Tuesday 10 February 2015 by Elizabeth Moran Opinion

ANZ notes need global scrutiny

The surprise RBA cash rate cut last week reminds us that we operate in a global market. The RBA considered that the Australian dollar was too high and, to try and bring it down, cut the cash rate when domestic indicators alone suggested it was at a reasonable level.

Focussing just on the domestic market can distort your view and lead to misjudgements.

Take the new ANZ notes as an example.

The hybrids have all of the new clauses we have come to expect. Income payments can be missed and the hybrids converted into shares if the banks get into trouble. Consequently, they are much higher risk than deposits and senior bank bonds and are closer to the risk of the shares, but with no upside.

Assuming that you are comfortable with the complexity, the next step is to assess the return on offer. A good place to start is to consider the drivers for the major banks when they raise funds.

ANZ, like any individual looking to borrow, does its research. It looks across global markets to determine where it can get cheap funding.

Late January, it found it could tap the Chinese market and issued a subordinated bond in renminbi. It was a very successful issue in a new market, raising the equivalent of US$402.7 million at a good price.

Its approach with the new ANZ notes would be no different. ANZ would have assessed the global market to determine the best value option. It’s no surprise it’s the listed Australian retail market.

The market has seen large scale hybrid issuance by all of the major banks. Late last year, CBA made a whopping $3 billion issue at a margin of 2.8 per cent. The hybrid has underperformed; the price is languishing around $5 below its $100 face value, pushing the margin up to around 3.65 per cent. Taken in isolation, this makes the 3.60 to 3.80 per cent offered on the new ANZ notes seem fair.

Institutional investors know better. They can compare the hybrids with those issued by other big international banks. If you compare the return to others on the global stage, the ANZ hybrid does not offer good value, nor do other listed bank hybrids.

The table below compares the hybrids to other lower risk investments in the capital structure. The margin offered by ANZ, by both measures, is poor compared to European bank hybrids. While the European comparison includes many banks, Australian banks are only in the second quartile in terms of capital adequacy, so not the best available and therefore should offer higher returns than the minimum.

Institutions with a broader global view don’t invest in the retail market because the returns on offer aren’t enough for the risks involved. Our big four banks issue bonds in the global market in US dollars, Euros and Sterling to international investors, wherever the yield is cheapest. However, they only issue hybrids in the Australian retail market (currently AUD21bn outstanding). This is despite the fact that the global hybrid market is worth over AUD200 billion; comprising €55 billion and USD102bn plus various other currencies. This tells me that Australian investors are pricing the risk too cheaply.

ANZ senior bonds and shares are much better value on a global scale. Some investors I know have bought both to make their own form of hybrid.

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