Australian Income Securities Research Monthly Review September 2012

Transcription

1 Australian Income Securities Research Monthly Review September Income Security Best Ideas 2 2. Rate Sheet at 19 September Recommendation Changes Since Last Month 5 4. Monthly Market Review 5 5. New Issues, Maturities and Resets 6 6. Outlook and Comparative Yield 7 7. Major Bank Income Securities 8 8. Other Floating-Rate Income Securities Fixed-Rate Income Securities Glossary 14 Copyright 2012 Morningstar Australasia Pty Ltd. All rights reserved. The information in this document is property of Morningstar. 1

2 1. Income Security Best Ideas ASX Code Name Recommendation Risk Gross Running Yield ANZHA ANZ Subordinated Accumulate Low 6.26% Notes ANZHA are subordinated, unsecured securities with a $100 face value. They mature on 14 June 2022 but ANZ has an option to redeem them early on 14 June 2017, or on an interest payment date for taxation reasons subject to APRA approval. The notes pay quarterly interest based on the 90-day BBSW rate plus a 2.75% margin. The notes rank ahead of ANZ ordinary and preference shares (including the ANZ hybrids on issue: ANZPA, ANZPB and ANZPC). The distributions are mandatory and unfranked. They are currently trading below our fair value estimate and offer a running yield of 6.26%. ANZPA ANZ CPS2 Accumulate Low 6.80% ANZPA are Convertible Preference Shares of ANZ with a face value of $100. ANZPB are unsecured securities with a mandatory conversion date of 15 December 2016, subject to conversion conditions. They pay non-cumulative, floating rate, fully franked distributions at a 3.10% margin above 90-Day BBSW. They are currently trading below fair value and offer a gross running yield of 6.80% and 7.06% yield to reset. CBAPA CBA Perls V Accumulate Low 7.06% CBAPA are exchangeable resaleable listed securities in CBA with a face value of $200. CBAPA are classified as perpetual securities as there is no maturity date, however there is a mandatory conversion date of 31 Oct 2014 subject to the call rights of the issuer. They pay non-cumulative, fully franked distributions at a 3.40% margin above 90-Day BBSW. They are currently trading below our fair value estimate and offer a gross running yield of 7.06% and 7.24% yield to reset. MBLHB Macquarie Accumulate Medium 8.44% Income Securities MBLHB are stapled securities with a face value of $100. They pay non-cumulative, unfranked distributions quarterly in arrears at 1.7% p.a.+90-day BBSW. MBLHB is a perpetual security that can be repaid with cash (no conversion to shares) and so is essentially floating rate corporate debt. MBLHB is backed by bank cashflows which are less volatile than cashflows from the Macquarie Group as a whole. The security is perpetual so market price is more sensitive to overall market movements than a security with a fixed maturity date. Investors have no redemptions rights. They look attractive with a running yield of 8.44%. This security is suitable for investors with an above average risk appetite. NABHA NAB Income Accumulate Low 7.21% Securities NABHA are stapled securities with a face value of $100. They pay non-cumulative, unfranked distributions quarterly in arrears at 1.25% p.a.+90-day BBSW. NABHA is a perpetual security that can be repaid with cash (no conversion to shares) and so is essentially floating rate corporate debt. Investors should note that as a perpetual this security will suffer greater price swings on market than other major bank hybrids. They look attractive with a running yield of 7.21%. Copyright 2012 Morningstar Australasia Pty Ltd. All rights reserved. The information in this document is property of Morningstar. 2

