Key points

• Westpac Capital Notes 3 will pay a quarterly distribution, expected to be fully franked.
• The distribution is set every three months at a fixed margin of 4.0% over the 90-day bank bill rate, and then adjusted for the company tax rate (to take into account the franking credit benefits).
• Westpac shareholders and security holders can apply for Westpac Capital Notes ($100 per security, minimum application $5,000) directly from Westpac when the offer opens next Monday. If applying through a broker firm offer, remember that your adviser, or their firm, is being paid a placement fee of 1.0% of your investment.

Margins on bank hybrid securities have hit record highs, with Westpac launching a new issue that is offering to pay a margin of 4.0% over the 90-day bank bill. Effectively, this means an initial return of 6.15% per annum for the first 90 days.

Westpac has launched the third series of its Capital Notes. To be listed on the ASX under stock code WBCPF, the offer is due to open next Monday. Westpac is seeking to raise at least $750 million, which it will classify as ‘Additional Tier 1 Capital’.

Hybrid securities have had a pretty rough trot over the last few months, as buyers remained on the sidelines and effective yields moved out in response to higher yields on bank ordinary shares. Towards the end of June, the effective yield on the benchmark PERLS VII issue from the CBA (CBAPD) traded as low as $90.50, an effective yield of over 4.5% (it was originally issued at a fixed margin of 2.8%). This has now moved higher in price, and at $93.50, is trading at an effective margin of just a fraction over 4.0%.

The Westpac Capital Notes are a little shorter than CBAPD, with an expected call date in only 5.5 years. So the issue margin of 4.0% is on the money in regard to the secondary market.

In the medium term, the work of the regulator (the Australian Prudential Regulation Authority) to strengthen the banks’ capital ratios is a positive for hybrid investors. While the fear of capital raisings has sent yields on bank ordinary shares higher, this is ultimately a positive for hybrid investors as it means that it is less likely that the capital trigger events on these securities will ever be fired.

Westpac shareholders and security holders can apply for Westpac Capital Notes ($100 per security, minimum application $5,000) directly from Westpac when the offer opens next Monday. There is also a broker firm offer (available through CommSec, Morgans, UBS and many financial planners and advisers), however if applying through this offer, remember that your adviser, or their firm, is being paid a placement fee of 1.0% of your investment and that they therefore have an incentive to show you this offer.

Set out below are the key features of the Westpac Capital Notes. However as always, please review the Product Disclosure Statement before investing.

Westpac Capital Notes 3

These securities will pay a quarterly distribution, which is expected to be fully franked. The distribution is set every three months at a fixed margin of 4.0% over the 90-day bank bill rate, and then adjusted for the company tax rate (to take into account the franking credit benefits).

With the 90-day bank bill rate around 2.15%, this implies a gross distribution rate of 6.15% per annum for the first three months (2.15% plus 4.0%). The actual distribution in cash, which is fully franked, would then be 4.305% (6.15% x 0.70 = 4.305%).

Distributions are discretionary and subject to distribution payment conditions. 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, Westpac is then restricted from paying a dividend on its ordinary shares.

Conversion into Westpac shares

Westpac Capital Notes are perpetual and have no term. However, Westpac must (subject to a test) convert the Notes into ordinary shares on 22 March 2023 (in about 7.5 years). If conversion occurs, holders are issued Westpac ordinary shares at a 1% discount to the then weighted average market price. The test for the conversion is the price of Westpac ordinary shares at the time – provided they are higher than approximately $19.00, 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 ‘capital trigger event’ and a ‘non-viability trigger event’. Under these tests, the Australian Prudential Regulatory Authority (APRA) can require Westpac to immediately convert the Capital Notes into ordinary shares if Westpac’s Common Equity Tier 1 Capital Ratio falls below 5.125% (the ratio was 8.72% on 31/3/15 or 8.5% on a pro forma basis following the changes announced by APRA to risk weights for residential mortgages), or if it believes Westpac needs an injection of capital to remain viable. In these distressed circumstances, conversion would most likely result in a holder receiving considerably less than $100 of Westpac ordinary shares, as there is a cap on the maximum number of ordinary shares that can be issued.

Westpac also has a “once” only call option on 22 March 2021 (in about 5.5 years), when it can elect to redeem or transfer the Capital Notes by paying holders the face value of $100, or converting the Notes into Westpac ordinary shares.

Details of the issue are as follows:

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.