nabha sbkhb for yield when margins/rates rise?

True or False or Maybe? NABHA and SBKHB are perpetual debt which have a slightly lower spot yield than other bank debt, but will have a larger yield than other debt if either interest rates or debt margins retreat towards long-term norms. Either their perpetual nature or the possibility of them being wound up makes them a worthwhile hedge.

[Since sending this a couple of days ago to some friends for feedback before posting, the prices of NABHA and SBKHB have both gone up a bit. I haven't checked if the bank rates have changed. This will change the figures in the following slightly.]

Both ASX-listed NABHA and SBKHB are (possibly) perpetual debt with the banks (NAB and SUN respectively), and date from a time when lending was easy and margins were low. As a result, both are heavily discounted compared with similar bank debt but with higher margins.

The spot figures and calculations... SBKHB has a margin of 0.75% over the 90 day rate of around 2.74%, but is trading around $65 of its face value of $100, making it (by my calculations) a yield of around 5.36%, or an effective margin of 2.62%. NABHA has a margin of 1.25% over the 90 day rate, but is trading at about $71 to its face value of $100, making it (by my calculations) a yield of around 5.62%, or an effective margin of 2.88%. So both of these margins are a little below that of current issues of bank debt, not drastically but enough that you'd want a reason to take on that lower rate, which might be provided by the following.

One feature of NABHA and SBKHB is that because of the low margin and discount they are far more susceptible to changes in interest rates. Since 80% of the interest in SBKHB and 69% of the interest in NABHA comes from the 90 day rate rather than the margin, they are considerably more sensitive to interest rates than debt with a margin of more than 3% (which seems to be common over the last few years) where currently less than 50% of the interest comes from the 90 day rate. Thus if interest rates drop, as a lot of people are predicting, they may decrease in value faster than other debt. If we return to a higher interest rate environment, the effective interest rate will go up faster than other bank debt and they may be worth more.

In the last week commentary seems to have shifted from the likelihood of a rates cut next week and now the talk is of the RBA showing less intention. Although it's always dangerous to use history and assume that we are not entering a "new normal", but if we at relatively low (but not emergency) interest rates at the moment then interest rate changes in the long-term may deliver more upside than downside. So although this debt is not inflation-linked (as it's based on the 90 day rate instead of the CPI) this debt may be protected against fluctuations in the 90 day rate more than if you put money into a long term deposit.

Another way of looking at it is via the effective margin. At the 15 year rate of 4.59%, SBKHB would have an effective yield of (4.59+0.75)*$100/$65 or 8.21% and a margin of 3.62%. For NABHA it would be (4.59+1.25)*$100/$71 or 8.22% and a margin of 3.63%. So if the 15 year rate is a fair means of estimating where interest rates are going, then the effective margin on NABHA and SBKHB is slightly above where bank debt issues have been over the last few years. So interest rates don't even have to get up to the 15 year rate for them to be better value than other bank debt.

Of course, that's all based on margins remaining the same. As I wrote earlier, these pieces of bank debt date from when margins were far lower prior to the GFC, and while I don't look forward to the return of any debt-fuelled mayhem, the effective margins on NABHA and SBKHB are well above where margins may be in future.

You can also get high yield on the banks themselves and a lot of people seem to prefer the possibility of capital gains in addition to the interest. But though bank debt doesn't offer the same possibility of gains, it also seems to be less negatively affected by any losses that the banks may suffer.

There are some discussions of the possible impact of changes to the capital requirements for banks which may lead to this debt being wound up in ten years or so. If this was to occur, then there would be a nice capital return on top of the interest payments. But there are no guarantees of this, and a part of me thinks that the banks might look favourably on the low margin depending on what is going on a decade from now, which none of us can predict very well. After all, it's not like the rules for capital requirements haven't changed over the last ten years.

So if either interest rates of margins return to anywhere near pre-GFC norms, both NABHA and SBKHB might be perpetually earning some high interest payments, or you might find yourself with a significant capital return on them if the banks wind them up. Is the slightly lower spot rate worth the hedge against these possible changes in interest rates and margins?

Or am I just deluding myself into thinking that I've found a infinite duration psuedo-inflation-linked term deposit with NAB or SUN for $0.65 to $0.71 on the dollar? I'm holding some of each and would appreciate some independent analysis of what I've written here to either confirm my ideas but would welcome opinions which take a different viewpoint to see what comes out.