What are Hybrid Securities
Hybrid security is a investment security with characteristics of debt and equity. In the company with a simple capital structure, hybrid capital sit between debt and equity where equity holders are at risk of first loss followed by hybrids then debt holders.
Due to its position in the capital structure before debt holders these securities would have to provide a higher return than debt but a lower return relative to equity holders.
Bank hybrid securities are listed on the ASX and can be traded on the same ASX trading days as any other listed equities. It is one of the most popular fixed income products traded on the ASX. In the eyes of the rating agencies, hybrids can be counted as equity hence it is a cheaper form of equity relative to shares due to fixed interest costs.
Fixed income from Australian hybrids from the company perspective are dividends, hence it includes franking credits. Investors of bank hybrids should take into account the value of franking credits in their individual circumstances in calculating the total return of the hybrid bond.
Typical structure include:
- Rate of return is known to a degree. This can be in form of fixed interest rate or a fixed margin over the Australia bank bill swap rate. The fixed nature of return is the commonality with fixed income.
- Securities can be convertible to equity at a fixed price or ratio in the near future. The hybrid convertible feature makes these investments equity like. The strike price of the conversion is set at a higher than current price and a specified time limit before the security can be converted.
- A maturity date where investment face value of the security is returned. An earlier call date by the issuer can be set before the maturity date. If the security is not called, face value will be returned at maturity date.
Given the fixed income nature and convertibility. The value of the security is a combination of the fixed income (which can be valued as a bond) and and call option on the underlying stock price.
ASX Capital Notes and Preference Share List
The list below shows the securities that are available for investors on the Australia Stock Exchange.
|BENPD||BENDIGO AND ADELAIDE BANK LIMITED|
|BOQPD||BANK OF QUEENSLAND LIMITED.|
|CAMPA||CLIME CAPITAL LIMITED|
|CBAPC||COMMONWEALTH BANK OF AUSTRALIA.|
|GMPPA||GOODMAN PLUS TRUST|
|IAGPC||INSURANCE AUSTRALIA GROUP LIMITED|
|KBCPA||KEYBRIDGE CAPITAL LIMITED|
|MBLPA||MACQUARIE BANK LIMITED|
|MXUPA||MULTIPLEX SITES TRUST|
|NABPA||NATIONAL AUSTRALIA BANK LIMITED|
|PXUPA||PAPERLINX SPS TRUST|
|RHCPA||RAMSAY HEALTH CARE LIMITED|
|SUNPC||SUNCORP GROUP LIMITED|
|SVWPA||SEVEN GROUP HOLDINGS LIMITED|
|WBCPC||WESTPAC BANKING CORPORATION|
|WCTPA||WESTPAC TPS TRUST|
Hybrid Security Risks
There are a number of risks for hybrid investments. The limited nature of alternative fixed income investment opportunities (aside from Real estate) and favorable tax treatment of dividends make hybrids popular in Australia. However we normally keep clear of these securities given the risks outlined below.
Longer than expected maturity
The maturity of the hybrid issue are set out in the prospectus with the ability by the issuer to call the securities at an earlier call date. There is always a risk that the issuer does not call back the hybrids at the first call date. This result in an adverse selection bias where it is companies with credit that are most at risk that will miss their first call dates making investment risk much greater going forward.
If the hybrids are not called, the face value of the security will trade relative to market interest rate at that time. The owner would have to hold until maturity to return the face value of the security which could be 10 or 20 years, depending on the time remaining after first call.
Missed dividend payments
Hybrid dividends can be stopped at anytime. The exact term can be either cumulative which means that the dividends otherwise would be paid is accrued and paid at maturity or whenever it recommence payment. Or non-cumulative which means that the issuer does not have to pay any dividends during the period when it ceased dividend payments during the borrowing term.
Convert to equity at worst possible time
Hybrid shares could also convert to equity at the choice of the issuer. This means when the company is in trouble and it is within the convertible period. Risk for investors could increase as the convertible shares are converted to ordinary shares. Investors would lose its superior position in the capital structure at the point in time when the equity risk is elevated.
Worst case for investors is when the issuer is unable to pay dividends and misses the call dates to repay the security at face value. Investors would be holding a non interest earning security with a long maturity and no certainty on payment at maturity.