NAB announces it will repay $2 billion NABHA hybrid in February as expected...

Christopher Joye

Coolabah Capital

NAB has announced that it will repay its long-outstanding $2 billion National Income Securities (ASX: NABHA) on 15 February 2021 at full face value (ie, $100 plus the last remaining coupon payment) consistent with the expectations Coolabah has repeatedly outlined in recent months. 

NABHA first listed on the ASX in June 1999 and has been subject to intense speculation for many years as to when it might be refinanced. In December NAB secured shareholder approval at its AGM to repay NABHA and Coolabah forecast that this would occur in February at full face value (ie, for $100). In particular, we recently advised our investors:

A final point of interest in respect of the local hybrid market is that NAB has recently obtained shareholder approval to be able to call (or repay) its long-neglected NABHA security. The first available opportunity is likely to be in February, which is CCI’s central case. This would put $2 billion into the hands of NABHA holders, who will have to search for income elsewhere. The supply outlook for bank hybrids otherwise appears relatively benign in the first half of 2020 with only a handful of new deals expected, which could provide for a positive bid-side technical.

Coolabah believes the trigger for the repayment of NABHA was the fact that NAB is carrying excess common equity tier one (CET1) capital as a result of raising circa $4.5 billion in ordinary equity in 2020 on a precautionary basis as a hedge against COVID-19 related credit losses. 

The modest COVID-19-induced impairments have meant that some of this excess capital is now surplus to NAB's needs given its pro-forma September 2020 CET1 ratio of 11.8% is materially above APRA's required unquestionably strong CET1 target ratio of 10.5%.

Way back in October 2018 we wrote:

"The pressure to replace NABHA intensifies in 2021 when it will only contribute 31.1 per cent to AT1, and much more in 2022 when NABHA's AT1 share evaporates entirely. Its implied cost climbs from 3.2 per cent above bank bills in 2020 to 8.3 per cent in 2021. This burden is further amplified in 2022 because NAB has said that tax changes will mean it has to pay franking on top of NABHA' official 1.25 per cent spread above BBSW, driving the total cost of the security to 4.54 per cent annually even though it will be useless for AT1 purposes...[Accordingly] NAB does have an incentive to replace NABHA with a new hybrid by the end of 2021, which is a year in which it notably has no hybrid maturities."

Since late last year we have argued that the likelihood of $2 billion of cash being returned to NABHA holders in February will be positive for the ASX hybrid sector and provide a tail-wind for returns in the first quarter of 2021, which is currently quite light from an expected supply perspective (only one hybrid is presently slated to be refinanced: the $530m MQGPB).

Having said that, we've noted that we would not be surprised if a major bank brings forward supply into the first quarter of 2021 to capitalise on the NABHA proceeds. There is also the remaining proceeds of the Westpac hybrid WBCPF that will be repaid in March, which we estimate to be about $458 million (ie, those investors that chose not to roll into the new Westpac hybrid that issued in December (ASX: WBCPJ)).

In January we advised our investors that the best value in the banks’ capital structure is in the AT1 hybrid space where 5-year major bank spreads remain today wide of where they were at the start of the year... 

In January 2020, 5-year major bank hybrid spreads were sitting at 2.81% above the quarterly bank bill swap rate. Today they are at about 2.98%. Of course, they blew-out to around 8.4% in March (we picked up over $300 million in that month alone). And yet the post-GFC tights are much lower at around 2.35% with pre-GFC levels sitting tighter again at 1.25%.

Another way to think about Tier 2 and AT1 hybrid valuations is through the multiple of their spreads over equivalent-tenor senior paper that sits higher up the capital structure, which is a heuristic commonly employed by institutional investors.

Since the application of the new Basel 3 banking rules in January 2013, 5-year major bank Tier 2 bonds have typically traded on a spread that is 2.15 times 5-year major bank senior bond spreads. Today that Tier 2/senior multiple has expanded to an unprecedented 5.04 times.

Five-year major bank AT1 spreads have historically traded at about 4 times 5-year major bank senior bond spreads. That multiple has likewise jumped to a never-before-seen 9.56 times (see the chart below, which is a screenshot from CCI’s proprietary internal systems).

Another tailwind for the hybrids sector is APRA’s proposal to adjust the way banks calculate and report their CET1 capital ratios (click here to read our research on this development). This will result in the big banks’ capital ratios rising by about 1 to 1.5 percentage points. Whereas CBA currently reports an 11.8% CET1 ratio, this could be expected to increase to 12.8% to 13.3%.

Aussie bank hybrids contain a clause that stipulates they must automatically convert into bank equity if the CET1 ratio declines to 5.125%. The current distance to default in the case of CBA would require its 11.8% CET1 ratio to shrink by 56.6% for its hybrids to be converted into equity. Under APRA’s proposal, CBA would have to suffer greater losses that reduce its new 12.8-13.3% CET1 ratio by about 60% to get down to the conversion trigger.

Finally, click here to read our analysis of APRA’s aggressive stress-tests of the Aussie banking system, which showed that they were able to comfortably withstand two recessions over 2020 and 2021 encompassing a 30% drop in house prices, a 40% decline commercial property values, and an increase in the jobless rate to 14% that resulted in cumulative credit losses of $163 billion.

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Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs over $8 billion with a team of 26 executives focussed on generating credit alpha from mispricings across fixed-income markets. In 2019, Chris was selected as one of FE fundinfo’s Top 10 “Alpha...

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