3 ASX Code Name Recommendation Risk Gross Running Yield NABHB NAB Subordinated Notes Accumulate Low 6.28% NABHB are subordinated, unsecured securities with a $100 face value. They mature on 18 June 2022 but NAB has an option to redeem them early on 18 June 2017, or on any subsequent interest payment date, or following a taxation or regulatory event, subject to APRA approval. The notes pay quarterly interest based on the 90-day BBSW rate plus a 2.75% p.a margin. The notes rank ahead of NAB ordinary and preference shares and NAB income securities (NABHA). The distributions are mandatory and unfranked. They are currently trading below our fair value estimate and offer a running yield of 6.28%. ASX Code Name Recommendation Risk Gross Running Yield WBCHA WBC Subordinated Notes Accumulate Low 6.31% WBCHA are subordinated, unsecured securities with a $100 face value. They mature on 23 August 2022 but WBC has the option to redeem them early on 23 August 2017, or on any subsequent interest payment date, or following a taxation or regulatory event, subject to APRA approval. The notes pay quarterly interest based on the 90-day BBSW rate plus a 2.75% p.a margin. The notes rank ahead of WBC ordinary and preference shares (including the WBC hybrids on issue: WBCPA, WBCPB, WBCPC and WCTPA). The distributions are mandatory and unfranked. They are currently trading below our fair value estimate and offer a running yield of 6.31%. ASX Code Name Recommendation Risk Gross Running Yield AGKHA AGL Subordinated Notes Accumulate Medium 7.45% AGKHA are subordinated, unsecured securities with a $100 face value. They mature on 8 June 2039 but AGL has an option to redeem them early on 8 June 2019, or on any subsequent interest payment date. The notes pay quarterly interest based on the 90-day BBSW rate plus a 3.80% p.a margin. The notes rank ahead of AGL ordinary shares but below senior debt facilities. The interest payments are deferrable (subject to leverage and interest coverage triggers) but we remain comfortable with management and their capacity to adhere to these triggers. They are currently trading below our fair value estimate and offer a running yield of 7.45%. Copyright 2012 Morningstar Australasia Pty Ltd. All rights reserved. The information in this document is property of Morningstar. 3

4 2. Rate Sheet at 19 September 2012 Issue Size Years To Trading Running Yield Yield to Reset Code Recommendation Price ($) Issuer ($m) Maturity Margin inc Fr ex Fr inc Fr ex Fr Dist ($) Ex Date AAZPB NOT COVERED ALZ % 9.31% 9.31% /06/2012 AGKHA ACCUMULATE AGK % 7.45% 7.45% 7.44% 7.44% /11/2012 ANZHA ACCUMULATE ANZ % 6.26% 6.26% 6.05% 6.05% /09/2012 ANZPA ACCUMULATE ANZ % 6.80% 4.76% 7.06% 4.99% /11/2012 ANZPB ACCUMULATE ANZ % 6.19% 4.33% 7.18% 5.27% /11/2012 ANZPC ACCUMULATE ANZ % 6.89% 4.82% 7.34% 5.24% /02/2013 AQHHA NOT COVERED APA % 8.14% 8.14% 8.09% 8.09% /12/2012 AQNHA NOT COVERED AMP % 8.11% 8.11% 5.59% 5.59% /10/2012 BENHA NOT COVERED BEN % 4.93% 4.93% 4.99% 4.99% /12/2012 BENHB NOT COVERED BEN % 6.34% 6.34% /11/2012 BENPC HOLD BEN % 5.96% 4.17% % /09/2012 BOQPC REDUCE BOQ % 6.25% 4.37% /09/2012 CBAHA ACCUMULATE CBA % 4.65% 4.65% 5.20% 5.20% /09/2012 CBAPA ACCUMULATE CBA % 7.06% 4.94% 7.24% 4.94% /10/2012 CBAPB HOLD CBA % 4.59% 3.21% 9.85% 6.51% /10/2012 CNGHA ACCUMULATE CNG % 6.86% 6.86% 6.81% 6.81% /09/2012 CTXHA HOLD CTX % 8.10% 8.10% 7.93% 7.93% /12/2012 CWNHA NOT COVERED CWN % 8.76% 8.76% 8.79% 8.79% /11/2012 ELDPA NOT COVERED ELD GMPPA HOLD GMG % 6.24% /09/2012 IAGPC HOLD IAG % 7.90% 5.53% 8.51% 5.90% /10/2012 IANG ACCUMULATE IAG % 7.68% 5.37% 7.69% 5.34% /12/2012 MBLHB ACCUMULATE MQG % 8.44% 8.44% /09/2012 MQCPA HOLD MQG % 11.58% /06/2012 MXUPA NOT COVERED NA % 9.97% 9.97% /06/2012 NABHA ACCUMULATE NAB % 7.21% 7.21% /10/2012 NABHB ACCUMULATE NAB % 6.28% 6.28% 6.08% 6.08% /09/2012 NFNG ACCUMULATE NUF % 9.66% 9.66% /10/2012 ORGHA HOLD ORG % 7.61% 7.61% 7.46% 7.46% /09/2012 PCAPA ACCUMULATE CBA % 5.14% 3.60% 8.32% 6.70% /09/2012 PRYHA NOT COVERED PRY % 7.81% 7.81% 8.37% 8.37% /09/2012 PXUPA NOT COVERED 9.45 PPX RHCPA HOLD RHC % 8.60% 6.02% /09/2012 SBKPB HOLD SUN % 6.90% 4.83% 8.52% 6.34% /11/2012 SVWPA ACCUMULATE SVW % 10.29% 7.20% /05/2012 TAHHA HOLD TAH % 7.72% 7.72% 6.12% 6.12% /10/2012 TAHHB HOLD TAH % 7.74% 7.74% 7.91% 7.91% /09/2012 TPAPA AVOID TPI % 11.98% 8.38% /09/2012 TTSHA ACCUMULATE TTS % 6.61% 6.61% 6.42% 6.42% /09/2012 WBCHA ACCUMULATE WBC % 6.31% 6.31% 6.21% 6.21% /11/2012 WBCPA ACCUMULATE WBC % 6.00% 4.20% 6.54% 4.76% /09/2012 WBCPB ACCUMULATE WBC % 7.30% 5.11% 6.35% 4.15% /09/2012 WBCPC ACCUMULATE WBC % 6.97% 4.88% 7.22% 5.13% /09/2012 WCTPA ACCUMULATE WBC % 5.18% 3.63% 8.63% 7.12% /09/2012 WOWHC HOLD WOW % 6.64% 6.64% 5.97% 5.97% /11/2012 Source: Morningstar (yields) and ASX (prices and ex-dates) - Yields and trading margins above 30% are not displayed. Ex-dates and distributions are the latest reported by the ASX at the publication date, 19 September Copyright 2012 Morningstar Australasia Pty Ltd. All rights reserved. The information in this document is property of Morningstar. 4

