As a long-term investor it is more important to buy at attractive levels and hold to maturity than to accurately time short term market movements. The graph below (courtesy of Westpac and Bloomberg) shows on a historical basis if 5 year Major Bank FRNs can be purchased when credit spreads are at or above 100bps this represents excellent value on a long-term basis. A margin of 100bps is a level not seen since early 2019 (excepting the rapid fall in markets in March 2020 when it was difficult to purchase any stock as there was no new issuance).
In addition to the apparent value, there are also some additional compelling reasons to purchase when these offers become available being:
Buying an FRN largely locks in performance over the benchmark bank bill index by the margin above BBSW at which the FRN is purchased. This is obviously premised on the Major Bank not defaulting and the FRN not being sold prior to maturity; both of which are reasonably safe assumptions for most buy and hold investors. This is potentially important for investors who measure their performance against the bank bill index given the index is rising rapidly as per our recently published article.
FRNs carry minimal interest rate risk with the coupon adjusting to prevailing market rates as interest rates rise and fall. This may be particularly appealing at this point in the interest rate cycle where interest rates are almost certainly going to rise in the short term, but after that there is a great deal of uncertainty as to how high they may rise or even if they will subsequently need to be reduced if inflation is brought under-control but in doing so a recession is induced.
FRNs are tradeable and are therefore are a source of liquidity. In a practical sense the “liquidity value” of any security is enhanced if it can be sold without loss (or even for a small profit). The chance of this occurring is increased if it has a high coupon margin as there is greater scope for the market trading margin to fall below the coupon margin through time (meaning the trading price rises above par). This is in addition to the normal “roll down” effect where the trading margin reduces through time due to the shortening maturity of the security.
