What are hybrids?
Hybrids are a broad classification for a group of securities, used by a range of corporations to raise money, that combine both debt and equity characteristics. They are usually higher risk investments than other fixed income securities due to their subordination in the capital structure, but generally lower risk than shares (equities), see the figure below. Other characteristics include:
Hybrids pay a predetermined (fixed or floating) rate of return or dividend until a certain date. At that date the holder may have a number of options including converting the securities into the underlying ordinary share of the issuer
Therefore, unlike a share the holder has a 'known' cash flow and, unlike a fixed interest security, there is an option held by the issuer to convert to the underlying equity
Hybrid securities have a wide variety of maturities, structures and varying liquidity as well as issuers across the credit rating spectrum. Since every hybrid is structured differently this allows more flexibility, but makes analysis and comparison more difficult
Hybrids usually offer higher returns than those offered by more senior assets in the capital structure such as senior and subordinated debt.
In Australia, the major banks are large issuers of these types of securities. Hybrid securities keep evolving. There are five types of hybrids securities currently available, which are outlined below.
1. Income Notes and Securities are true perpetual securities, that is, they have no maturity date or a very long maturity. These securities usually pay floating rate coupons and while the issuer normally has the option to call (i.e., redeem them for their face value) on any payment date it is unlikely they will ever be redeemed.
2. Income Notes and Securities examples: Bendigo Bank (BENHB), Macquarie Group (MBLHB), National Australia Bank (NABHA) and Suncorp Metway (SUNHB).
3. Reset Preference Shares are typically fixed rate preference shares where the coupon is set for a defined term, normally five years. At the end of the five year period, the preference shares are remarketed where they are either redeemed or a new fixed coupon rate is set. They are technically perpetual in nature.
4. Reset Preference Shares include: Bendigo Bank RPS (BENPA), Bank of Queensland (BOQPA), IAG Reset Preference Shares 1 (IAGPA and, Suncorp Metway RPS (SUNPA).
5. Converting Preference Shares are preference shares that convert into the ordinary shares of the issuer after a defined period of time assuming certain conditions occur. Most converting preference shares offer the option for the issuer to redeem them for cash, however equity conversion is usually the default option. They are technically perpetual in nature.
6. Converting Preference Share include: ANZ (ANZPA & ANZPB), Westpac (WBCPA & WBCPB) and Commonwealth Bank PERLS 4 & 5 (CBAPB & CBAPA).
7. Step up Preference Shares are the most common type of corporate hybrid. These preference shares normally pay a floating rate coupon and have a call date after a set period, normally five years. If these securities aren't called at the first call date, then the coupons 'step up' to a higher rate to compensate investors for non-redemption. They are technically perpetual in nature.
8. Step up Preference Share include: Elders SPS (ELDPA), Fairfax SPS (FXJPB), Goodman Plus (GMPPA), Orica SPS (ORIPB) and Woolworth's Notes (WOWHB).
9. Stepped up Preference Shares are step up preference shares that have already passed the step up date and pay a higher coupon over and above the original coupon. They are perpetual in nature although the issuer has the option to call the securities on any future coupon payment date.
10. Stepped up Preference Share include: Australand Assets Trust (AAZPB) and Gunns Limited (GNSPA).