NAB Convertible Preference Shares

[Sardine]

The prospectus, 6.1.2, says "The payment of Dividends on NAB CPS is subject to the discretion of the Directors".
Can somebody explain to me what this means? The whims of the directors or what?

 

[sydboy007]

The prospectus, 6.1.2, says "The payment of Dividends on NAB CPS is subject to the discretion of the Directors".
Can somebody explain to me what this means? The whims of the directors or what?

To a degree. It would be more about profitability and capital adequacy ratios.

The important thing to look at is if there is a clause that stops dividends if they don't make a dividend payment. Some of the more recent offerings - here's looking at you CROWN - allow dividends to be paid while interest payments are not made.

 

[kid hustlr]

Kind of Off Topic and I'm just spit balling a bit but it blows me away how many of these flaoting rate note offerings have come to market over the last 18 months. From a long term perspective it just makes me feel like these things aren't the best thing to be investing in from a return basis.

I mean if all the bankers are flogging these things at swap + 3% or w/e its because they are thinking thats cheap funding and they can use the funds for better purposes. As usual retail will jump all over these things and then watch equities greatly outperform for the next 10 years

 

[sydboy007]

Kind of Off Topic and I'm just spit balling a bit but it blows me away how many of these flaoting rate note offerings have come to market over the last 18 months. From a long term perspective it just makes me feel like these things aren't the best thing to be investing in from a return basis.

I mean if all the bankers are flogging these things at swap + 3% or w/e its because they are thinking thats cheap funding and they can use the funds for better purposes. As usual retail will jump all over these things and then watch equities greatly outperform for the next 10 years

To a degree.

But there is a good case to have some of these in your investment portfolio.

They pay a reasonable and reliable income stream, have less volatility that shares, and for a lot of retirees are a good fit to provide the income stream you need to live on.

Would I say have 100% of you money in them. Definitely not, but I'd say 20-30% of your capital in these is prob not a bad thing to do. They provide a reasonable hedge against inflation.

 

[McLovin]

They pay a reasonable and reliable income stream, have less volatility that shares, and for a lot of retirees are a good fit to provide the income stream you need to live on.

This doesn't really hold water. Most of these hybrids pay a floating rate above BBSW. If interest rates fall then the income stream falls too. It shouldn't be sold as a reliable income stream because it's no more reliable than an at call deposit. Personally, I find it easier to find stable well run companies that pay dividends than I do trying to predict where interest rates are going. Buy bonds if you want a reliable income stream. There's still some decent corporates offering 5-6%, fixed.

Like I said, there's a reason this sort of equity is sold primarily to retail investors.

 

[ROE]

This doesn't really hold water. Most of these hybrids pay a floating rate above BBSW. If interest rates fall then the income stream falls too. It shouldn't be sold as a reliable income stream because it's no more reliable than an at call deposit. Personally, I find it easier to find stable well run companies that pay dividends than I do trying to predict where interest rates are going. Buy bonds if you want a reliable income stream. There's still some decent corporates offering 5-6%, fixed.

Like I said, there's a reason this sort of equity is sold primarily to retail investors.

It hold water, it's very good hedge against inflation, 90-Day Bank Bills always track around inflation rate or higher
and then you get 3.2% on top...dividend is not hedge against anything, it dependent on company profit and at the board discretion..

Now unless the company goes belly up, they have to pay these interest payment...company can lower dividend payment but they can not lower hybrid rate ....your payment varies according to 90-Day Bank Bills...

buying solid companies hybrid is a very secure way of getting good income and your notes would not drop in value but have a decent chance of trades above face value...

There are various articles pumping out by regulators in the last couples of year warning people about these type of products but they lump everyone into the same baskets...

buying hybrid of solid companies like CBA, WOW, WES, WBC you make some decent money there..

Obvious there is always risks but be disciplined and buy solid companies hybrid and you will be rewarded just like invest in solid companies

 

[McLovin]

It hold water, it's very good hedge against inflation, 90-Day Bank Bills always track around inflation rate or higher
and then you get 3.2% on top...dividend is not hedge against anything, it dependent on company profit and at the board discretion..

