* CBA to sell high-risk benchmark hybrid bond to retail
* Jumbo AT1 to come after UK bans banks from selling to
* 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,"
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
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
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%
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