Hybrids are still cheap

In The AFR I publish new research on the bottom-up valuation models we use to price ASX hybrid securities to determine whether they are cheap or expensive given high-profile hedge fund manager Michael Hintze's claim this week that the sector is attractive. While we employ a range of top-down regression-based factor models to price bonds and hybrids, we also use bottom-up Merton models that focus on the issuer's financial data and the security characteristics to estimate the probability of default, expected loss, and hence the fair value credit spread or return required to compensate for these risks. Our conclusions around fair value spreads for deposits, senior bonds, subordinated notes, and hybrids are interesting: "The AT1 analysis is trickier because it is a perpetual security with significant extension risk beyond 5 years subject to mandatory equity conversion in year 10. Our fair value spread for a 10-year AT1 is 353bps above cash, which is closer to current trading levels. The average of the five- and 10-year maturities is 282bps. On this basis, AT1s are also very cheap." Free (VIEW LINK)