Income Report / Why we’re adding the new AMP Hybrid to the Income Portfolio

By Market Matters 27 November 19

Why we’re adding the new AMP Hybrid to the Income Portfolio

Market Matters Income Report 27th November 2019

The market opened lower this morning however has edged up into positive territory at time of writing (10.45am) and is now looking poised to test recent highs. What’s most impressive about the move at the index level is the lack of participation from the influential banking sector which has clearly been on the nose again – a flight to quality obvious with CBA outperforming the sector however the other three majors along with Bank of QLD (BOQ) and Bendigo (BEN) have been hit hard over the course of the last week or so. Regulatory scrutiny front and centre again.

The flight to quality (CBA) is clearly shown in the table below. CBA now trading at a 25% premium to the broader sector versus its historical sector premium of 12%.

Source: Bloomberg

The market’s underlying strength this morning is coming from the Telco space with Telstra (TLS) trading +2.5% higher on upbeat commentary at their investor day, largely around the trajectory of cost cutting. We’ll cover more on this in the afternoon.

Overall, the ASX 200 is currently trading up +29pts or +0.43% to 6816.

ASX 200 Chart

The Income Portfolio was down during the week, falling -0.62% which was weaker than the ASX200 Accumulation index which traded down -0.39%. The bank equity exposure dragged the performance with WBC (-6.37%) and NAB (-4.07%). A broker upgrade for Spark Infrastructure (SKI) helped the stock perform the best for the portfolio, adding +3.38%. The portfolio is tracking above the benchmarks, currently up +3.33% financial year to date, versus its absolute return benchmark of +1.99%. Since inception the portfolio is up +20.47% vs the benchmark of +12.91%

Why we’re adding the new AMP Hybrid to the Income Portfolio

The AMP CFO and Treasurer were in yesterday to talk about the new AMP Hybrid issue as they look to raise up to $250m. Most will stop reading here given its AMP, I can hardly blame you however there are a few reasons why this hybrid is worth a look and why we’re adding it to the Market Matters Income Portfolio.  I’ve often found that the best investments have some curly parts to them, but importantly an identifiable catalyst that can re-rate them at some point in the future. While we doubt the AMP Hybrid will be up there with the best, there are a few elements to this deal that we like.

The Numbers

Issue Type: Tier 1, floating rate capital note

Par value: $100

Issue Margin:  4.50% to 4.70%
Yield to First Call: 5.51% to 5.71%

First optional call date: 16th December 2025 (6-year deal)
Distributions: Quarterly

This is a typical tier 1 security however for all conditions please review the prospectus available here. 

Comparison with current issues

There are currently four main parts to the AMP business - Life Insurance, Wealth Management, the Bank, and AMP Capital. Wealth Management is the weak link, AMP Bank is okay, and AMP Capital is strong while they are in the process of selling off the capital-intensive life insurance business, and that really provides the catalyst mentioned above.

While we are not keen on AMP equity (too many variables in terms of earnings), their capital position makes this hybrid attractive.

The hybrid being marketed is said to be raising money for general business operations, however there is a hybrid due to be called early next year (issued in the over the counter market) and we’d expect these funds to be used to refinance this issue. Given their reporting dates and subsequent blackout period beforehand, they need to raise the capital now which is not ideal from AMP’s perspective - we believe they’re having to pay more for this hybrid due to a couple of timing issues

1.       AMP has recently raised new equity which means they’ve used their 15% placement capacity. In a Hybrid there are conversion triggers that mean under certain circumstances, hybrids can covert to equity, however given AMP has used their 15% placement limit, AMP need to seek shareholder approval for these conditions in the hybrid to be met. They made a big point of this in the presentation with a negative slant, however it’s largely irrelevant as it does not apply at the mandatory conversion date in any case. We think this perceived complexity added to the issue margin

2.       The sale of the life insurance business is progressing which will ultimately improve their capital position once complete by over $1bn. Ultimately, the timing and uncertainty of the life sale means they needed to issue this hybrid now.  If the life sales go through as we expect it will, then the capital position of AMP is very strong and the hybrid would re-rerate, meaning the margin would contract pushing the price higher.  

What we like

1.       The capital position of AMP is strong even though their earnings profile has been weak, and the headlines have been horrific.  That capital position will further improve with the sale of their life insurance business

2.       The margin is big / generous, and the size of the deal is small, they will cap it at $250m

3.       They have just completed an equity raise – this instrument sits above equity in the capital structure

4.       There is a near term catalyst to see these securities re-rate higher being the sale of Life

What we don’t like

1.       Unknowns from a customer remediation perspective

2.       A new approach in the wealth space is unproven and a lot of challenges face that division

3.       Given AMP is not paying an ordinary dividend on the shares, there is no real hurdle to stop distributions on the Hybrids

4.       AMP equity – we’re not a fan of the stock however the debt / hybrids look attractive given spreads

For those who would like to bid, we can take bids through our desk at Shaw and Partners, however an account at Shaw would need to be opened. If you have interest, please email [email protected]

The Broker Firm Offer Bookbuild will close on 3 December 2019 and may close early.

**Please note Shaw and Partners are a co-manager to this deal and will be paid a fee**

ASIC has published guidance on hybrid securities on their MoneySmart website which may be relevant to your consideration of AMP Capital Notes 2. You can find this guidance by searching ‘hybrid securities’ at www.moneysmart.gov.au. The guidance includes a series of questions you may wish to consider, and a short quiz you can complete to check your understanding of how hybrids work, their features and risks.

Conclusion

We are looking to add the new AMP Hybrid into the Portfolio with a 5% weighting 

The offer is likely to close in the next day or two given the size of deal

Have a great day!

James & the Market Matters Team

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Friday, or after the session when positions are traded.

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