Asbpa & asbpb

[crighton100]

I assume that brokers & financial advisers do not recommend these two ASB stocks.Because I am at a loss as to why they are trading at such a huge discount to their face value.I understand the rate of return has dropped in line with interest rates,but at their present cost with the return being paid on the full face value,they surely are a great investment.Regular income which at present I think works out at a better than a 5 year t/d when you take into account the current cost to buy,they will appreciate when interest rates rise in the next year or two.What is it that I am missing? After all they are backed by the largest local bank,if ASB goes under we are in trouble!

[macduffy]

I don't think the market has any particular concern about the safety of ASB -the "problem" is the perpetual nature of these securities. At least with a five year TD you know that the face value of the principal will be redeemed but if interest rates remain low - or even lower - when you want your money back, then there's a potential capital loss to consider.

[Penfold]

Had a look at these the other day. I couldn't see a call date. They genuinely look perpetual. No mention that they can buy them back on market either. I am flagging these. Low returns for years to come. Am going to get a few RBOHAs instead, and maybe some Credit Agricole if I get brave enough.

I would also look at Quayside, and two others I already own Infral perps and Origin prefs...

[Penfold]

Looks like CBA can buy at their discretion. The reset margins at 100 and 130 may not entice them to do it until credit margins tighten.

[modandm]

I assume that brokers & financial advisers do not recommend these two ASB stocks.Because I am at a loss as to why they are trading at such a huge discount to their face value.I understand the rate of return has dropped in line with interest rates,but at their present cost with the return being paid on the full face value,they surely are a great investment.Regular income which at present I think works out at a better than a 5 year t/d when you take into account the current cost to buy,they will appreciate when interest rates rise in the next year or two.What is it that I am missing? After all they are backed by the largest local bank,if ASB goes under we are in trouble!

Read the NZDX forum and the thead about perpetuals. There is another good one about IFTHA. If you are at a loss to why they are trading where they are I suggest you don't understand how they work too well - however you seem to understand the relationship between the capital value and interest rates so I guess that is promising.

Anyway by my rough calcs ASBPA is on a running yield of 6.26% and ASBPB is on 5.73%. If you think that the 1 year swap rate will rise over the next few years by all means a good investment.

Three things to note:

1. Wholesale Interest rates are not going to shoot back up to 5 or 6% in the near future unless the global economy really sorts itself out so you will need to be more patient than you think.

2. IFTHA is on a running yield of 7.6% so if you think Infratil is safe enough I would consider that one.

3. If you think interest rates will rise due to economic improvement why not invest in shares - you can prob get 7 or 8% gross yield + capital gain.

[modandm]

Had a look at these the other day. I couldn't see a call date. They genuinely look perpetual. No mention that they can buy them back on market either. I am flagging these. Low returns for years to come. Am going to get a few RBOHAs instead, and maybe some Credit Agricole if I get brave enough.

I would also look at Quayside, and two others I already own Infral perps and Origin prefs...

The running yield on RBOHA is lower. And credit agricole and Quayside - madness - equities are safer - especially global equities.

[Dubdee]

These are in effect perpetual bonds but the valuation is complicated by the fact that they have annual resets of the base rate.

The reason they are travelling at such large doscounts is that the market now demands a 300bp point margin for risk whereas these have a fixed margin which is much lower. I also think the market has got the pip with them being floating rate at the short end of the curve, the current coupons being very low.

Valuing these is very complicated but I know Forsyth Barr have a model which they use which is very complex.

However a rule of thumb I use is Price = annual coupon rate divided by annual yield. I use the 10 year swap rate as a proxy for the base rate and add the fixed margin to get the coupon and use the price to solve for the equivalent perpetual yield. This will be very gratifying.

These definitely have an issuer call at par for both taxation and regulatory reasons. The treatment of these as equity capital for banks under Basel 3 may see them called which could give a significant windfall but our RBNZ is yet to decide if they still qualify as tier 1 capital.

Ordinary shares is the bank have a better return but also more volatility, so the choice is yours

[Penfold]

The running yield on RBOHA is lower. And credit agricole and Quayside - madness - equities are safer - especially global equities.

