After a horror start to the year, the hybrid securities market has settled and secondary market yields have come down (prices have risen). A well-managed issue by the Commonwealth Bank of PERLS VIII, improving bank ordinary share prices and, as a corollary, lower yields, and finally, a cut in the cash rate by the RBA have been the main drivers in boosting investor sentiment.
The hybrid securities market is somewhat unique in that it largely comprises retail investors and opportunistic issuers, usually banks. Accordingly, demand can be very fickle, and supply is lumpy. The second major issuer to test the market this year is Westpac, which has announced an issue of Capital Notes 4.
Priced at a margin of 4.9% over the 90-day bank bill rate, this issue will be well sought. It compares favourably to the secondary market trading margins of the major hybrid issues that have similar call dates and issue margins such as CBAPE (see table below). It is also towards the higher end of the range of hybrid security issue margins that have come to the market over the last decade.
Provided Westpac doesn’t seek to flood the market with supply (i.e. leaves some demand in the initial offer unfilled), then the post issue secondary market should see these Notes trade initially at par or even a small premium.
Detailed below is a description of the Notes, including the conversion terms and key dates.
Westpac Capital Notes 4
Westpac Capital Notes 4 will pay a quarterly distribution, which is set at a fixed margin of between 4.90% and 5.10% over the 90-day bank bill rate, and then adjusted for the company tax rate (to take into account the franking credit benefits). The final margin will be set in an institutional bookbuild on Wednesday.
With the 90-day bank bill rate around 2.00%, this implies a gross distribution rate of 6.90% pa for the first 3 months (2.00% plus 4.90%). The actual distribution in cash, which is fully franked, would then be 4.83% (6.90 x 0.70 = 4.83%).
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 holders from this discretion being mis-applied, if a distribution is not paid, Westpac is then restricted from paying a dividend on its ordinary shares.
Conversion into Westpac Shares or Early Repayment
These Notes are perpetual and have no term. However, Westpac must (subject to a test) convert the Notes into ordinary shares on 20 December 2023 (in about 7.5 years). If conversion occurs, holders are issued $101.01 of Westpac ordinary shares for every Note of $100 face value (which effectively means that they are issued Westpac shares at a 1% discount to the then weighted average market price).
The test for the exchange is the price of Westpac ordinary shares at the time – provided they are higher than approximately $16.80, conversion occurs – otherwise, it is retested on the next and subsequent distribution date(s) until the test is met.
To qualify as regulatory capital for Westpac, 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 Westpac Capital Notes 4 into ordinary shares, if Westpac’s Common Equity Tier 1 Capital Ratio falls below 5.125% (the ratio was 10.5% as at 31/3/16), 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 an option to redeem the Notes in approximately 5.5 years’ time on 20 December 2021. It can redeem or transfer the Notes by paying holders $100 per Note.
Details of the issue are as follows:
How to invest
The offer is due to open on Thursday. A number of brokers can offer stock forms and are taking expressions of interest now. Brokers involved include Westpac Online Broking, CommSec, Macquarie, Shaw, JB Were, Bell Potter, UBS, Morgan Stanley and Morgans.
Westpac ordinary shareholders and Capital Note holders can also access stock directly from Westpac through a Securityholder offer (click here).
And if you are investing via a broker or financial planner, most are receiving a placement fee of 1% and in some cases, will be willing to share some or all of this with potential investors.
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.
