* CBA to sell high-risk benchmark hybrid bond to retail investors
* Jumbo AT1 to come after UK bans banks from selling to retail
* Securities regulator warns of potential risks
By John Weavers
LONDON, Aug 22 (IFR) - Australia’s biggest bank is pressing ahead with plans to offer complex hybrid capital securities to retail buyers even after the UK regulator deemed the format too risky for individual investors.
Commonwealth Bank of Australia announced a A$2bn (US$1.86bn) retail-targeted Additional Tier 1 hybrid offering on Monday, less than two weeks after the UK announced a one-year ban on the sale of similar securities to retail investors.
Earlier this month, the UK’s Financial Conduct Authority said it would stop banks from selling “risky and highly complex” contingent convertible instruments to the mass retail market, while still allowing access for experienced investors.
European banking regulators also issued a stern warning at the end of July, reminding banks to avoid conflicts of interest when selling their own capital notes to clients.
CBA’s issue of perpetual subordinated CommBank PERLS VII capital notes raises the awkward question of whether Australian retail investors are considered to be more knowledgeable or more gullible than their British counterparts.
“A lot can happen during the lifetime of PERLS VII, which are not callable for over eight years,” said Philip Bayley, principal at ADCM Services.
“No one saw the global financial crisis coming, while Royal Bank of Scotland was one of the world’s largest banks just before it was rescued from bankruptcy.”
The Australian Securities and Investment Commission (ASIC) has consistently warned investors of the dangers of hybrid securities, without any notable impact on demand.
Unlike the FCA, ASIC currently has no banning powers, leaving any such move in the government’s hands.
“ASIC is focused on the sale of hybrids to retail investors and a big reason for this is the potential for misleading conduct - for example, when promoters spruik the returns of hybrids without being upfront about the risks,” Matthew Abbott, senior executive leader for corporate affairs at ASIC, told IFR.
“To date, we have found some promotional material that did not include a balanced disclosure of features and risks. In particular, issues we identified include inadequate disclosure of risk, disclaimers that were not sufficiently prominent, hybrids being referred to as stocks or shares, and hybrids being classified as fixed income in a way that may be misleading,” Abbott said.
CBA’s capital raising is for an indicative A$2bn, matching the size of the PERLS V notes that are callable in October.
Such offerings are typically substantially increased and anything over A$2bn would set a record in the Australian hybrid market. PERLS VII are rated BBB by S&P, five notches below the bank’s senior unsecured rating of AA-.
Australian hybrids rely heavily on local retail demand as they pay a franked, or after-tax, coupon that entitles investors to tax credits when they file individual returns.
Australia’s army of high-net-worth individuals and self-managed superannuation funds have been enthusiastic buyers, allowing banks to raise funds at rates far lower than in the institutional market.
There are some differences between the Australian and UK systems. For example, CBA is required to pay the coupon on the AT1 notes before it pays a dividend to common equity holders, an investor-friendly feature that is not allowed in the UK.
However, the issue facing regulators is the same: retail investors may focus on the issuer’s name and headline returns without fully understanding the greater risks associated with loss-absorbing capital securities.
PERLS VII and other Basel III-compliant Tier 1 issues include a “non-viability trigger event”, under which the notes will convert into ordinary shares if the Australian Prudential Regulation Authority declares the bank to be no longer viable. The notes also include a common equity trigger, whereby they will convert into ordinary shares if the bank’s common equity capital ratio falls to 5.125% or below.
CBA is very well capitalised with a common equity capital ratio of 9.3% as of June 30, up from 8.3% a year earlier. Such a strong capital position, as well as a Double A credit rating, provides considerable comfort to hybrid investors.
Many buyers expect the government to step in to prevent ANZ, CBA, NAB and Westpac from going bust, but this does not necessarily mean hybrid holdings are safe as they could convert into equity when a bank is still a going-concern.
Existing investors that roll over their PERLS Vs into PERLS VIIs will have to accept a lower return since PERLS Vs pay a margin of 340bp over three-month BBSW. Guidance for the new notes is set at a spread of 280bp-300bp over.
Assuming the margin is set at the low end of guidance and with local three-month bank bills quoted around 2.64%, a 280bp spread suggests a coupon of just under 5.5% - the lowest since the global financial crisis.
This is still attractive relative to the 4% or so returns available for five-year term deposits in Australia and the approximate 3.8% yields for senior unsecured five-year major bank bonds.
Any ban on the sale of hybrid notes to Australian retail investors would create obvious problems for the country’s systematically important banks, which have to meet demanding Tier 1 requirements.
In order to boost institutional demand, the banks would need to offer a significantly higher return to compensate for the risks involved, perhaps alongside a new institutional-friendly domestic Tier 1 structure.
Even then local demand may not be high enough, since Australian fund managers are notoriously conservative, and many are barred from buying hybrids. This may lead Australian banks to target offshore institutional investors, but this route can be extremely pricey.
Non-major lender Macquarie Bank issued the first Basel III-compliant hybrid Tier 1 from an Aussie bank outside the domestic market in March 2012. The BB+ (sub investment grade) rated offering only raised half of its targeted maximum US$500m issue size and priced at the wide end of the 10.00%-10.25% guidance range.
CBA’s PERLS VII will be perpetual, subordinated, unsecured notes with a call date on December 15 2022 and mandatorily exchangeable into CBA ordinary shares on December 15 2024.
The margin will be determined through a bookbuilding process and is expected to be announced on Tuesday (August 26) when the offer opens. The offer closes on September 19 with the issue date set at October 1.
CBA and Morgan Stanley Australia Securities are the arrangers of the transaction.
Goldman Sachs Australia, JP Morgan, Morgans Financial Limited, UBS and Westpac have been appointed joint lead managers. ANZ Securities, Bell Potter Securities, Deutsche Bank and Ord Minnett are co-managers. (Reporting by John Weavers, Editing by Steve Garton and Abby Schultz)