Should we buy the new NAB Hybrid (NABPG)?

Earlier in the week, NAB launched a new Hybrid offer – the NABPG’s to raise around $750m in new tier 1 capital, although they’ll likely do more as they need to re-finance an existing $1.34b worth of NABPC’s. The structure is the same as the last NAB note (NABPF) which was issued in March of 2019 and also the same as the recent issue from CBA trading under code CBAPI.

In terms of rate, the proposed issue margin is 2.95% – 3.15% over the 90 day bank bill rate, which at the lower end (likely) equates to a yield now of ~3.85% grossed for franking, however when looking at the forward curve for interest rates and applying that (which is what we should do), the rate is 4.04%, with 7.5 years until first call.

While we find it hard to get enthused about a ~4% rate of return (although that will go up if interest rates increase), the security does offer decent ‘relative value’ and importantly, we believe that tier 1 bank hybrids are becoming safer instruments (given increasing regulated capital requirements for the banks), and that’s underpinning a tightening of spreads (which is the margin over bank bills that are being offered).

Comparisons

In terms of relative value and assuming a 2.95% margin, the issue screens well relative to others as the table shows above. The most recent note came from CBA which was the PERLS XII (CBAPI) issued in November 2019 for ~7.5 years, the longest dated issue at the time. The note before that was issued by NAB (NABPF) in March 2019 at a tenor of ~7.25 years.

It makes sense from the banks to be issuing longer dated notes,  essentially they lock in capital at good rates for extended time periods when demand is there, however it also helps investors who are happy to go up the risk spectrum for income. All things being equal, a higher rate should be applied to longer dated issues.

Here is further comparison and trading margin analysis for those interested.

Source: Lonsec, Thomson Reuters

Thinking more broadly, it’s also worthwhile looking at where tier 1 bank hybrids as a group typically trade in terms of margin over the bank bill rate. This is essentially a function of investor demand, the higher the margin, the less demand and vice versa. Just like a stock that has consistent earnings – when the market is bullish, they’ll pay 30x those earnings but when the market is bearish they may pay 20x or even 10x.

Source: Lonsec, Thomson Reuters

We have previously written that as a general rule of thumb for Tier 1 major bank securities, a 4% margin means the security is cheap and a 3% margin means it’s expensive. The average was around 3.5% however it’s now closer to 3% as spreads have tightened in recent times, however as suggested above, we also think the securities have become safer.

The reason being the recent increases in core equity capital, lending constraints and higher risk weights required by APRA which are positive for debt and hybrid holders of the banks. Safer investments pay a lower return, but that return is more certain.

Ultimately, this is a solid security and if we were looking to increase our hybrid weightings (we are not) we would subscribe to the issue.

Details

Interest: It’s a floating rate with the guided range of 2.95% – 3.15% per annum above the 90-day BBSW, which currently sits at 0.90%. They will likely print at the bottom of the range so expect a grossed-up yield of ~4%. As shown above, that compares reasonably with other currently listed notes, and for that reason, the NAB note should be well bid. We are seeing as much through the desk already.

Term: This is a tier 1 bank hybrid so therefore does not have a fixed maturity date for repayment. That said the first optional call date is 27th September 2027

Key Dates

Broker Book Build:  17-24th February – closes this Friday although it will likely close early (I’m hearing as soon as today).

Issue Date: 23rd March 2020

Please see  Prospectus for further details.

Risks; Before applying for NAB Capital Notes 4, you should consider whether NAB Capital Notes 4 is a suitable investment for you.

ASIC has published guidance which may be relevant to your consideration of whether to invest in NAB Capital Notes 4 – namely, information for retail investors who are considering investing in bank hybrid securities. This guidance can be found on ASIC’s MoneySmart website at moneysmart.gov.au.

NAB has also developed a web-based Hybrid Securities Education Guide (Guide) to help investors understand some of the typical features and risks associated with an investment in bank hybrid securities. It is available at www.nab.com.au/about-us/shareholder-centre/welcome.

NAB Capital Notes 4 are subject to risks which could affect their performance, including distribution rate risk and market price fluctuation. Information about the key risks of investing in NAB Capital Notes 3 are detailed in Section Seven of the Prospectus