Can you explain the workings of NAB Capital Notes 6 NABPI

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Question asked 11/06/2022

Can you explain the workings of NAB Capital Notes 6 NABPI

Hi James, I have read the info on the NAB website relating to NABPI. This hybrid was mentioned in the Monday newsletter. Does the (secondary) market value of capital notes (like NABPI) diminish when interest rates rise? Why would that be the case if they pay above the Bank Bill rate and BB seem to rise and fall pretty well in line with cash rates. Is it a sentiment thing, people will sell their capital notes when they think they can get better than 3.5% above the BB rates elsewhere (ie equities)? Not sure if this question makes sense... if it doesn't happy with a brief explanation of what moves the secondary market for these products. cheers Alain

Answer

Hi Alain,

A few reasons to explain this. When rates go up there are more alternatives that are lower risk in fixed income so instead of getting the higher return on offer, they maintain the return by going down the risk spectrum.
While rates going up increase the return on a hybrid, the margin as a proportion of the overall return declines. When the margin is 3% and bank bills are 0.10%, that’s a big uplift. When bank bills are 3% and the margin is 3%, the margin as a proportion of the total return in less.
As a general rule, I view Hybrids as expensive below a 3% margin and cheap nearer 4%. In the mid 3% range they are about fair value.

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