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Macquarie's new listed hybrid versus existing OTC Tier 1 hybrids

by Justin McCarthy | May 22, 2013

Last week Macquarie Group launched a new ASX listed hybrid paying a margin of 400bp over 6mBBSW. The issue, officially called the Macquarie Group Capital notes, has been upsized to $600m and will be used to repay the 11.095% fixed rate Converting Preference Share issued in June 2008 with a first call in June 2013.

The new security has a first conversion into Macquarie shares (or resale or cash call) date of 19 June 2018 and a final mandatory conversion into equity date of 21 June 2021 (subject to exchange conditions being met).

To qualify as Tier 1 capital the notes are perpetual and the coupons are non-cumulative, payable at the sole discretion of Macquarie. Also, as a “new style” hybrid there is a "non-viability trigger" meaning that APRA have the power, at their sole discretion, to convert the notes into ordinary Macquarie shares if they deem Macquarie to be at risk of failure, most likely resulting in a capital loss for investors. (See link for further details on “new style” versus “old style” hybrid risks).

While this new ASX listed issue compares reasonably well to recent issues with a similar structure from the majors which are trading at a margin of circa 285bps over 3m BBSW, there is also value for investors in the OTC market.

Macquarie Group and Macquarie Bank, the latter rated one to three notches higher by the three main rating agencies, have a number of existing OTC issues in USD. While they may not suit all investors, wholesale investors can access these issues including the Macquarie Bank Limited (London Branch) 10.25% Tier 1 hybrid with a first call date in June 2017 at an equivalent margin of 502bps over USD Libor. Given the shorter call date and 102bps in extra margin, this is considered a better security, notwithstanding the currency implications.

In the AUD OTC market, there are seven Tier 1 hybrid issues from four entities, none of which are franked and as such avoid the lower cash distributions and imputation credit issues that most ASX listed bank hybrids bring, including the proposed Macquarie issue.

All seven OTC issues are “old style” hybrid securities which are considered to be significantly more debt like and do not contain a non-viability clause. In addition, all are “step-up” securities and as previously written, we believe “step-up” securities are materially more likely to be called due to regulatory developments under Basel III and to a lesser extent Solvency II.

The following table highlights the credit margin over the relevant benchmark BBSW/swap curve for each of the seven OTC existing issues. All securities are priced to the first possible call date, although we believe given the structure of the “new style” Macquarie hybrid, the prospect of conversion to equity in 2018 or 2021 is relatively high.

With the more debt-like structure of the “old style” securities and higher level of confidence in call for cash at first date (as opposed to conversion into Macquarie shares), we believe the OTC options represent superior risk-return dynamics despite the lower credit margins on offer. However, the new Macquarie issue does compensate somewhat via additional margin for the higher risk issuer and “new style” structure.

In particular, we believe the Swiss Re securities continue to offer value given the estimated six to seven rating notch differential compared to the proposed new Macquarie issue and longer expected maturity date. As written may times in recent months we reiterate our view that any new or existing wholesale clients should strongly consider an overweight position to Swiss Re given the very strong credit metrics and comparative value versus other Tier 1 securities. Further, existing wholesale clients holding AXA SA should consider selling down some of that exposure and increasing their weighting to Swiss Re (subject to maintaining an appropriate weighting to financials and Tier 1 hybrid securities in their overall portfolio).

Investors looking for a shorter term horizon may prefer the Rabobank Tier 1 hybrid securities with an expected call date of 31 December 2014, just over 18 months away. Despite the short expected maturity, the current margin of 250bps is considered attractive compensation for what we regard as arguably the world’s strongest bank.

The National Capital Instruments appeal for investors who are looking for a domestic name or a higher quality banking name. Further, it is important to note that these are an obligation of the National Australia Bank as opposed to the Macquarie securities which will be issued by Macquarie Group/parent as opposed to Macquarie Bank Limited.

While the AXA Tier 1 hybrid securities exhibit the highest margin of seven OTC Tier 1 hybrids, we believe the Swiss Re, Rabobank and National Capital Instruments represent superior value on a risk-reward basis. Compared to new Macquarie issue, we would still prefer AXA due to the more debt like structure and existence of the step-up clause, however it is a close call and we would remind investors that AXA remains highly exposed to developments in Europe, as well as Solvency II regulatory risk and Standard and Poor’s revision of its methodology towards the rating of subordinated debt and Tier 1 hybrids of insurance companies.

All prices and yields are a guide only and subject to market availability. FIIG does not make a market in these securities