not sure if this is the right spot but does anyone know much about hybrid/capital notes and if any chance of arbitrage here?
ANZ has launched an additional tier one (AT1) capital hybrid – called ANZ Capital Notes 4 (ASX: ANZPG) – that is something of a first for the Aussie primary market and actually looks quite cheap relative to the secondary curve.
This follows on from the stunning success of ANZ's landmark US$1 billion hybrid, which was issued in June at $100 and is lavishing 10 per cent capital gains on investors (with secondary bids around $110).
Swapped back to Australian dollars, ANZ's US dollar AT1 is trading at about 4.65 percentage points above the three-month bank bill swap rate for a security with an expected maturity (or optional call date) in June 2026.
This is important because among the listed major bank hybrids, the "curve" ends with the ANZPF hybrid that has a March 2023 call date.
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ANZ's latest deal, which will be used to refinance the $1.9 billion invested in ANZPA (known as "CPS2") that is being called in mid December, has an optional first call in March 2024. Related Quotes
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In considering whether this transaction offers fair value, we've extended out the Australian AT1 curve to include the over-the-counter US dollar deal, which is the most actively traded Aussie bank hybrid in the world. Fair value
On this basis, the new security is fair value at about 4.49 percentage points above the bank bill swap rate. This is a fairly chunky 20 to 40 basis points inside ANZ's proposed trading margin range of 4.7 to 4.9 percentage points above swap.
Another way of thinking about fair value is the spread the AT1, which will be rated BBB- by Standard & Poor's, offers relative to ANZ's tier two (T2) subordinated bonds, which are rated BBB+, and its ordinary shares. The hybrid is a preferred perpetual equity instrument that sits between T2 debt and the voting equity.
Using our proprietary multi-factor regression model for investment-grade debt, we can maturity-match a hypothetical ANZ T2 bond with the new AT1 to quantify the relative spreads.
This implies the AT1 will pay about 2.06 percentage points extra annual interest than an equivalent T2 security (or about 1.8 times T2 spreads) assuming the AT1 prices at 4.7 per cent. (For what it is worth, the AT1 deal would also trade at 3.9 times ANZ's senior bonds on a like-for-like or curve-adjusted basis.)
The current three-month bank bill swap rate is 1.75 per cent, which means the AT1 deal would deliver a total annual running yield of 6.45 per cent assuming the cash rate does not change. That looks very ordinary compared to ANZ's equity, which is paying a grossed-up dividend yield of 9.4 per cent.
Value arbitrage
Yet the AT1 offers a relative value arbitrage of sorts across the capital structure. In our view, ANZ is going to have to boost its common equity tier one ratio (CET1) from 9.1 per cent to a new regulatory minimum target of 10 per cent by 2018 or 2019.
As ANZ delevers its balance sheet, credit risks will decline (as will the returns on equity captured by shareholders). There is effectively a net transfer of wealth from equity owners, who have been benefiting from excess leverage, to those creditors that sit higher up the capital structure, including AT1 owners. The bottom line is that shareholders face unique equity valuation risks that the AT1 holders may be somewhat insulated from.
A higher CET1 ratio also puts more room between the de facto default triggers AT1 holders face if ANZ's CET1 ratio falls below 8 per cent, notably not the 5.125 per cent level that the entire hybrid market has been duped into believing is the only default risk. (I will explain the disconnect between these 8 per cent and 5.125 per cent CET1 triggers in my next column.)
A final factor in favour of this deal is ANZ will likely limit its size to a little more than $1 billion, with all the majors now having the new option of raising AT1 capital overseas rather than just in the domestic listed market. This has profoundly improved the local supply technicals.
In summary, I am a buyer of the ANZ AT1 deal at the proposed spreads.