My reply was to the assertion that it provides stable income, that is not true. It provides as variable an income as an at call deposit. Perhaps even more. Considering it trades at a margin to a variable rate, there's little chance of IR based price appreciation so unless you buy when the price is severely depressed capital gains are pretty limited but then I guess at that point it might be better to take a punt on the common.

In a high inflation environment it's debatable whether or not they would continue to make payments, depending on the sort of business.

Now unless the company goes belly up, they have to pay these interest payment...company can lower dividend payment but they can not lower hybrid rate ....your payment varies according to 90-Day Bank Bills...

There's no obligation to make the payment, all they are not allowed to do is pay a dividend if they don't make the "interest" payment. In many instances they're non-cumulative either. Don't pay a divvie, don't pay the interest. So, as long as the company is healthy enough to pay a dividend you get your interest payment. Sound a little like equity risk/debt return?

Like I said in an earlier post, there's guys like Bill and yourself who understand the risks but there seems to be quite a lot of misconceptions about what hybrids actually are.

 

[ROE]

stable income is true in a sense as it cant not goes below 3.2%....
deposit rate can go to zero % like in the US

90 days bank bill at 0% you get guarantee 3.2%....

obviously you lose money if the company went belly up...you rank 1 rank higher than shareholder
but I wouldn't hold out for any cash back that why it's paramount you only invest in solid business
and don't be tempted to go a bit higher for dodgy business....

 

[ROE]

this is a good place for those who want to see hybrid, look at all the good companies their hybrid all trades above
face value or around face value.....

WOWHC trades close to $105, decent income plus 4% extra if you want to offload for cash just like
cash at call but better ...WOW has this thing going for decades now they roll over when the time is up
the one before this is WOWHB

http://www.morningstar.com.au/Hybrids/HybridsLatestPrices

 

[sydboy007]

This doesn't really hold water. Most of these hybrids pay a floating rate above BBSW. If interest rates fall then the income stream falls too. It shouldn't be sold as a reliable income stream because it's no more reliable than an at call deposit. Personally, I find it easier to find stable well run companies that pay dividends than I do trying to predict where interest rates are going. Buy bonds if you want a reliable income stream. There's still some decent corporates offering 5-6%, fixed.

Like I said, there's a reason this sort of equity is sold primarily to retail investors.

I would argue they were more stable during the GFC than dividends were.

Unless you're looking to hold a fixed interest bond till maturity you're pretty much going to take a capital loss buying now, unless the world goes to poo over the next 6 - 12 months.

 

[sptrawler]

This doesn't really hold water. Most of these hybrids pay a floating rate above BBSW. If interest rates fall then the income stream falls too. It shouldn't be sold as a reliable income stream because it's no more reliable than an at call deposit. Personally, I find it easier to find stable well run companies that pay dividends than I do trying to predict where interest rates are going. Buy bonds if you want a reliable income stream. There's still some decent corporates offering 5-6%, fixed.

Like I said, there's a reason this sort of equity is sold primarily to retail investors.

I rang my mentor,lol, he said what you are saying.
The reason I rang him was, I remembered he bought converting preference shares years ago.
His take on it was, there was no capital gain and dividends weren't any better than the ordinary shares.
He sold them after three years and still doesn't regret it.

 

[McLovin]

I would argue they were more stable during the GFC than dividends were.

That's a tough argument to make considering the BBSW fell from near 8% to 3% during the GFC then went back up to ~5% and now is back down at ~3%. All that in a five year period. Stable income, I think not!

Bank dividends by comparison had a had a brief blip before resuming their upward trajectory.

Fair enough, hindsight is 20/20 but again the point remains if AU banks were in as bad shape as their European or American equivalents the hybrids would have been just as done over as the common equity.

 

[tinhat]

Preference shares, hybrids, convertible notes, etc are just a form of debt. They are a debt obligation that the borrower takes on with their lenders.

