As investors move to fill the hole left by bank hybrids, an alternative is emerging among corporates that may be worth considering. Perpetual’s Vivek Prabhu explains
- Corporate hybrid issuance is growing in Australia
- Potential alternative as bank hybrids disappear
- Find out about Vivek’s Perpetual Diversified Income Fund
There is a $43 billion hole in investment markets that needs to be filled over the next seven years as Australian banks withdraw from the hybrid market – and Australian corporates have begun filling the gap.
For example, fuel refiner and distributor Ampol issued a hybrid in December – and it’s performed pretty well, says Perpetual’s head of fixed income Vivek Prabhu.
“It is an investment grade issue at a premium of two-and-a-half per cent over bank bills. It was a large issue size – about $600 million – and for Ampol it was a good start.”
But there is a long way to go for non-bank corporate hybrids, says Prabhu, who manages the Perpetual Diversified Income Fund – an actively managed, diversified portfolio of floating-rate debt investments.
What are corporate hybrids?
“The corporate hybrid market in Australia hasn’t been particularly active – it’s been patchy until now,” Prabhu explains.
“With the banking sector stepping back from hybrid issuance, there’s unmet demand and corporates see that. They realise that to optimise their capital structure and cost of funding, hybrids have a role to play.”
The name hybrid reflects the debt instruments’ characteristics – part traditional bonds, including fixed income payments, and part equities. In a corporate’s capital structure, hybrids are subordinate to senior debt.
Under rules announced by the Australian Prudential Regulation Authority last year, banks will no longer be allowed to issue hybrids from 1 January 2027.
By the beginning of 2032, the grandfathering of hybrids in the bank capital structure will cease. That has left $43 billion worth of hybrids to recycle into other instruments.
Replacing hybrid returns
Investors like the returns that hybrids provide.
“When you are looking for bank bills plus two-to-three per cent, there’s not a lot of high-quality, investment-grade fixed income investments that offer that type of return,” Prabhu says.
The withdrawal of highly regulated banks issuing hybrids has given other corporates confidence that they can now get deals done, because they are not competing with the big four.
“There’s low execution risk and there’s an unmet investor demand that they can take advantage of. It’s all systems go on that front.”
Investors have bought bank hybrids mostly for income and capital stability, although Prabhu says that during periods of market stress, hybrids have not done a good job filling the latter role.
“Some investors have seen hybrids as an alternative to cash, but they are much riskier than cash. We saw that in the global financial crisis and Covid pandemic.”
Corporate hybrids aren’t always considered as “safe” as bank hybrids, Prabhu says, notwithstanding credit ratings because banking is such a highly regulated sector.
But there is a growing amount of corporate hybrid issuance in the market, with almost $3.5 billion issued since the beginning of December.
“There was Ampol ($600m) closely followed by Pacific National ($500m), the rail haulage company, in December.
“This year we’ve had AusNet ($950m) and TransGrid ($1.4bn) – both large, regulated utilities.
“People may feel additional comfort around the fact utilities are regulated, essential national infrastructure.”
About Vivek Prabhu and Perpetual Diversified Income Fund
Vivek is Perpetual’s head of fixed income. He joined Perpetual in 2004 and has more than 30 years of experience in accounting, finance, investments, governance and risk management.
He has managed multi-billion-dollar fixed income, credit and currency portfolios and his role involves credit analysis, trade execution and portfolio construction.
Vivek’s Perpetual Diversified Income Fund is an active, diversified portfolio of high quality, floating rate debt investments. It’s designed for investors seeking predictable outcomes - including above cash rate returns, consistent income and capital preservation.
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