5 3. Recommendation Changes Since Last Month WBCHA We initiated coverage on WBCHA with an Accumulate recommendation on 31 August WBCHA were trading below our fair value and looked attractive at levels around $ The security offered a yield to reset of 6.52% and a 6.54% running yield. The trading margin was 2.73% versus our 2.15% fair margin. WBCHA are subordinated, unsecured securities with a 10-year maturity. It is very similar to the subordinated notes (ANZHA and NABHB) issued by ANZ and NAB. WBC has an option to redeem the notes early on 23 August 2017, on any subsequent interest payment date, or following a taxation or regulatory event, subject to APRA approval. The notes pay quarterly interest based on the 90-day BBSW rate plus a 2.75% p.a. margin. The notes rank ahead of WBC ordinary and preference shares (including WBCPA, WBCPB, WBCPC and WCTPA) and subordinated perpetual debt. The distributions are interest payments, so are not franked. CTXHA We initiated coverage on CTXHA with a Hold recommendation on 18 September CTXHA were trading near our fair value estimate and looked fairly priced at levels around $ The security offered a yield to reset of 8.04% and 8.21% running yield. The trading margin was 4.23%, inline with our 4.25% fair margin. CTXHA is suitable for investors with an above-average risk appetite and we would suggest a small portfolio exposure. CTXHA are subordinated, unsecured debt securities, which rank above Caltex Australia (CTX) ordinary shares and below other CTX debt. The notes mature on 15 September 2037 unless CTX exercises an option to redeem early on 15 September 2017, on any subsequent interest payment date or following a trigger event. The notes pay quarterly interest based on the 90-day BBSW rate plus a margin of 4.50%p.a. If the notes are not redeemed on the first call date the margin steps up once by 0.25% p.a. Interest payments are cumulative and deferrable but there are no mandatory deferral conditions. Being interest payments they are not franked. We will be ceasing coverage on the following securities effective 12-Nov-2012: BENPC, BOQPC and TPAPA. We ceased coverage on the following securities effective 10-Sep-2012: BENPA, BENPB, GNSPA, SBKPA and SBKHB. 4. Monthly Market Review The Australian share market continued its strong start to the new financial year with the ASX200 accumulation index increasing 2.14% over the month of August. Despite the broad market volatility over the past twelve months the performance has been stable (5.48%) with dividends representing the majority of returns. On a sector basis the picture was mixed with Energy (3.6%), Healthcare (6.36%), Consumer Staples (5.83%) and Information Technology (11.78%) sectors outperforming month on month. International markets continued to drift higher in a traditionally quiet summer month as expectations of European Central Bank intervention (DAX: 2.93%) and strong results from Apple (NASDAQ:4.34%) continued to buoy global markets. Conversely Chinese stock markets (Hang Seng: -1.59%) were weaker primarily as a result of an unexpected contraction in domestic manufacturing output. The US markets continue to outperform its global peer s (year on year) as Bernake s quantitative easing policies continue to push for job growth at the expense of real wealth. The monthly performance numbers were: US: Dow Jones: 0.63%; S&P500: 1.98%; Nasdaq: 4.34% UK: FTSE100: 1.35% Germany: DAX: 2.93% France: CAC: 3.69% Japan: Nikkei: 1.67% Hong Kong: Hang Seng: -1.59%. Copyright 2012 Morningstar Australasia Pty Ltd. All rights reserved. The information in this document is property of Morningstar. 5

