A reset security is one that will have its coupon (interest rate it pays) reset at a margin over the prevailing interest rate on the reset date. In NZ we have annual, three and five year reset securities. This is in contrast to a fixed rate security that has the same coupon until it matures.
These can be a useful investment option but, if not monitored, they can turn into an unattractive option depending on the timing and the state of the interest rate cycle.
Note that this article was updated 20 September 2016, prices and rates may have changed by the time you read it, the concepts will still be valid..
For example take the ASB Capital Limited Perpetual Preference securities (Stock exchange code - ASBPA). These reset in November every year. They are currently paying a coupon 4.00% and they are trading at about $0.764. This applies until November when the rate will be reset , probably a little lower (If reset today that would be 2.13% + 1.3 = 3.33%). These were issued by the ASB Bank in 2004 at $1.00..
To calculate your return on these securities you divide the coupon by the price. To be conservative we will assume they will reset at 3.33%. If you paid 76.4c your return for the next year would be about 4.36%. But you have to pay transaction costs - brokerage, to buy them. Again we'll be conservative and assume 1.5% brokerage - you should never pay more than that - so your cost is now about 77.6c and your return is 4.29% for the first year until they reset again. That may not sound very attractive but currently you'll only get 3.20% from the ASB on a 12 month term deposit.
Would you rather invest in a one year ASB term deposit at 3.20% (current advertised rate) or a ASBPA at 4.29%? Before you answer you should also consider the following.
Due to changes to the International rules that the banks are required to operate under since these were issued, these types of securities are potentially very expensive for the ASB Bank. So they might want to get rid of them. They can do so buy "redeeming" them, which means paying them back. Under the terms of the issue the first date at which they can do so this is in November 2018, just over two years away.
If ASB redeem the ASBPA securities they are required to pay back the original dollar, so if you own them on redemption date you'll get $1.00 back for something that you paid $0.776c for an extra 22.40%. As at 17 September 2019 Analysts at First New Zealand Capital estimate the yield to redemption on ASBPA at 17.2%.
You'd get interest in four quarterly payments over the first two years and you might get an extra 22.40% in November 2018 if ASB redeem ASBPA. If they don't you continue to receive interest at the new (admittedly probably lower) rate.
Based on the current market price the market is currently implying a 26% chance ASB will redeem these securities in November 2018. At Bay Financial Partners we believe the chances to be a lot higher.
ASB also have ASBPB securities on issue, they are similiar to ASBPA. A bit cheaper to buy, currently 70.8c and a lower reset margin so slightly lower chance of redemption, the market is say 21%. The estimated yield to redemption on ASBPB is 26.2%!
If you have money to invest you owe it to yourself and your loved ones to at least consider these and other similiar opportunities available.
At Bay Financial Partners we firmly believe that if you don't understand an investment you shouldn't make it. We understand some of the concepts aren't easy to grasp if you are unfamiliar with them so we are very happy to try and explain how these and other securities work and explain the risks as well as the return you might get.
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