Hybrids market grows rapidly

FROM a standing start less than two years ago, hybrid securities have become a highly popular investment product.

A review of “Aussie Hybrids” by Moody’s Investors Service said that $7 billion of listed hybrid securities had been raised since mid-1999. The current $700 million offer of Commonwealth Bank PERLS (Preferred Exchangeable Resettable Listed Shares) will add to that total.

While the market has grown rapidly, it has also attracted plenty of controversy. New entrants to the market, such as Coles Myer and the Commonwealth Bank, believe they have learnt from the past and that the new style of hybrids have a bright future.

The term hybrid reflects the nature of these securities – they are listed on the ASX and have some characteristics of shares, but they also have characteristics of bonds.

They fall into two broad categories – income securities and reset convertible preference shares, and within each category there is a range of products.

Hartley Poynton’s Brett Anderson believes the key attraction of hybrids is their high

“They mostly appeal to investors seeking a good income, especially where the dividends are fully franked,” he said.

Mr Anderson cautioned that, unlike traditional shares, hybrids offered little scope for capital growth.

The market was kicked off in Australia by National Australia Bank, which attracted keen demand when it offered $2 billion of income securities in 1999.

Key features of income securities are that the income is in the form of unfranked interest payments, and they are perpetual. That is, they have no maturity date. The latter feature has turned off many investors and, in most cases, income securities have traded well below their issue price.

The Moody’s review noted that Woolworths’ income securities were an exception, trading close to par value. Moody’s saw this as an example of retail investors being driven by sentiment, buying the securities “based on their knowledge of Woolworths and its strong position in the domestic retail market”.

“A recent draft ruling by the Tax Office, which cast doubt on the ability of issuers of income securities to claim interest payments as a tax deduction, has created more uncertainty,” Mr Anderson said.

The new generation of hybrids, such as Coles Myer’s ReCAPS, are similar to converting preference shares. They give the holder the option of converting their hybrid security into ordinary shares, normally after five years. Alternatively, the holder can roll over the security and continue to receive the specified dividend payments. In the case of ReCAPS, the dividend is currently fixed at 6.5 per cent p/a fully franked although Coles has the right to “reset” the dividend in future.

Commonwealth Bank’s PERLS, have two distinguishing features. First, the fully-franked dividend is linked to the 90-day bank bill rate rather than being fixed. Therefore it will fluctuate in line with market rates. The initial quarterly dividend will be 5.6 per cent p/a fully franked. Second, the PERLS can be converted into either ordinary Commonwealth Bank shares or cash. This will be at the discretion of the bank.

Bryan Davies, of Salomon Smith Barney, the joint lead manager of the PERLS offer, said he anticipated that the Commonwealth would reset the terms so that investors had a good incentive to hold the PERLS long term.

n Mark Beyer can be contacted at mbeyer@vianet.net.au