6 5. New Issues, Maturities and Resets AQHHA On 9 August 2012 APA Group (APA) announced a Subordinated Note issue (AQHHA). AQHHA are longdated, unsecured, subordinated debt securities, which rank above APA stapled securities and below other APA debt. The notes mature in 60 years unless the issuer exercises an option to redeem at the first call date in March 2018, on any subsequent interest payment date or following a trigger event. The notes pay quarterly interest based on the 90- day BBSW rate plus a 4.50%p.a margin. If the notes are not redeemed on the March 2038 step-up date the margin steps up once by 1.00% p.a. Interest payments are cumulative and deferrable but there are no mandatory deferral conditions. Being interest payments they are not franked. We had recommended investors Subscribe and suggested a small portfolio allocation. AQHHA is similar to the subordinated note issues (CTXHA, ORGHA and AGKHA) of Caltex Australia, Origin Energy and AGL Energy. It is closest to ORGHA given its long dated term and similar first call and step-up terms. We think AQHHA has a similar risk profile to ORGHA and AGKHA but lower than CTXHA. $515m was raised via the offer. The security commenced trading on 17 September We expect to commence coverage shortly. CWNHA On 13 August 2012 Crown (CWN) announced a Subordinated Note issue (CWNHA). CWNHA are longdated, unsecured, subordinated debt securities, which rank above CWN ordinary shares and below other CWN debt. The notes mature in 60 years unless the issuer exercises an option to redeem at the first call date in September 2018, on any subsequent interest payment date or following a trigger event. The notes pay quarterly interest based on the 90-day BBSW rate plus a 5.00% p.a margin. If the notes are not redeemed on the September 2038 step-up date the margin steps up once by 1.00% p.a. Interest payments are cumulative and deferrable at CWN s option and subject to mandatory deferral conditions. Being interest payments they are not franked. We had recommended investors Subscribe, but only if they have a high risk appetite, and we suggested a small portfolio allocation. We assess CWNHA as being high risk so potential investors need to weigh up an investment in CWNHA versus CWN equity. $532m was raised via the offer. The security commenced trading on 19 September We expect to commence coverage shortly. CBAPC On 3 September 2012 CBA announced a hybrid issue Perpetual Exchangeable Resaleable Securities VI (PERLS VI) (ASX Code: CBAPC). This is another mandatory converting hybrid. CBAPC are perpetual, exchangeable, unsecured, subordinated notes with a mandatory exchange date of 15 December 2020, subject to conditions unless they are redeemed or exchanged earlier following specific events or CBA exercising an option to call the security two years early. Face value is $100. Fully franked dividends are discretionary and non-cumulative payable quarterly, based on the 90-day BBSW rate plus a margin. CBA has did provide an indicative margin range. This issue will fund the redemption of PERLS IV (CBAPB), which are approaching their mandatory conversion date of 31 October Following the bookbuild the margin was set at 3.80%. We had expected the margin to be set well above our 3.15% fair margin. Our preference was for the margin to be at least 3.80%, which is where similar securities (ANZ s ANZPC and Westpac s WBCPC) had been trading. The CBAPC offer size is now at least $1.5bn. The broker firm, reinvestment, securityholder and customer offers close on 5 October The general offer to other applicants will not proceed. CBAPB will be redeemed via resale or reinvestment for face value by the 31 October 2012 mandatory conversion date. The redemption will be funded by a new hybrid issue, CBAPC. CBAPB. We recommend CBAPB holders reinvest into the CBAPC offer. It offers attractive distributions backed by a business with strong competitive advantages. However, the additional terms such as mandatory trigger conditions make CBAPC the most equity-like of the major bank hybrids on issue and therefore the riskiest in that relatively low risk group. Investors need to be comfortable with this. We have published a special report on CBAPC and options available for CBAPB security holders. The reinvestment offer closes 5 October 2012 GMPPA The responsible entity of Goodman Plus Trust, Goodman Funds Management Limited is proposing to change the terms of GMPPA (Goodman PLUS) effective 27 September The proposed changes are to be put to a meeting of Goodman PLUS holders to be held on 26 September If the proposal is approved the notes will be known as Goodman PLUS II. If the proposal is not approved Goodman has indicated that Goodman PLUS will remain on issue on current terms with the margin stepped up by 1.00% p.a. to 2.90% p.a. after 21 March 2013 and have a Copyright 2012 Morningstar Australasia Pty Ltd. All rights reserved. The information in this document is property of Morningstar. 6