The whole purpose of a publicly listed company is to raise working capital from the stock market and use that working capital to carry out business to create profit. Businesses take on debt because it can be a cheaper means of raising money than a capital raising and furthermore, if used sensibly and put to use in expanding the production and marketing capacity of a company it should result in the company increasing profits thus increasing the rate of return to equity holders (share holders).

So, in the case of a well managed company, all other things being equal, it should generally be the case that the returns to an equity holder should be greater than the returns to the lender (preference share holder). Therefore in theory, preference shares and other corporate debt products in general seem to be an inferior investment vehicle to me.

A profitable company that has some competitive advantage in the market with either normal or inelastic demand should be a hedge to inflation anyway, which is why consumer staples and utilities are often considered defensive income stocks.

 

[tinhat]

At the risk of having a conversation with myself, and without getting biblical about it, it seems that that equity investor versus lender argument has been brewing in away in the less oxygen fed regions of my mind.

To my feeble mind there is something slightly more noble about being on the equity end of financing. Taking a stake in a business and being rewarded for the risk. There is something less exciting and less noble in my mind to just lending money. You lend money to your drunk buddy so he can catch a taxi home. You take equity in a business to seek a return based on the prosperity of the venture.

An insurance broker has most probably never been to sea. I on the other hand enjoy sailing.

 

[craft]

I reckon a lot of these things are being bought by people that are simply chasing yield and don’t understand the product and in doing so they are pushing themselves dangerously up the risk curve.

If you do a yield to maturity and then subtract the floating interest rate on current issues you will see that the risk margin (ie the fixed margin) is being priced very cheaply by the market at the moment.

Take TAHHA – original risk margin 4.25% market currently pricing it at 1.6%.

The risk margins are incredibly sensitive to market changes against face value – yet these things are all being bid up – either risk aversion is dead or people don’t realise the lack of compensation they are getting for taking on the risk.

I haven’t looked to see what risk margin NAB is offering or if it is fair compensation for risk, but whatever it is set at, the current mood will probably see the price bid up and hence risk premium bid down soon after listing – Hybrids seem to be the new stag floats. Hmmmm

 

[skc]

If you do a yield to maturity and then subtract the floating interest rate on current issues you will see that the risk margin (ie the fixed margin) is being priced very cheaply by the market at the moment.

Take TAHHA – original risk margin 4.25% market currently pricing it at 1.6%.

Are you sure about this calculation? It's only gone up to $103 from face value of $100.

If the original yield was 4.25% the current yield at market is 4.13%. So a 12bps difference.

 

[craft]

Are you sure about this calculation? It's only gone up to $103 from face value of $100.

If the original yield was 4.25% the current yield at market is 4.13%. So a 12bps difference.

Taking into account both accrued interest and a maturity date of 1/5/14 The IRR for yield to maturity is 4.6%. The BBSW is 3% therefore you are only getting 1.6% return for your risk component.

The original yield was 4.25%(risk margin) + BBSW.

 

[skc]

Taking into account both accrued interest and a maturity date of 1/5/14 The IRR for yield to maturity is 4.6%. The BBSW is 3% therefore you are only getting 1.6% return for your risk component.

The original yield was 4.25%(risk margin) + BBSW.

I see. I wasn't aware it's maturing so soon. Perhaps your average punter didn't bother reading about the expiry date, or forgot the fact that you only get paid face value on expiry.

On the other hand, the chance of TAH running into trouble between now and May 2014 is probably small enough to command a 1.6% margin?

 

[craft]

Perhaps your average punter didn't bother reading about the expiry date, or forgot the fact that you only get paid face value on expiry.

On the other hand, the chance of TAH running into trouble between now and May 2014 is probably small enough to command a 1.6% margin?

There’s the rub – clear understanding allows calculated risk taking. Lack of understanding makes any instrument risky.

I would wager most people buying these things for yield don’t fully understand them. They are a very sensitive instrument for views on solvency. They have very little risk mitigation against re-investment risk arising from changes in interest rates.

 

[McLovin]

This chart is pretty interesting. A comparison of debt/equity/hybrids pre and post GFC. Hybrids function like debt when times are good but like equity when times are bad...