Buying US dollar-denominated perpetual preferred securities (PPS) of major banks may be an extremely rewarding investment if held for the next few years, according to Merrill Lynch Global Wealth Management Australia and New Zealand managing director Chris Selby.
“If you want to buy something like ANZ and CBA [Commonwealth Bank of Australia] to get bank exposure and you don’t want to buy equity you have limited choices,” Selby said.
“You either buy their senior debt which is not cheap or distressed as it is government guaranteed, or you can buy their US dollar-denominated PPS, which are heavily discounted in the market due to liquidity.
“These things have been trading at extremely wide yields, with returns exceeding 20 per cent on some A-rated securities.”
US dollar-denominated PPS of ANZ and CBA have the same credit quality as their Australian dollar-denominated equivalents because they are issued by the same institution. They also sit higher in the capital structure of a bank than common stock.
These instruments recently traded around 55 to 92 cents in the dollar because they were originally issued to overseas institutions which have sold them off heavily due to risk aversion or redemptions, leaving the market illiquid and mispriced.
“The restriction on US dollar-denominated PPS of banks is that these things are more likely to be held until maturity, so you have to be prepared for that,” Selby said.
When these PPS were originated, they generally had a call date of five, seven or 10 years. Some even had explicit investor rights.
Technically, PPS count as equity in a bank’s capital structure but were senior in a credit event. Several issues, although not debt, do have investors’ rights to convert to shares, creating a real maturity date around the call date.
