NEWS + VIEWS – 15/08/2025
MARKETS
Record highs on share markets are the order of the day despite being in the middle of a traditionally weak part of the year. Interest rate cuts have been built into expectations despite central banks being wary of tariff induced inflation rearing its head. Their biggest fear would be rising inflation combined with the current weakness in economies. The current domestic profit reporting season will be important for share market direction.
INTEREST-BEARING SECURITIES
As interest rates fall and bank hybrids are being phased out, there are alternative interest-bearing securities that give a reasonable return. The defensive and less volatile part of a portfolio generally consists of cash, term deposits, bank hybrids, and company/government bonds. Understanding the relative risks and returns between each type of security is important.
The chart below shows the order of priority or the order in which security holders get paid in a company liquidation. Typically, the higher on the chart, the more likely the investor will receive a return, the less risk the investment attracts and usually the less return an investor will receive.
Source: FIIG
Senior secured debt is the lowest risk and generally ranks higher than even employee entitlements. The debt has a charge over specific assets as security.
Bank deposits typically rank above other capital. In Australia, for a bank to take a deposit they must be an Authorised Deposit-Taking Institution (ADI) regulated by the Australian Prudential Regulation Authority (APRA). ADI deposits are guaranteed up to $250,000 by the Federal Government. The guarantee is applicable to individual accounts in different ADIs. Due to the priority of depositors over other capital (and the government guarantee), deposits are a very low risk form of investment, but they also attract a relatively low return.
Senior unsecured debt (or bond) is a loan to the company that attracts a fixed interest rate or a fixed base and a variable margin (e.g. Bank Bill Swap Rate plus a margin). Generally, they have a fixed date of repayment and if an interest payment is missed, it can be regarded as a default on the loan. The advantages are the higher priority in a wind up and the regular interest payments along with a set maturity date. Betashares Australian Bank Senior Floating Rate Bond ETF (QPON) holds Australian bank senior unsecured bank debt.
Subordinated debt is usually issued by banks and called after five years (albeit with a 10-year maturity date). APRA may instruct the bank not to call the debt if it is deemed to be having some financial difficulties. Not calling the debt at the five-year call date would severely affect the bank’s ability to raise debt in the future. Across developed countries, only one European bank has failed to meet the five-year first call date. Betashares Australian Major Bank Subordinated Debt ETF (BSUB) holds Australian bank subordinated debt.
Hybrids are deemed riskier than the types of debt above since the priority in a liquidation is behind other debt securities. They can be converted to equity if the bank experiences difficulty and are not converted on a dollar-for-dollar basis. Distributions can be deferred or even missed. APRA can instruct the bank to instigate those actions.
Equity (shares) is the riskiest capital type for an investor but the most likely to achieve higher returns and losses. There is no maturity date to repay an investment. Dividends may be paid but do fluctuate with the company’s fortunes. Some companies pay no dividends as they may need all their cash to reinvest in the company or have not made sufficient profit to make distributions. Australian companies tend to pay higher dividends than say US companies. The franking credits attached to company dividends are an encouragement for Australian companies to pay dividends.
ALTERNATIVES TO HYBRIDS
Hybrids are attractive to retail investors as relatively small parcels can be bought at a reasonable cost. The franked distributions are prized by investors, particularly those in pension phase. The relatively high return (or yield to maturity) of around 5 to 5.5% p.a. for a quite acceptable risk from major bank hybrids isn’t replicated in the broader bond market.
Chasing these types of returns elsewhere would require investing in higher risk products such as private credit or those funds with portfolios of higher risk securities. Non-bank hybrids (e.g. insurance companies) also offer higher returns but again involve higher risk.
Exchange Traded Funds (ETF) such as BSUB are probably the closest to a bank hybrid. As subordinated debt is one rung higher on the priority ladder, it theoretically attracts less risk but a slightly lower return (currently between 4.5% and 5%).
Senior unsecured debt ETFs are higher up the priority order (lower risk) but attract lower returns. For example, QPON is delivering a targeted return of around 4.5%.
Government bond ETFs are another alternative but to achieve returns approaching those of a hybrid, long terms to maturity are needed.
Term deposits and cash sit atop the capital stack and are thus low risk. However, the returns are also low. Term deposit rates have been falling with 12-month rates from Macquarie Bank attracting only 3.7% and six months 4.05%.
Hybrids will be available for a few more years although prices will probably get to a point where supply can’t meet investor demand. In addition to existing ETFs, it is expected that other type of issuances will eventuate as the cash previously in hybrids looks for a new home.
COMPANY PROFIT REPORTING SEASON
Commonwealth Bank (CBA) reported a solid result but not to the high expectations needed to support its share price. Westpac (WBC) turned that sentiment around with a quarterly update reporting a 14% rise in earnings, which resulted in a 6% rise in the share price. NAB and ANZ followed suit with a more moderate share price rebound but CBA eased a bit more.
Telstra (TLS) also delivered a solid result, just missing analyst forecasts. An on-market buyback and a 31% rise in profit wasn’t enough to maintain the share price as it fell by more than -2%.
Computershare (CPU) delivered a 3.5% rise in earnings and a higher dividend, but the share price fell.
It is a little early to draw any patterns in the earnings season so far except that any misses will be dealt with harshly. Perhaps even only meeting expectations is not enough to maintain the company’s share price.
Gerard O’Shaughnessy
P 0423 771 330
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