7 next remarketing date of 21 March The key elements of the proposal include: the margin is essentially being increased two interest payment periods early from 1.90% p.a. to 3.90% p.a rather than to 2.90% p.a.; the note is becoming long-dated with a 61 year term and a first remarketing date at the five year mark; and the dividend restriction is being loosened. Our preference would have been for the notes to be redeemed, funded by a new security issue. On balance we recommend Goodman PLUS holders vote in favour of the proposal. We believe that they are better off holding Goodman PLUS II than they would be holding Goodman PLUS if the proposal is not approved. Goodman PLUS II will pay a higher margin and have a fixed maturity with a couple of step-up margin milestones. The loosening of distribution restriction is the main negative though not significant enough to warrant voting against the proposals. 6. Outlook and Comparative Yield At the September Reserve Bank Board meeting the decision was made to maintain the official cash rate at 3.50%. The board discussed a number of domestic and external indicators (particularly from China) which had deteriorated over the month making the interpretation of future growth more difficult. The board was explicit in mentioning the recent sharp decline in some bulk commodity prices and its knock on effect to the terms of trade. This in turn this could potentially have negative implications on GDP forecasts for 2013/14. However, the board suggested that the domestic economy was currently growing at trend and there were signs that the effects of earlier reductions in the cash rate were still working their way through the domestic economy. The expectations from domestic money markets remained relatively stable over the month of August with any expectation of rate cuts pushed out towards the end of This is consistent with board meeting minutes and hence any significant changes in swap rates would be a result of external influences affecting the growth outlook. In September the US Federal Reserve announced the third round of quantitative easing (QE3) in order to create ongoing, sustained improvement in the labour market. The Federal Reserve will expand its purchase of mortgage backed securities at an open ended rate of $40 billion per month on top of the existing operation twist which is expected to conclude in December This in turn created a selloff in longer dated treasuries and risk assets rallied. The 10Y and 30Y US Treasuries yield rose by around 30 and 40bps respectively. QE3 had minimal impact on the domestic government bond market, as the key driver for growth remains the outlook for bulk commodity prices. The domestic yield curve remains inverted at the front end as the short term outlook remains uncertain, but long term expectations for real growth improved as the yield on the 10Y government bond increased by 30bps to 3.34%. Copyright 2012 Morningstar Australasia Pty Ltd. All rights reserved. The information in this document is property of Morningstar. 7

8 Figure 6.1 AUD Swap Rates Annualised 4.25% 4.00% 3.75% 3.50% 3.25% 3.00% 2.75% 2.50% Source: Morningstar/Reuters Bank Bill Rate IR Swap (Fixed Leg) RBA Cash Rate 3.50% 1 year 3.14% 1 month 3.53% 2 year 3.11% 2 month 3.49% 3 year 3.16% 3 month 3.43% 4 year 3.37% 4 month 3.45% 5 year 3.48% 5 month 3.47% 7 year 3.71% 6 month 3.48% 10 year 3.95% Source: Reuters 7. Major Bank Income Securities Over the past 12 months we have seen an abundance of new issuance in the retail market for non-dilutive bank capital (Tier 1 and Tier 2 securities). So we thought it might be a worth exploring why these securities are appearing now. Over the past few years the domestic regulator (APRA) and the banking industry have been in discussions about the implementation of new global banking regulations (Basel III) in Australia. The discussions have gone through a number of iterations but as at 1 January 2013 banks will be legally required to meet the revised minimum capital ratios and (and adjustments). Why is this important? Each bank has a number of Tier 1 and Tier 2 instruments outstanding (both listed and unlisted) which must meet specific eligibility criteria to qualify at transitional capital. As there are a number of instruments that do not qualify under the new framework the banks have been raising replacement capital so as to optimise their capital base before the 1 January 2013 deadline. The key problem is that when issuing replacement capital the issuer must adhere to the new eligibility requirements which are strict and broadly untested in the already unstable wholesale debt market. Hence the reason why we have seen a flood of new issuance from banks over the past year. It should be noted that these securities are broadly cyclical and normally issued as part of a regulatory transition period and/or specific event. How does this affect investors? The nominal value of issuance continues to increase and as each new security must offer relative value to remain attractive. This has in turn created an artificial widening of credit spreads to accommodate the supply. We expect that credit spreads will remain under pressure over the short term in the lead up to the 1 January 2013 deadline after which time we expect credit spreads to normalise and new issuance to reduce. Copyright 2012 Morningstar Australasia Pty Ltd. All rights reserved. The information in this document is property of Morningstar. 8

