The listed Virgin Australia bonds (VAHHA) look set to go down as one of the worst investments ever to appear on the ASX. After being issued in November 2019, the bonds didn’t even make it to their first interest payment in May 2020. This beats the mere nine months that Axsesstoday survived after it issued ASX listed debt in 2018. Those who have followed the ASX listed note market (which includes both corporate and financial securities) since its early days will remember names like ABC Learning, Allco, Babcock and Brown, Great Southern, Gunns, Paperlinx and Timbercorp. The predominantly retail buyer base has long struggled to recognise the risks of these securities that institutional debt investors routinely avoid.
Virgin is a good case study in the structural and business weaknesses that so often come with listed notes. The primary structural weakness was that Virgin’s listed bonds were unsecured, with the debt ranking equally with a large group of unsecured creditors. Whilst Virgin’s secured creditors will get most or all their money back, the unsecured creditors will get little or nothing. Last year Virgin had almost nothing left to hock, so it turned to Australian listed note buyers and the US high yield bond market to get its last debt hit.
The primary business weakness was that Virgin had a long history of losses, constantly struggling to make a fist of being the number two airline in a duopoly. If an airline can’t make money in the good years, what hope does it have of surviving some economic turbulence? The main positive for Virgin was that its shareholders had a history of tipping in more money. However, as predicted in my review published before the notes hit the ASX shareholders would eventually stop throwing good money after bad.
What many retail investors fail to realise is that ASX listed debt and preference shares are often used by issuers to obtain cheaper and looser terms than institutional investors are willing to grant. The companies get what they want, the investment banks and brokers earn a fee with the retail buyers being underpaid for the risk. If you go drinking at the last chance saloon don’t be surprised if you end up with a few bruises. Not every listed note is bad, but it only takes one bad security in a portfolio of twenty to wipe out a year’s worth of income.
There are those that argue it is only the corporate securities you need to worry about; that the banks will always pay their preference share dividends and hit their call dates. If we review the results from overseas missed call dates are becoming much more common. In Australia, holders of BENHB, NABHA and SBKHB have endured miserable returns for over 20 years hoping for their securities to be called. The possibility of banks being forced to miss calls on their securities, if their share price is below the threshold level set at issue, is a rarely mentioned risk that is now in play.
In the last financial crisis several large European and American banks fell over with their subordinated securities wiped out. Whilst defaults haven’t happened on bank preference shares in Australia, the coming downturn in house prices accompanied by substantial unemployment will be a much stiffer test than 2007-2010. It is not unforeseeable that bank preference share dividends get turned off for a period.
The volatility in listed notes over the last two months has been a wake-up call for many investors. Some who thought they were invested in low risk securities were shocked to see falls over 10% in a few weeks. These moves were small compared to the last financial crisis when some Australian major bank preference shares traded in the 60’s and some smaller Australian bank preference shares traded below 50. The bounce back since late March has created an opportunity for listed note holders to reconsider their positions and exit at a minimal loss.
History and human nature tells us that the vast majority of investors- including the professionals- underestimate risk. The words- That is never going to happen are often followed up later by - Why didn't someone see that coming. As for Virgin -I remember someone remarking many years ago that over time airlines have destroyed more wealth than a world war. Virgin is just part of that long history. We cannot afford to see another case of capitalising the profits and socialising the losses. Good to see the Federal Govt and Super funds standing back and assessing the risk.
So where do bank hybrids sit in this world?
Thanks Geoff and Mark for the comments. Bank hybrids do have a place as an alternative to owning ordinary equity in a bank under some circumstances. They're not a substitute for term deposits or investment grade credit. For institutional investors that focus on long term returns, non-LMI securitisation is a superior form of accessing the same sort of systemic credit risk that bank hybrids have. These can offer both lower risk and higher returns, with less complexity and negative optionality. In short, better value elsewhere.
Thanks for the contribution Jonathan, insightful and educational.