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Huge Credit Margins – an investment opportunity or not?

Equity markets volatility over recent months has crossed into bond markets with a ‘blowout’ in credit margins and significantly higher yields in both ASX listed and unlisted interest rate securities. Is this an opportunity for investors or should they stay on the sidelines?

The most recent Tier 1 hybrid issues by the four major banks are trading  at an average margin over the interest rate swap curve of 5.13% which equates to an average yield to maturity (YTM) of 7.55% over 6 years.  This compares to a margin three months ago of 4.6% over and yield of  7.0%.

Clearly there is a correlation between the sell-off in  hybrids and that of the 4 major banks shares and uncertainty in world credit markets hasn’t helped either.  Our general view is these margins and yields generally represent an opportunity for investors as these securities rank above ordinary equity in the capital structure and  represent a credible alternative to investing in an uncertain share market .

The risks to a further ‘blowout’ in margins in 2016 are:

  1. further weakness in bank shares; and
  2. predicted large issuance in Tier 1 hybrids again

The latter of course depends on whether the banks desire to issue these securities well and truly above 7% exists or not.

The question again in 2016 is whether to stay in term deposits  (2.5-3.0%), try your hand up the risk scale in hybrid securities (5.5-7.5%) or have another crack at bank shares ‘hoping like hell’ you don’t dust another 15-20% of your capital.

At BondAdviser we recognise the need to educate our clients on the various levels of  credit risk that can be offered to them  particularly in the banks capital structure. We also monitor the trends in credit risk and the prevailing demand and supply for securities.

Trading Margin

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