Investors should not hold their breath for an income securities buyback

There has been renewed speculation in the past week about whether banks that have issued income securities over the years will buy them back.

Issues that remain outstanding include National Australia Bank, Macquarie Bank, Suncorp and Bendigo and Adelaide Bank income securities.


The question arises because income securities used to count as tier one capital,  but under the Basel III capital adequacy rules the income securities qualify only as transitional additional tier one capital.


Under the rules, their capital value has been amortising by ten per cent every year since 2013. So this year only 70 per cent of the face value of the securities will count as transitional additional tier one capital.


As the capital value of the notes steadily declines, the cost of the notes as capital will significantly increase.


For example, NAB issued income securities in 1999. The perpetual instrument pays a non-deferrable coupon of 1.25 per cent over the 90-day bank bill rate. The effective cost of the margin over bank bills that NAB is paying on its income securities is now almost 1.8 per cent, if these notes are viewed as capital.


Income securities have not been a stellar investment for the buyers, and if any original holders are left, they will certainly be hoping for an eventual redemption. The price of the securities started drifting down as soon as the meaning of perpetual sunk in.

The price of the NAB income securities, which have a face value of A$100 (as do the others), approached $60 during the financial crisis and has alternated between $60 and the mid-$70s since then.

While the income securities still have value as transitional additional tier one capital, there would seem little point in buying them back. Even at an effective margin of 1.8 per cent over the bank bill rate this is very cheap compared with the four per cent-plus that the market would demand for any additional tier one capital issued now.



The amortised capital value of the notes would have to fall to 30 per cent before the effective cost of the margin on the NAB income securities would reach the level currently demanded for additional tier one capital.

However, this is perhaps an overly simplistic analysis and it also misses a critical point.



It does not matter if income securities qualify as transitional additional tier one capital or not. They are just one component in the funding mix of debt and equity for each of the issuers and all that is going to happen is that the classification of the notes will progressively move from capital to debt.



Suncorp pays a spread of just 75 basis points over 90 day bank bills on its income securities, Macquarie Bank pays a spread of 170 bps, with Bendigo and Adelaide Bank and NAB in between. If nothing else the income securities are very cheap perpetual debt.   



A buyback of the income securities would seem to be quite some way off.