Madness - Credit Agricole maybe (time will tell). Quayside, not really. But accept for the yield you may be better off else where. I just like to diversify my fixed interest. I have no problem with Quayside being part of that.

[Lizard]

It is not the benchmark interest rate that is the problem on the re-sets, but the premium that the market no longer considers adequate. That has come about mainly through a relative switch in wholesale vs retail deposit rates as bank funding mix requirements change.
From the Economist (http://www.economist.com/node/18654578) - May 2011

An equally pressing reason for the sudden revival of big banks’ interest in the tedious business of taking deposits and processing payments is that they can no longer rely on wholesale money markets for most of their funding because that would leave them vulnerable to sudden freezes. Those that depend on short-term wholesale funding are required to pay higher interest rates, have lower credit ratings and are subject to closer scrutiny from regulators. Basel 3, along with raising the amount of capital that banks have to hold, will also encourage them to get more of their funding from sources that are less fickle than the money markets. Among the best of these are deposits from retail customers. Regulators love these because they are “sticky”: ordinary savers tend not to move their funds around. So banks that wish to survive, never mind prosper, will have to compete a lot harder than they used to for the deposits and cheque accounts of millions of retail and small business customers.

This means that while retail deposits and benchmark swap rates were at similar levels in late 2007 at the start of the crisis (about 8.8% for 1 year rates), the fall for benchmark swap rates has outstripped that of retail deposits, so that benchmark swap rates are now nearly 2% lower than retail deposit rates (2.63% vs 4.4%). When most of these bonds were issued, it was at a 0.75% to 1.5% risk premium to swap rates (depending on credit rating) - a premium that now does not even cover the gap to retail rates, let alone account for risk. For contrast, in recent months, issues for ANZ and BNZ fixed rate bonds have been set at a 2.10-2.15% premium to swap.

4020

If swap rates had continued to match deposit rates, then it is likely that the market value of these issues would be much closer to face value (perhaps some discount due to increased risk aversion). The upshot of this is that the issues are likely to remain discounted until such time as either the issuer wishes to re-purchase or there is a return to parity for term deposits and swap rates (I need Xerof or another fixed interest expert to comment on the likelihood of this and what it might take - my impression has been that this is long term structural change relating to Basel 3 requirements, but would be good to know more about the drivers and trends).

On the re-purchase front, there have been mixed views over time as to whether banks might re-purchase once the perpetuals had passed shelf-life and were no longer considered equity. This has at times meant that some of the bank perpetuals have traded higher than might be calculated from comparative interest rates. However, the current yield of 5.0% on RBOHA seems about right for risk c.f. their one year deposit (special) of 4.5%, so seems to me that it is unlikely there are very high odds of 2017 re-purchase currently built in. Nor does there seem to me any other reasons why issuers would want to re-purchase while the premium is in their favour - indeed, IFT expressed the view that it would be against their obligations to shareholders if they were to do so (so they continue to buy on market and book a gain on the difference)

To draw a conclusion on buying at current prices probably requires more information on likely long term trends in the gap between retail deposit and swap rates (expressed as a proportion of deposit rates). Thoughts welcome! However, making the big assumption that we have reached a point of stability in this gap, then buying on-market seems to me to be a reasonable alternative to rolling one year term deposits, offering slightly higher rates (and higher risk) with greater liquidity.

ASBPA and ASBPB carry a larger risk premium (lower credit rating) than RBOHA and I think have a lower chance of being re-purchased in the medium term, so hence the higher effective yields of 5.8-6.4%. Given that most retail investors will pay brokerage on purchase and sale, a round trip will typically knock at least 1% off capital, so need to allow for this when comparing to term deposits too.

Of all the perpetuals, WKSHA might be of interest - although DOW:ASX carries cyclical risks and could stop paying dividends without them becoming cumulative. However, the 4.05% premium over benchmark currently gives an 8.9% return at 74cps - possibly a good deal while DOW seems to be on the mend - definitely at the "junk bond" end of the spectrum.

(PS: Just saw Dubdee's excellent post - I took too long writing this, trying to format the charts!)