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Perpetual investors can bank on Basel III news

September 15, 2010

Perpetual investors can bank on Basel III news

15 September, 2010

The recent Basel III global capital requirements have created an opportunity to invest in an endangered species of high yielding hybrid debt before it goes extinct.  Coupled with the recent Christchurch earthquake and inevitable deployment of South Canterbury Finance funds, we feel that the following bonds may be the fixed income trades of the year:

NZ Fixed Income YTM/Reset Maturity Date Reset Date
ANBHA 8.6% Perpetual April 2013 & 2018
BISHA 8.6% Perpetual March 2013 & 2018
CASHA 16% Perpetual December 2012
WKS 010 18% 2 yrs June 2012


Basel III global capital changes: Most of the perpetual shares have been classified as hybrid debt, meaning they are not quite equity and not quite debt, but have always been considered Tier 1 Equity for the banks issuing them.  The implications of the Basel III global capital requirements have created a situation which will no longer allow banks to classify perpetual/hybrid debt with calls and step up features as Tier 1 Capital Equity.

The new rules will alter the underlying structure of bank equity and we feel banks will stop producing hybrid debt, therefore placing a cap on these instruments.  As pure debt it will be extremely expensive to have out on issue and banks will use the first opportunity to buy the hybrids back.  We predict this redemption to be the closest reset date for each perpetual share, which for most is between 2012 and 2013.


The Christchurch Crisis: We believe the New Zealand government will issue short term treasury bills with less than 12 month duration to help fund the capital costs for rebuilding the city.  One of the impacts of this will be a change in the shape of the yield curve when New Zealand banks switch out of 2-3 year government bonds.  As this occurs, we predict that 2012 and 2013 bonds will fall in price and rise in yield, which will likely result in higher coupon resets for eligible hybrid debt.  Whilst WKS 010 are not hybrid bank debt, they will be positively impacted by the change in the yield curve when reset in 2012.

Logic Recommendation: Buy big bank hybrid debt with 2012-2013 rate resets, step-ups and calls.  Take advantage of the current forced selling in WKS 010.

Disclaimer:

The information and any opinions herein are based upon sources believed reliable, but Logic Fund Management and its directors make no representations as to its accuracy or completeness.  All opinions reflect our judgment on the date of this report and are subject to change without notice.  The information contained in this publication should not be used as a basis for making an investment decision about any particular company. Professional investment advice should be taken before making an investment.  Past performance is not a reliable guide to future performance.  Disclosure statements available upon request.

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