ANZ’s new hybrid security

Co-founder of the Switzer Report
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After somewhat of a drought of new issues, the hybrid securities market has come to life with a new floating rate jumbo issue from the ANZ.

ANZ Capital Notes 2 follows up on the earlier ANZ Capital Notes issue (ANZPD), and other issues from the major banks, including Commonwealth Bank’s PERLS VI (ASX Code CBAPC), Westpac Capital Notes (WBCPD), NAB’s CPS I and CPS II (NABPA and NABPB) and Macquarie Capital Notes (MQGPA). These issues qualify as ‘Additional Tier 1 Capital’ under the Basel III rules and employ very similar structures.

Distributions

ANZ Capital Notes 2 will pay a semi-annual floating rate distribution, 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 3.25% to 3.40%.

With the 180-day bank bill rate around 2.67%, this implies a gross distribution rate of 5.92% pa for the first six months (2.67% plus 3.25%). The actual distribution in cash, which is fully franked, would then be 5.92% x (1 – Company Tax rate) = 5.92% x 0.70 = 4.14% pa.

The payment of any distribution is 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 mis-applied, if a distribution is not paid, ANZ is then restricted from paying a dividend on its ordinary shares.

Conversion into ANZ shares

ANZ Capital Notes are perpetual and have no term. However, ANZ must (subject to a test) convert the notes into ordinary shares on 22 March 2024 (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 $17.50, conversion occurs – otherwise, it is retested on the next and subsequent distribution date(s) until the test is met.

To qualify as Additional Tier 1 capital, there are two further mandatory conversion events – a ‘common equity trigger event’ and a ‘non-viability trigger event’. Under these tests, the Australian Prudential Regulatory Authority (APRA) can require ANZ to immediately convert the capital notes into ordinary shares if ANZ’s common equity tier 1 capital ratio falls below 5.125% (the ratio was 7.6% as at 31/12/13), or if it believes ANZ needs an injection of capital to remain viable. In such distressed circumstances, conversion would most likely result in a holder receiving considerably less than $100 of ANZ ordinary shares, as there is a cap on the maximum number of ordinary shares that can be issued.

ANZ also has a “once” only call option on 24 March 2022 (in about eight years), when it can elect to redeem the capital 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.

How does this issue stack up?

In terms of pricing, 3.25% is the going margin for these types of bank issues and trading prices on the ASX have quickly adjusted to the new supply. While spreads have been higher, they have come in over the last 12 months. An advantage of a primary issue is that it is much easier to acquire volume – buying hybrid securities on the ASX can be subject to the vagaries of a sometimes-illiquid market, and incurs brokerage.

In terms of how to categorise an investment in securities like ANZ capital notes, I suggest you include these within your asset allocation to fixed interest securities or bonds. As this is a floating rate security, it will suit an investor who expects interest rates to increase over the medium term. If you are expecting interest rates to decrease, look to acquire bonds or long-dated term deposits paying a fixed rate of interest, rather than a floating-rate note instrument liked ANZ Capital Notes 2.

ANZ capital notes, ANZ shares or an ANZ term deposit?

While the answer to this question is probably not ‘one’ or the ‘other’ (it may indeed be all three) and will depend on your asset allocation, the following table highlights the key differences between the investments.

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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