Review: A new high yielder from BOQ

Co-founder of the Switzer Report
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Regional financial institution Bank of Queensland (BOQ) has announced details of a new ‘hybrid’ securities issue that provides a floating rate of interest for a set period of time. The announcement came in a week when the Reserve Bank of Australia (RBA) implied that interest rates were on hold for the time being, and suggested that investors consider the sharemarket if they are seeking yield.

BOQ is issuing $200 million worth of Convertible Preference Shares (CPS), commonly called ‘hybrids’ because they mix elements of debt and equity. The funds are being used to effect the buyback of BOQ’s existing PEPS issue as well as fund the growth of the bank’s business. The funds will qualify as Tier 1 capital, which the regulator uses to measure the strength of a financial institution.

The details

The CPS will pay a fully franked semi-annual floating-rate dividend. The dividend 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 5.10% to 5.30%.

The 180 day bank-bill rate is around 3.20% and this implies a gross dividend rate of 8.30% per annum for the first six months (3.20% plus 5.10%). The actual dividend in cash, which is fully franked, would be 5.81%.

(8.30% x (1 – Company Tax rate) = 8.30% x 0.70 = 5.81% pa.)

While the CPS are perpetual, BOQ must convert the CPS into ordinary shares on 15 April 2020 (which is in 7.3 years), provided they meet a test. The test for the conversion is the price of BOQ ordinary shares at that time – the conversion will only occur if they are higher than about $4.20 – otherwise, it is retested on the next and subsequent dividend dates until the test is met. If the conversion occurs, holders are issued BOQ ordinary shares at a 1% discount to the then weighted average market price.

In order to qualify as Tier 1 capital for the bank, there are two further conversion triggers – a ‘capital trigger event’ and a ‘non-viability trigger event’. Under these tests, the Australian Prudential Regulation Authority (APRA) can require BOQ to immediately convert the CPS into ordinary shares if BOQ’s Common Equity Tier 1 Capital Ratio falls below 5.125% (the ratio was 8.6% as at 31/8/12), or if APRA believes BOQ needs an injection of capital to remain viable. Due to a cap on the maximum number of ordinary shares, a CPS holder could, under these scenarios, receive less than $100 of ordinary shares.

Dividend payments on the convertible preference shares are discretionary and subject to a ‘dividend payments test’. They don’t accrue if not paid, and won’t subsequently be paid. The main protection CPS holders have is that if a dividend is not paid, a dividend stopper is placed on BOQ ordinary shares.

BOQ also has a once-only call option on 15 April, 2018 (which is in about 5.3 years’ time), when it can redeem the CPS by paying holders the face value of $100.

The details of the issue are:

Our View

This issue is very similar in structure to the recent jumbo PERLS VI issue from the Commonwealth Bank, and issues by Bendigo and Suncorp. At an indicated margin of 5.1%, the BOQ issue is attractively priced compared with the PERLS VI issue (originally issued at a quarterly margin of 3.80% and now trading at a margin of 3.40%), and the smaller Bendigo issue (originally priced at a semi-annual margin of 5.0% and now trading at 4.89%). This reflects BOQ’s weaker credit rating; it is rated BBB+/Baa1 by S&P/Moody’s respectively, one/two notches lower than Bendigo, and four notches lower than Commonwealth Bank, which is rated AA-/AA2.

With 60% of its loan book based in Queensland (see chart below), BOQ is heavily exposed to the Queensland economy and in particular, residential and commercial property in south east Queensland.

When reporting the first loss by an Australian bank in over twenty years at the end of October, BOQ was able to point to a reduction in impaired assets in the second half and a fall in home loan arrears. That said, if property prices in Queensland come under material downward pressure, there has to be some chance that one of the mandatory early conversion triggers could be exercised.

On the positive side, a new and energised management team at BOQ is in place, and with its unique Owner/Manager branch model, BOQ has a differentiated distribution strategy.

Deposit growth is strong and retail deposits have risen from 51% of the funding mix in 2010 to 59% in 2012. BOQ’s capital (as measured by its Common Equity Tier 1 ratio) compares favourably to the major banks, and was strengthened earlier this year through a capital raising.

The bottom line

This is not an issue to ‘bet the house on’, however within a diversified portfolio of hybrid securities, a moderate investment may suit the yield seekers.

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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