Roy Keenan, Head of Australian Fixed Income, looks at Yarra Capital Management’s experience investing in the National Income Securities.
News from the National Australia Bank (NAB) last month that it proposes seeking shareholder approval to repurchase its perpetual National Income Securities (ASX: NABHA) in 2021 was the culmination of an 8-year odyssey which has delivered outstanding performance for our investors.
Pleasingly, the investment grade (IG) BBB-rated perpetual has delivered equity-like returns for credit risk across those of our portfolios that hold it. Back in 2012, our thesis was predicated on the view that new bank capital rules would, in time, incentivise NAB to call the NABHAs. Its effective maturity and credit quality have consistently been mispriced, with our view on the changing regulatory landscape central to understanding the potential for outsized returns. Incredibly, even as late as March 2020, the yield to a call in 2021 still ranged between 20-40% (refer Chart 1).
Back in late 2011 the transitional rules from Basel II to Basel III were announced, meaning old Basel II styled securities (e.g. NABHA) would lose their contribution to Tier 1 capital over time, eventually contributing zero from Jan 2022. And post this date, distributions on NABHAs would have to be franked for the first time. Faced with holding expensive debt that will contribute nothing to Tier 1 capital, the case for NAB to redeem is clear.
NABHA is also more debt-like than many investors realise, with no documented capital or non-viability trigger to convert into ordinary shares (unlike Basel III Tier 1). And in the unlikely scenario where APRA required banks to utilise loss-absorbing capital, NABHA would effectively float up the capital structure to rank just behind senior debt. Despite these abundant creditor protections, NABHA’s fell below $70 at the peak of the COVID sell-off (refer Chart 2). Buyers at that time like us – who will receive $100 when the securities are called – will do phenomenally well.
For at least the past eight years – some might say longer – NABHA’s pricing has failed to reflect the full value of its creditworthiness or the probability of being called. This is despite Macquarie Bank calling its near identical MBLHB on 15 April 2020. Understanding NABHA’s terms has delivered equity-like returns from investment grade credit risk. In fact, since first investing back in 2012 in the $65-70 range, returns on the NABHA securities have meaningfully outperformed NAB’s equity (refer Chart 3).
We continue to scour Australia’s large, multi-sector credit universe and identify compelling mispriced securities. We have recently added to holdings in COVID-impacted sectors (e.g. A-REITs) which are well placed to continue outperforming as conditions normalise.