-term.

Rivkin does not ever provide financial advice. Please consider your own circumstances before purchasing any of our products or acting on our general advice, for any Rivkin product or recommendation.

SHOW COMMENTS / QUESTIONS (0)

Comments

You need to be a Strategies user to comment on this post. Click here and become premium now!

We are glad you liked it

For your convenience, this will appear under your Saved articles in the top menu.