9 Issue Size Years To Trading Running Yield Yield to Reset Code Recommendation Price($) Issuer ($m) Maturity Margin inc Fr ex Fr inc Fr ex Fr Dist ($) Ex Date ANZHA ACCUMULATE ANZ % 6.26% 6.26% 6.05% 6.05% /09/2012 ANZPA ACCUMULATE ANZ % 6.80% 4.76% 7.06% 4.99% /11/2012 ANZPB ACCUMULATE ANZ % 6.19% 4.33% 7.18% 5.27% /11/2012 ANZPC ACCUMULATE ANZ % 6.89% 4.82% 7.34% 5.24% /02/2013 CBAHA ACCUMULATE CBA % 4.65% 4.65% 5.20% 5.20% /09/2012 CBAPA ACCUMULATE CBA % 7.06% 4.94% 7.24% 4.94% /10/2012 CBAPB HOLD CBA % 4.59% 3.21% 9.85% 6.51% /10/2012 NABHA ACCUMULATE NAB % 7.21% 7.21% /10/2012 NABHB ACCUMULATE NAB % 6.28% 6.28% 6.08% 6.08% /09/2012 PCAPA ACCUMULATE CBA % 5.14% 3.60% 8.32% 6.70% /09/2012 WBCHA ACCUMULATE WBC % 6.31% 6.31% 6.21% 6.21% /11/2012 WBCPA ACCUMULATE WBC % 6.00% 4.20% 6.54% 4.76% /09/2012 WBCPB ACCUMULATE WBC % 7.30% 5.11% 6.35% 4.15% /09/2012 WBCPC ACCUMULATE WBC % 6.97% 4.88% 7.22% 5.13% /09/2012 WCTPA ACCUMULATE WBC % 5.18% 3.63% 8.63% 7.12% /09/2012 Figure 7.1 Major Bank Income Securities Trading Margins Source: Morningstar Copyright 2012 Morningstar Australasia Pty Ltd. All rights reserved. The information in this document is property of Morningstar. 9

10 Figure 7.2 Risk vs. Trading Margins Source: Morningstar 8. Other Floating-Rate Income Securities The activity on the listed income security market continued at a frantic pace over the past month with a number of new listings, announcements and resets all of which will impact the broader market over coming months. Issuance has hit more than $10 billion year to date with that number widely anticipated to increase to over $12 billion by year end. Issuers from various sectors and all around the country have been firming up their balance sheet with subordinated debt issues with long maturities and the ability to defer or cancel interest payments if things go sour. Although this downside protection is a positive for the issuer, it is not a typical feature of traditional fixed income investing. We believe that with conservative management practices these securities should perform in line with expectations but we err on the side of caution to those reaching for yield. We maintain a consistent and conservative methodology in making security recommendations and use a number of objective measures in the overall assessment of an issuer credit quality. However it is important to understand that credit quality can improve or deteriorate over time and hence the performance of a particular instrument will be a function of issuer quality and market stability. These securities are not a set and forget investment like a term deposit. They must be monitored to ensure stable credit quality and compliance with issue specific triggers. Copyright 2012 Morningstar Australasia Pty Ltd. All rights reserved. The information in this document is property of Morningstar. 10

