ANZ, Westpac and Colonial launch hybrid issues into the retail market

The market is crowded with hybrid bank issues, following Westpac's launch last week of an issue of convertible preference shares. ANZ and Colonial launched subordinated note issues earlier in the week.

Westpac is seeking a minimum of A$750 million. The preference shares should be priced at the higher end of the 320 to 350 basis points range for the margin applied to the bank bill rate to determine the dividend paid.

ANZ launched an issue of subordinated notes, seeking a minimum of $500 million and the Commonwealth Bank subsidiary Colonial Holding Co launched an issue of subordinated notes, also seeking to raise a minimum of $500 million.

The structure of Westpac's converting preference shares is very similar to ANZ's CPS3 issue completed last September. The Westpac CPS feature deferrable and non-cumulative dividends, and there is also the APRA-imposed common equity conversion trigger that could result in a capital loss to investors.

The Australian Prudential Regulation Authority now requires all Tier 1 capital raised by banks to be capable of absorbing losses. The Westpac CPS qualify as non-innovative, residual Tier 1 capital.

The "compensation" for investors taking this risk is the additional margin that will be used to determine the dividend to be paid. ANZ's CPS3 have a margin of 310 basis points.

However, credit spreads in bond markets have widened considerably since September, and, it must be said, the margin being offered by Westpac does not reflect this, especially given the considerable risk involved.

The non-cumulative dividends will be franked if Westpac has sufficient franking credits or, if not, will be grossed-up to reflect the benefit of franking. But the dividends will only be paid if the directors determine, at their discretion, that a dividend is payable and that the amount to be paid does not exceed distributable profits, and it is approved by APRA.

If a dividend is not paid, then Westpac is prohibited from paying a dividend on its ordinary shares or buying back its ordinary shares. That this restriction applies only to Westpac's ordinary shares, shows how lowly ranked the CPS are in the bank's capital structure.

CPS are deeply subordinated securities.

The perpetual CPS will be listed on the Australian Securities Exchange. If the CPS are not eventually converted into Westpac ordinary shares, transferred or redeemed, the ASX listing will allow investors to retrieve their capital.

However, if it comes to that, they can be assured of a capital loss – just look at the current value of the various income securities issued by the banks in the late 1990s.

Nevertheless, there are reasonable prospects for the CPS being converted into Westpac ordinary shares within a relatively short period of time. The scheduled conversion date is the end of March 2020 and there is also an early conversion date at the end of March 2018.

But conversion will only occur if the conversion conditions are met, and, in the case of the early conversion date, only if APRA approves. Investors are warned not to expect approval from APRA.

For the conversion conditions to be satisfied, Westpac's share price must not have fallen to 56 per cent, or less, of its value at the time of issuing the CPS, when it is 20 days away from the conversion date. In addition, Westpac's share price must not have fallen to 50.5 per cent or below on the conversion date.

These conditions must be met for conversion to take place. Hence the CPS are perpetual.

As for the mandatory common equity conversion trigger, this will come into effect should Westpac's core Tier 1 equity ratio fall to 5.125 per cent - the same as for ANZ's CPS3. Investors will receive no more than the maximum number of ordinary shares they would have received under a scheduled or early conversion.

At such a point, investors can expect a capital loss, as the share price is likely to have fallen below 50.5 per cent of what it was at the time the CPS were issued.

Colonial subordinated notes will make a minmum 7.5 per cent first payment

Colonial Holding Co. is the holding company for Colonial Group, a wealth management and insurance business owned by Commonwealth Bank.

Colonial Holding aims to raise A$500 million through an offer to retail and institutional investors.

The floating rate securities will pay a margin over the 90-day bank bill rate. That margin will be set through an institutional book-build.

The indicative range is understood to be between 3.25 per cent and 3.75 per cent.

The offer includes a guaranteed minimum first-quarter interest payment of 7.5 per cent.

The term is 25 years, although the issuer may redeem early. The securities will be listed on the Australian Securities Exchange.

ANZ offer initial yield in excess of seven per cent

ANZ's subordinated note issue yesterday that is expected to pay an initial yield in excess of seven per cent.

The notes, which will be listed on the Australian Securities Exchange, will have a maturity date of June 2022, although ANZ may redeem them in June 2017. Redemption will be in cash.

ANZ will not have discretion to withhold interest (unless it is insolvent).

The notes will have a floating rate. The bank expects to pay a margin of 2.75 to three per cent over the bank bill rate, calculated on a quarterly basis.

The notes will also be offered to institutional investors.

The notes will not be protected under the Financial Claims Scheme. They will rank higher than the bank’s perpetual convertible preference shares, CP3.