Value in OTC T2 and AT1
The ASX-listed hybrid market generally trades at a premium (i.e., lower yield) versus similar securities in the OTC market. However, we are currently seeing very large yield irregularities beyond what is normal in the OTC T2 and AT1 space − largely due to differentials in credit spreads on these securities versus the ASX-listed market. In our opinion, the best risk/return is in the OTC T2 space, and we have listed some major bank offers below.
The main reason is that the buyer base for OTC tends to be wholesale and institutional investors, while the ASX market tends to be dominated by retail investors − who tend to hold to the call date without a need to mark to market (MTM) their holdings. Wholesale and institutional investors care about their MTM exposure and so will sell due to economic/global factors, thus creating price weaknesses.
In the wholesale and institutional space, established relationships exist between the credit spread on bank bonds across different levels in the capital structure (senior debt, Tier 2 (T2), and Additional Tier 1 (AT1)). Senior debt generally trades at an average of 50%* of the credit spread of T2 with similar maturity, while T2 trades at an average of 70%* of the credit spread of AT1. These relationships reflect the relative risk in the capital structure, but also the structural features (i.e., AT1 securities are more “equity-like” than T2).
Using CBA’s listed AT1 security (CBAPK – issued March 2022) as the closest comparison to the new CBA T2 issue, we see that the credit margin on this security is 2.60%, with a first call in June 2029 (seven years to call). The credit margin of 2.60% looked to be the right level versus where T2 bank paper was sitting at the time. However, since the issuance of the CBAPKs, wholesale and institutional credit markets have sold off in line with other risk assets.
Consequently, the T2 bank market has widened around 0.50%, with 5-year T2 securities trading with a credit margin of c.2.10%. Using the historical relationships above, the CBAPK should be trading with a credit margin of above 3%.
However, the CBAPK’s have not traded significantly wider, with the current price of AUD100 implying a credit margin of c.2.80%. The valuation irregularity can also be seen with the NAB OTC AT1 bond with a July 2025 (three years to call) or four years shorter than the CBAPK. The NAB OTC AT1 bond is trading with a credit margin of c.3.10% and offers excellent relative value versus any of the ASX listed AT1s.
* Note: the credit spread represents the major item to the yield of a subordinated bank security.
|Major Bank AUD T2 Offers||Legal Maturity*||Level|
* First Call is 5 years