11 Issue Size Years To Trading Running Yield Yield to Reset Dist Code Recommendation Price ($) Issuer ($m) Maturity Margin inc Fr ex Fr inc Fr ex Fr ($) Ex Date AGKHA ACCUMULATE AGK % 7.45% 7.45% 7.44% 7.44% /11/2012 BENPC HOLD BEN % 5.96% 4.17% 11.62% 9.88% /09/2012 BOQPC REDUCE BOQ % 6.25% 4.37% /09/2012 CNGHA ACCUMULATE CNG % 6.86% 6.86% 6.81% 6.81% /09/2012 CTXHA HOLD CTX % 8.10% 8.10% 7.93% 7.93% /12/2012 GMPPA HOLD GMG % 6.24% /09/2012 IAGPC HOLD IAG % 7.90% 5.53% 8.51% 5.90% /10/2012 IANG ACCUMULATE IAG % 7.68% 5.37% 7.69% 5.34% /12/2012 MBLHB ACCUMULATE MQG % 8.44% 8.44% /09/2012 NFNG ACCUMULATE NUF % 9.66% 9.66% /10/2012 ORGHA HOLD ORG % 7.61% 7.61% 7.46% 7.46% /09/2012 RHCPA HOLD RHC % 8.60% 6.02% /09/2012 SBKPB HOLD SUN % 6.90% 4.83% 8.52% 6.34% /11/2012 SVWPA ACCUMULATE SVW % 10.29% 7.20% /05/2012 TAHHA HOLD TAH % 7.72% 7.72% 6.12% 6.12% /10/2012 TAHHB HOLD TAH % 7.74% 7.74% 7.91% 7.91% /09/2012 TPAPA AVOID TPI % 11.98% 8.38% /09/2012 TTSHA ACCUMULATE TTS % 6.61% 6.61% 6.42% 6.42% /09/2012 WOWHC HOLD WOW % 6.64% 6.64% 5.97% 5.97% /11/2012 Figure 8.1 Floating Rate Income Securities Trading Margins Source: Morningstar Copyright 2012 Morningstar Australasia Pty Ltd. All rights reserved. The information in this document is property of Morningstar. 11

12 Figure 8.2 Risk vs. Trading Margins Source: Morningstar 9. Fixed-Rate Income Securities The universe for fixed rate securities is limited and not the focus for our coverage. There have been no recommendation changes in our fixed-rate hybrids coverage universe since our last report. MQCPA: On the 30 June 2013 Macquarie Group (MQG) can onsell MQCPA to a third party and thereby return $100 cash to security holders. If MQG does not sell/redeem these securities they mandatorily convert into MQG shares worth $101.01, subject to conditions the most important being that the VWAP of MQG ordinary shares 25 business days before conversion is above $ If conversion does not occur at that time then the conversion test is applied at each conversion date. Also if conversion does not occur then MQCPA will become a floating rate security paying fully franked distributions at a 3.50% margin above the 90-day BBSW. In the current market this margin does not look attractive when you consider that major bank issued mandatory convertibles are trading at margins as high as 3.7%. The Macquarie Bank issued security MBLHB is trading at a margin around 5.2%. HOLD. Years Issue Size To Trading Running Yield Yield to Reset Code Recommendation Price ($) Issuer ($m) Maturity Margin inc Fr ex Fr inc Fr ex Fr Dist ($) Ex Date MQCPA HOLD MQG % 11.58% 12.72% 12.72% /06/2012 Copyright 2012 Morningstar Australasia Pty Ltd. All rights reserved. The information in this document is property of Morningstar. 12

13 Figure 9.1 Fixed Rate Yields Source: Morningstar Figure 9.2 Fixed Rate Yields Fixed Rate Income Securities Risk vs. Yield Source: Morningstar Copyright 2012 Morningstar Australasia Pty Ltd. All rights reserved. The information in this document is property of Morningstar. 13

