Published in The Australian 28 November 2015
Macquarie launched a new floating rate hybrid last week with an initial spread of between 5.15 and 5.35 per cent over the benchmark 180 day bank bill swap rate (an all-up rate of 7.5 per cent assuming 5.15 + 2.35 per cent). The eye-catching number alone should see desperate income investors come to the party, ensuring the success of the issue despite the poor performance of some recent bank hybrid issues
The Macquarie hybrid has many of the clauses found in new style bank hybrids that are issued to be loss absorbing investments (interest may not be paid or capital can be written off) should the Group get into financial difficulty. Specifically, the high return compensates for:
- Where similar securities are trading - it needs to be competitive in the current market. Macquarie’s existing hybrid MQGPA with a similar structure, traded at a margin of 5.21 per cent during the week. The MQGPA has a shorter term until first call in June 2018 and like the new proposed MQGPB, it has a non-viability clause but does not contain a capital trigger clause. Investors should consider the older issue if the trading margin remains near 5 per cent
- A long term to mandatory exchange of over eight years, although Macquarie will have the option to redeem on 17 March 2021, 17 September 2021 or 17 March 2022
- Four conditions must be met for mandatory conversion in March 2024. Two conditions are related to the price of the shares, based on when the hybrids are first issued
- The notes are perpetual but are subject to mandatory conversion in March 2024 (as well as the optional conversion dates). If mandatory conversion is missed then it will be re-tested on each future distribution date
- Like other Basel III compliant hybrids, the MQGPB distributions are discretionary and non-cumulative. That means they can be missed and never have to be made up at a later date. Investors are somewhat protected by a dividend stopper clause
- If a non-viability event occurs, Macquarie must immediately exchange the hybrids into ordinary shares. If an exchange of shares doesn’t occur within 5 business days for any reason then the holders rights are immediately and irrevocably terminated for no consideration and investors will suffer a total loss on their investment
As long as the market remains fairly stable and Macquarie continues to perform, the hybrids should be fine and investors can expect to have funds returned to them at mandatory call, if not before. However if global markets deteriorate, as they did in 2008/09, a range of outcomes are possible.
For example, if Macquarie’s’ share price declines by more than approximately 50%, the hybrids may not convert at the scheduled mandatory conversion date.
While Macquarie has been consistently profitable, its share price has fluctuated. As at 31 March 2007 it was $82.75 (not dis-similar to the current share price), then declined a year later to $52.82 in 2008 and declined further as at the same date in 2009 to $27.05.
Aside from the possibility of non-conversion any volatility in the share price - especially as the hybrid nears mandatory conversion - should also be reflected in the hybrids.
New style Basel III compliant bank hybrids are complex, high risk investments that need careful analysis and are a world apart from ‘set and forget’ term deposits.