ANZ capital notes – a hybrid worth considering?

Co-founder of the Switzer Report
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ANZ is the latest borrower to tap the hybrid securities market, with an issue of $750 million of ANZ Capital Notes.

Structurally, the issue is similar to other recent raisings in the hybrid market from the major banks – Commonwealth Bank’s PERLS VI (ASX Code CBAPC), Westpac Capital Notes (WBCPD), NAB Convertible Preference Shares (NABPA) and Macquarie Capital Notes (MQGPA).  Like these earlier issues, the funds ANZ is raising will qualify as Additional Tier 1 capital.

Interestingly, the issue is a couple of years longer in term – the expected mandatory conversion date is 10 years out (rather than seven or eight years), and the issuer’s optional redemption date is eight years out (rather than five or six years).

Distributions

ANZ Capital Notes will pay a floating rate distribution half yearly, which is expected to be fully franked. The distribution is set every six months at a fixed margin over the 180-day bank bill rate, and then adjusted for the company tax rate (to take into account the franking credit benefits). The indicative margin for this issue is in the range of 3.40% to 3.60%.

With the 180-day bank bill rate around 2.80%, this implies a gross distribution rate of 6.20% per annum for the first six months (2.80% plus 3.40%). The actual distribution in cash, which is fully franked, would then be 6.20% x (1 – Company Tax rate) = 6.20% x 0.70 = 4.34% per annum.

These notes are effectively a form of capital for the ANZ, and the payment of any distribution is absolutely discretionary and subject to no ‘payment condition’ existing. If a distribution is not paid, it doesn’t accrue and won’t subsequently be paid. To protect note holders from this discretion being misapplied, if a distribution is not paid, ANZ is then restricted from paying a dividend on its ordinary shares (‘dividend stopper’).

Conversion into ANZ shares

While these notes are perpetual and have no term, ANZ must (subject to a test) convert the notes into ordinary shares on 1 September 2023 (in about 10 years). If conversion occurs, holders are issued ANZ ordinary shares at a 1% discount to the then weighted average market price. The test for the conversion is the price of ANZ ordinary shares at the time – provided they are higher than approximately $15.60, then the conversion occurs – otherwise, it is retested on the next and subsequent distribution dates until the test is met.

To qualify as Additional Tier 1 capital, there are two further conversion triggers – a ‘common equity capital trigger event’ and a ‘non-viability trigger event’. Under these tests, the Australian Prudential Regulatory Authority (APRA) can require ANZ to immediately convert the notes into ordinary shares if ANZ’s capital ratio falls below 5.125% (the ratio was 8.20% as at 31/3/13), or if it believes ANZ needs an injection of capital to remain viable. Due to a cap on the maximum number of ordinary shares that are issued upon conversion, a note holder could, under these scenarios, receive less than $100 of ordinary shares.

ANZ also has a “once” only call option on 1 September, 2021 (in about eight years), when it can elect to redeem the notes by paying holders the face value of $100 or converting the notes into ANZ ordinary shares.

Details of the issue are as follows:

The institutional book build on Tuesday will set the final margin.

Our view

Questions over whether the US Federal Reserve may taper their bond buying program has led to a steepening of the yield curve and an increase in wholesale credit margins (the margins banks and others pay to borrow monies from offshore institutions). Reflecting this, trading spreads on hybrid issues in the secondary market on the ASX have also increased. For example, the WBCPD and NABPA issues, which were issued earlier this year and pay a distribution margin of 3.2% per annum over the 90-day bank bill, are both now trading at a margin of around 3.4%.

Compared to a term deposit, 6.2% per annum (gross) on this security stacks up favourably to the best current major bank six month term deposit rate of 3.75%, and the best other bank rate (UBank) of 4.4%. So, if you are developing a portfolio of hybrid securities and are prepared to take on the additional risk of investing in hybrids, this issue may suit.

That said, if the final margin is set at the lower end of 3.4%, it is no real bargain compared to the secondary market issues. With a further issue from Westpac rumoured to be on the cards, and ANZ expected to satisfy surplus demand in the primary offer, it is unlikely that the issue will trade at much of a premium (if any) when listed on the ASX.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

 

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