In my Weekend AFR column I offer my latest analysis of relative value investment opportunities across the banks' capital structures in the context of the recent AMP subordinated bond deal, highlighting what appears to be dysfunctions between senior bonds, subordinated debt and hybrids (click on that link to read for free or AFR subs can use the direct link here). Excerpt below:
"Few investors understand the acute distortions manifesting across the rich and endlessly fascinating bank capital structure right now, which insinuates opportunities and threats. In short, senior bonds are cheap, offering "spreads" (or interest) above cash that are well wide of 2014 "tights", while subordinated debt is expensive with spreads compressing to post-crisis lows that are miles inside those offered on similarly situated hybrids. These dysfunctions were highlighted via a $250 million Tier 2 (T2) subordinated bond issued by AMP this week, which was three times oversubscribed and "printed" at a crazy-tight margin of merely 1.8 per cent (180 basis points) above the 1.7 per cent (170 basis points) three-month bank bill swap rate (BBSW). That means investors accepted a total floating-rate of interest of just 3.5 per cent. (BBSW normally trades 20 basis points above the 1.5 per cent official cash rate.) When the initial price guidance was announced at 190 to 200 basis points above BBSW, we thought there was modest value for investors at the upper end of this range (between 195 and 200 basis points). AMP subordinated debt typically trades alongside the "non-major" complex, which includes Suncorp, Bendigo, Bank of Queensland, IAG and ME Bank. Since 2013 there have been 11 non-major T2 issues domestically with a median spread of 280 basis points. AMP last dealt in December 2013 at 265 basis points. AMP subordinated debt typically trades alongside the "non-major" complex, which includes Suncorp, Bendigo, Bank of Queensland, IAG and ME Bank. The most comparable recent transaction was an identically rated (BBB+) issue by Suncorp in September 2016 that printed at 320 basis points over, which has a very similar maturity to the AMP T2 offer. On the basis of "primary" market (or new issue) precedents, one might have presumed AMP would price the deal in the low to mid 200s after allowing for the aggressive rally in spreads since Suncorp's 2016 print. One problem with this T2 rally in particular, which relative to post-crisis spread levels has exceeded all other parts of the bank capital structure, is that it has been driven by crazy-brave retail and private bank bids that cannot properly price assets with "bail-in" or "non-viability" clauses that allow the regulator to unilaterally write off these securities, or convert them into equity, on a whim. (Even big institutions like PIMCO struggle, as we will see.) In 2015 and early 2016 we were the most vocal proponent of buying T2 bonds when major bank issues were trading wide of 250 basis points (maxing out at 300-plus in February 2016) and non-major issues were paying spreads in excess of 300 basis points. While most folks were trying to avoid or sell T2 at the worst possible time, it was obvious that these securities were dirt cheap, which the ensuing rally confirmed. The concern is that now investors are rushing to acquire these assets at excessively dear levels, inverting the age-old buy low, sell high maxim. Prior to the AMP deal, major bank T2 at the five-year tenor was pricing at circa 155 basis points over in the "secondary" market while Suncorp's September 2016 issue was bid at 185 basis points. Working off these secondary marks, one could rationalise a super-tight 195-200 basis points level for the AMP issue assuming a minimal new issue concession, which is where we set our own bids. Goldman Sachs' founders had an aphorism that advised bankers to be "long-term greedy" with clients. In today's context, that implies issuers should account for the fact they are sourcing T2 funding that is much cheaper than anything they've seen since the crisis and leave value on the table for the same creditors they will be begging for money from in the next dislocation. Inherently volatile T2 deals almost always come with chunky new issue concession of 20 to 50 basis points on top of secondary market levels as compensation for the risks. If we get risk-off events akin to those that emerged in 2012, 2015 and 2016, this AMP security could easily trade 100 basis points wider, inflicting a painful 4 per cent capital loss on holders." Read full article at AFR here.