In my AFR column I analyse one of the most debated investments on the ASX: the $2 billion NAB raised in 1999 via its National Income Securities (ASX: NABHA) (click on that link to read via Twitter or direct AFR subscribers can click here):
“While it was clearly marketed as a perpetual hybrid with no maturity or mandatory equity conversion date, NAB has always had the free option of "calling" NABHA after five years (ie, repaying the $100 principal). Nineteen years have passed and NAB has never availed itself of this option despite the vocal protestations of punters.
The NABHA story has nothing to do with its ordinary 4 per cent running yield, which is average compared with other shorter-dated hybrids like CBAPD which is paying 4.8 per cent annually before franking (6.4 per cent after). The hype emanates from hope NAB will finally redeem.
Before the global financial crisis NABHA regularly traded above $100. But a combination of that shock and that NAB never looked like calling NABHA since it could in 2004 saw its price slump as low as $62 in 2009.
More recently it has surged towards $80 on speculation NAB will redeem, which would deliver investors who bought between $60 and $80 a chunky windfall. Taking NABHA's current $79.66 price and assuming a $100 redemption happens in December 2021, this equates to a large 10.6 per cent annual return (more if it occurs sooner)…
To figure out NABHA's true cost, my analysts computed a blended rate – the amount of AT1 capital NABHA contributes in any given year (eg, 93 per cent in 2019) and the residual (7 per cent) sum of subordinated funding.
One question is what is the appropriate price for the perpetual subordinated funding that ranks ahead of Basel 3 sub debt? We use the mid-point of two senior and subordinated CBA bonds that have 30-year maturities, which equates to 1.80 per cent above BBSW.
The blended cost of NABHA capital ranges from 3.6 per cent above BBSW in 2018 to 2.5 per cent above BBSW in 2021, which is way above its actual 1.25 per cent cost. This suggests NABHA is cheap funding for NAB until 2022.
In its half-year results, NAB disclosed that from December 31, 2021 it will start franking the NABHA distributions because of a change in the security's tax treatment. NAB has since confirmed this means the income it has to pay NABHA holders will increase to 1.25 per cent above BBSW plus the extra franking credits, which translates to a total franked margin of 2.64 per cent above BBSW.
Accordingly, it would appear that NAB has an incentive to call NABHA in 2021 (a year in which NAB has no hybrid maturities) because its blended 2.64 per cent cost above BBSW from 2022 is higher than the cost of replacement funding at 1.8 per cent.
Yet it is not easy to raise $2 billion of perpetual funding with CBA's 30-year bonds the exception rather than the rule. NAB may simply decide to keep NABHA in place. If it does, investors may demand higher spreads of up to 4 per cent above BBSW, which would reduce NABHA's price to $61.
Another concern is that our assumption that the opportunity cost of replacing NABHA of 1.8 per cent above BBSW could be optimistic.
NABHA does have equity-like features as perpetual funding with optional income payments. The true cost may be closer to Basel 3 hybrids, in which case NAB may decide to pay the annual price of 1.25 per cent above BBSW plus the franking credits in perpetuity while retaining the free option to redeem at any time. Betting on NABHA being refinanced at $100 is therefore no sure thing.”
Christopher Joye is Co-Chief Investment Officer of Coolabah Capital Investments, which is a leading active credit manager that runs over $2.2 billion in short-term fixed-income strategies. He is also a Contributing Editor with The AFR.
Chris does NAB have to call it at a 100 can it offer a discount ......what’s the history of similar securities I think Suncorp and Macquarie redeemed in the past ...