The Liberty credit curve appears to offer standalone value, as well as substantial relative value to the major bank credit curve. Liberty FRN credit margins appear to have reached the top of their historical range and currently offer a substantial pick-up to equivalent major bank senior unsecured securities. Moreover, there is considerable relative value switching from short-dated major bank subordinated paper to the longer-dated nonbank senior unsecured paper. Whilst moving from major bank T2 to Liberty senior increases credit risk, structurally investors move up the capital structure (removing call risk and equity characteristics of T2) and pick-up margin returns of 1.5x to 2.00x, depending on the call date. Furthermore, a credit margin increase of ~ 3.75x for Liberty senior versus major bank senior appears fair compensation.
IAM Credit View:
Liberty Financial Group (ASX: LFG, market cap $1.27b)
In our view, Liberty remains an improving credit in the BBB space, and we expect it to be upgraded within the next 12 months. S&P placed Liberty’s outlook on positive in April 2021. The positive outlook reflects a one-in-three chance of upgrade if S&P’s view on Australian financial institutions industry risks decrease in the next two years. Following yesterday’s results, S&P stated that they expect Liberty to continue to manage capital above 15% under S&P’s risk-adjusted capital framework.
One positive for bondholders is that Liberty bonds are issued from the OpCo and not the HoldCo. While Liberty does utilise secured warehouses in its funding base, the OpCo structure is generally preferred for credit investors. Liberty established eight new funding vehicles in FY21 raising A$4.9bn in new liquidity. As a credit investor, it’s always better to have direct access to the assets of the company’s major operating subsidiaries (OpCo) rather than being at the holding company (HoldCo). In a default scenario, if you’re at the OpCo, you’ll effectively be lining up at the front of a que to receive you’re cash back from the sale of assets. On the contrary, if you’re at the HoldCo, you’ll effectively receive the residual, which may in extreme scenario’s be quite limited.
At the time of issue (04/2022), the 5-year credit margin differential for the Liberty 04/2027 FRN versus ANZ 05/2027 FRN was 213bps. Today it is approximately 263bps. Hence, the pick-up from major bank FRNs to Liberty has increased by ~ 50bps.
At the same time, the underperformance in the margin differential is set against a backdrop of the Australian Itraxx credit index (a proxy for macro investment grade credit margins), roundtripping from ~+100bps to a high of 140bps in early July, before falling back to ~ +100bps today. Given the recent stabilisation of broader domestic credit markets, one would expect a tightening of the differential and therefore relative outperformance of the Liberty curve versus major banks in the near term.