Let's start by looking at some low risk investments, for comparison:
NZ government stocks maturing on 15/04/2013 have a market yield of 6.02% p.a..
ANZ National Bank bonds maturing on 02/03/2012 have a market yield of 6.45% p.a.
Now let's look to some investments carrying a bit more risk:
BNZ Subordinated bonds maturing 15/06/2012 have a market yield of 6.5% p.a.
Marac (rated BB+) bonds maturing 15/07/2013 have a market yield of 10% p.a.
And now let's look at South Canterbury Finance (also rated BB+):
Bonds maturing 15/12/2012 have a market yield of 19% p.a. This is basically unchanged since before the credit rating was affirmed, and shows that only the brave are willing to invest in SCF, and that investors are not giving the company credit for having its BB+ rating affirmed.
Investors in Marac long term secured debt require a premium of about 4% p.a. to carry the risk that Marac, rated BB+ will default. Remember that a BB+ rating has an historical default rate of 0.68% p.a. If the loss given default is about 50%, the expected loss is therefore about 0.34% p.a. and a 4% p.a. risk premium is about 10 times the expected loss, which seems more than adequate compensation for the risk to me. Marac's problems appear to be sorted out with a massive recapitalisation and a balance sheet clean up, their risk level seems to me not far from investment grade, if not worthy of investment grade treatment.
Investors in South Canterbury Finance require a premium of about 13% p.a. which implies they treat it as not being in the same league as Marac.
6 comments:
This is a great return for the bonds, and I believe it far outwighs the slightly higher risk in SCF than other alternatives.
Why would anyone buy the prefs on a lower yield when they rank below the bonds?
This i nothing more than a market oddity and an opportunity for canny investors.
The preference shares have more upside, if the company recapitalises they could move up 60%+ from 50c to 80c or perhaps even back to to the issue price of $1. But they have more downside, too, if the company doesn't manage to get new capital faster than it makes new losses, preference shares could be totally wiped out.
Hi David,
>
> David Hillary said...
>
> The preference shares have more
> upside, if the
> company recapitalises they could
> move up 60%+ from 50c to 80c or
> perhaps even back to to
> the issue price of $1. But they
> have more downside, too, if the
> company doesn't manage to
> get new capital faster than
> it makes new losses, preference
> shares could be totally
> wiped out.
>
Okay - but the 'potential upside' argument could be applied to almost anything (all ordinary shares on the market in fact).
However, can you see any reason why someone holding the prefs would not sell out of (at least some of) them, and put the funds into the bonds?
The bonds have a higher yield and a lower risk, so in this one specific case, there is an 'arbitrage' opportunity (a free lunch perhaps!)?
.
The bond can only pay its yield till maturity, and only if the issuer does not default, so this limits the upside on investing in bonds if held to maturity.
The preference shares are like bonds with no fixed maturity, and therefore they are more sensitive to the discount rate. The situation of the company could change for the better or worse significantly within the next 12 months, so in that time they could be wiped out, or recover to near their issue price of $1.
Ordinary shares have no limit on the upside, but preference shares and bonds do not.
Of course the bonds are much lower risk than the preference shares, and even if the company fails, they should pay at least about 50c in the dollar. If the company fails during the guarantee period, the bonds could even get full repayment.
David,
Hubbard put $27.5m into SCF via Southbury in Jan 2010 I believe.
Does that have any impact (positive or negative) on the security of the bonds?
No, it wasn't Hubbard, it was outside investors who invested in $27.5m in convertible notes of Southbury Corporation, which in turn invested $27.5m in ordinary shares of South Canterbury Finance.
It does improve the position of debenture holders, bondholders, preference shareholders and the crown, compared to not having these additional funds in SCF, but as the amount is fairly small, this just keeps them going for a while, probably just offsetting losses since 30 June 2009, rather than actually improving its position.
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