The fixed income manager said a downgrade of major bank hybrids below investment grade will force many investors to sell.
FIIG head of markets Craig Swanger said the move by Standard & Poor’s may force fund managers and financial planners who are not permitted to hold investments below investment grade to dump the hybrids.
“Such a high volume of forced sellers is likely to put downward pricing pressure on these hybrids, which reinforces our view that they are very volatile and investors are not being fairly compensated for the associated risks,” said Mr Swanger.
According to FIIG Securities, prices for several of the largest hybrids on the ASX have fallen by $4 to $5 and are now below issue price in many cases.
Mr Swanger said recent developments have moved prices closer to the sort of levels that hybrids trade at in Europe.
“The recent CBA Perls issue was done at 2.8 per cent over the bank bill reference rate being about 5.4 per cent,” he said.
“Bank hybrids in Europe are trading at around double this level, but even if at the lowest end of the European range, the CBA deal should have been around 400 [basis points] over or 6.6 per cent per annum.”
Mr Swanger said if Australian hybrids corrected to that sort of yield, their price would fall to $95 or $96.
A re-rating, Mr Swanger said, will affect the new generation of equity hybrids or contingent convertibles, including NABPA, NABPB, WBCPD, WBCPE, CBAPC (Perls VI) and CBAPD (Perls VII), which are structured to allow banking regulators to convert them into equity in times of crisis.
Investors have invested a total of $20 billion in the equity hybrids, including the recent CBA hybrid (Perls VII), he said.
“The problem is that these new securities are engineered for a specific purpose, namely to be used to “bail in” capital in the event that the banking regulator becomes concerned,” he said.
“This is a post-GFC device that as yet is untested so markets don’t know how to price this risk and regulators are still shifting their rhetoric around how they will use their right to force conversion.”
