Why ASX hybrids are likely to perform strongly

The major banks’ ASX hybrids are expected to perform strongly in the period ahead as their credit spreads compress back to pre-COVID levels and we move past a torrent of recent new supply with no less than five deals having priced on the market.

Ying Yi Ann Cheng, Portfolio Management Director at Coolabah Capital Investments, which manages $4.7 billion in assets, says 5-year major bank hybrid spreads blew-out to around 3.4% above the quarterly bank bill swap rate in November as a flood of new issues from Bendigo, Bank of Queensland, Challenger, Westpac, and NAB came to market.

“Pre-COVID, 5-year major bank hybrid spreads were around 2.6% above the bank bill swap rate. This implies potential capital gains of more than 3.3% if credit spreads mean-revert back to pre-COVID levels.”

The two images below from Coolabah below show major bank hybrid credit spreads over time and relative to major bank senior bond spreads.

Another sector that Cheng says Coolabah likes is the AA rated state government bond market, which is benefiting from the RBA’s quantitative easing (QE) program where the central bank is actively buying these bonds. Coolabah expects the RBA to extend its QE program next year as it seeks to continue to reduce Australia’s jobless rate to below 4% in an effort to boost otherwise anaemic wages growth.

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