14 10. Glossary BBSW Conversion Conversion Discount Conversion Number Convexity Cumulative Dividend Yield Duration Exchange Face Value Gross Margin Market Rate Mandatory Conversion Net Reference Rate Reset Running Yield Step-up Tax Deferred Time to Maturity/Reset Trading Margin The Bank Bill Swap Rate (BBSW) is the average mid rate for Australian dollar bills of exchange accepted by an approved bank, having a tenor with a designated maturity, that appears on an approved information vendor s service (e.g., Reuters Screen BBSW page). Under certain circumstances, the hybrid security may be converted into a number of ordinary shares of the underlying stock at a specified conversion number, subject to terms, conditions and corporate events, including conversion discount, conversion date and triggers. A discount in percentage applied to the underlying stock price into which the hybrid security may be converted. Also referred to as exchange discount. The number of ordinary shares of the underlying stock into which the hybrid security may be able to convert. For certain hybrid securities, there may be a minimum and/or a maximum conversion number applied. The conversion number is generally calculated based on a formula: Conversion Number = Face Value / [VWAP х (1 Conversion Discount)] A measure for bonds used in conjunction with modified duration in order to measure how the bond's price will change as interest rates change. It is equal to the opposite of the second derivative of the bond's price relative to its yield, divided by its price. For example, since a non-callable bond's duration usually increases as interest rates decrease, its convexity is positive. Depending on the hybrid security, the dividend, distribution or coupon paid may or may not be cumulative. If the dividend, distribution or coupon is cumulative and if the issuer defers the payment of the dividend, distribution or coupon on any payment date, then additional dividend, distribution or coupon will accrue at the prevailing distribution rate. Expressed as a percentage, dividend yield is the company s annual dividend payments divided by its market cap, or the dividend per share divided by price per share. The change in the value of a fixed-income security that will result from a 1% change in interest rates. Duration is stated in years. For example, a five-year duration means the bond will decrease in value by 5% if interest rates rise 1% and will increase in value by 5% if interest rates fall 1%. Duration is a weighted measure of the length of time the bond will pay out. Exchange means the conversion, redemption, buy-back or cancellation of the hybrid security. The face value of the security is the issue price typically being $100 per security. Yield expressed, inclusive of any available franking credits or tax-deferred benefits. Expressed as a percentage per annum, the margin offered by the hybrid security over a reference rate. The initial margin is typically determined by a bidding process within a prescribed margin range known as bookbuild. For certain hybrid securities, the margin may be increased (refer to Step-up) at a predetermined date. See Reference Rate. Some securities include a mandatory conversion condition, which forces conversion if the underlying stock price is above some threshold level and the issuer chooses not to redeem the security for face value. Yield expressed, exclusive of any available franking credits or tax-deferred benefits. Typically a floating reference rate (e.g., 90-day BBSW) used to reference the periodic coupon payment of a hybrid security. The reference rate is generally applied at the beginning of a distribution period for the upcoming distribution. Also referred to as the market rate. For certain hybrid securities, on a reset date, the issuer may reset certain terms including the next reset date, the dividend/distribution rate, the conversion discount and the timing of frequency of dividend/distribution payments. Resets may mean significant change to the terms of the hybrid security and as a result investors may or may not accept such new terms. Further, the issuer may elect to redeem or to exchange the hybrid security. As such, Morningstar has a conservative approach to treating resets and considers it as a probable maturity. In tables and abbreviations, we use Reset to refer to any step-up, mandatory conversion, call or other pseudomaturity event. The hybrid's annual coupon payments expressed as a percentage of the market value of the security. For certain hybrid securities, the margin above the reference rate may be increased or stepped-up at a predetermined date upon the occurrence or non-occurrence of a certain event (e.g., non-conversion at a specified date). The distribution of certain hybrid securities may have a tax-deferred component (may be less than 100%), which allows the distributions to be tax deferred over a certain period. The tax-deferred distributions are not assessable to Australian income tax upon receipt for most investors, but instead reduce the cost base of the security for capital gains tax purposes and as a result defer tax until the disposal of the security. Securities offering a tax-deferred component may give rise to tax benefits. Changes to tax legislation may have the effect of reducing the taxdeferred component of distributions. Investors should seek professional taxation advice in relation to dealing in these securities and their individual situation. The time expressed in number of years from now to a reset date, conversion date, step-up date and/or maturity date, where on such date, either the terms of the security may change or the security may be repurchased, redeemed, exchanged or converted. In simple terms if an issuer already had securities on issue, they could expect any new securities with $100 face value to trade close to the trading margin. The Trading Margin of a security s is the effective margin at which s trades; it is the margin which a new security n with face value of $100 would need so the sum of the discounted cash flows of n equal the discounted cash flows of s assuming redemption of both s and n at the pseudo-maturity date of s. The calculation is grossed up for franking where appropriate. Copyright 2012 Morningstar Australasia Pty Ltd. All rights reserved. The information in this document is property of Morningstar. 14

15 VWAP Volatility Yield to Reset/Maturity (YTR/YTM) pcp p.a. Capex YoY HoH QoQ The average of the daily volume weighted average sale price of ordinary shares sold on ASX during the relevant period subject to specific terms and adjustments of the relevant hybrid security offer. The degree to which the price of a security tends to fluctuate. The hybrid's internal rate of return to reset, step-up or other pseudo-maturity event. previous corresponding period per annum Capital expenditure Year on Year Half on Half Quarter on Quarter Copyright 2012 Morningstar Australasia Pty Ltd. All rights reserved. The information in this document is property of Morningstar. 15