Bank subordinated debt has been a favoured trade for wholesale investors, with good relative value yields. We are pleased to make the bonds available to retail investors
Prices updated and republished 21 December 2017
The ongoing development and implementation of the Basel III global reform agenda post the Global Financial Crisis has, amongst other things, forced Australian banks to lengthen the tenor of their funding profiles and strengthen their regulatory capital bases. In turn, this has forced changes to the structure of the instruments issued by banks, and opens potential opportunities for astute investors with appropriate risk appetites.
Like all good investments, no one is quite like the other and the devil is always in the detail. Whilst Point of Non Viability (PONV) and heightened expectations of loss absorption complicates the analysis of Tier 2 subordinated bonds, in my view, it is well worth digging exploring for the higher yields on offer.
Source: FIIG Securities
Features of Tier 2 capital bonds versus equity hybrids:
- Dated securities with a fixed maturity date
- Payments are based on a floating interest rate
- Unfranked and non discretionary payments
- Payments are cumulative, which means any missed must be made up at a later date, unless PONV event is triggered by APRA
- There is no mandatory conversion, or scheduled conversion, to equity
- Any losses are applied to preference shares and AT1 capital, ahead of Tier 2 capital
The role of the Australian regulator, APRA, is of critical importance when analysing subordinated Tier 2 bonds. PONV trigger events are essentially a forward looking and pre-emptive tool used by the regulator when they believe that absent converting some or all of the contingent capital securities to ordinary shares – or a public sector injection of capital – is necessary to prevent the bank from becoming non viable. Frustratingly, yet understandably, APRA will not define what constitutes PONV so that it does not paint itself into a corner.
Astute investors can look through to see what buffers an authorised deposit taking institution (ADI) as well as what incentives the regulator has built into the system, to ensure management are heavily incentivised so buffers are never put at risk. Of course surprises may occur from time to time, so maintaining a well established track record of accessing new capital, as and when required, is equally important.
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In this context, we have investigated a couple of seasoned Basel III compliant subordinated Tier 2 bonds in the Australian market, and feel that some investors may be attracted to these new style instruments.
| ADI | Type/rank | Coupon | Call date | Clean price* | Yield to worst |
| Australia and New Zealand Banking Group Limited (ANZ) | Subordinated 10.5 year non call five | BBSW +2.70% or 270bps | 17 May 2021 | $105.338 | 3.295% |
| Members Equity Bank Limited (ME Bank) | Subordinated 10 year non call five | BBSW +2.70% or 270bps | 29 August 2019 | $102.012 | 3.406% |
Source: FIIG Securities
*
Note: Pricing is indicative only and accurate as of 21 December 2017 but subject to change
Glossary
ADI
Authorised Deposit-taking Institution. APRA defines ADIs as the following:
“ADIs are corporations which are authorised under the Banking Act 1959. ADIs include banks, building societies and credit unions. All ADIs are subject to the same prudential standards but the use of the names ‘bank’, ‘building society’ and ‘credit union’ is subject to corporations meeting certain criteria”.
APRA
APRA is charged with the prudential supervision of Authorised Deposit-taking Institutions (ADIs). Its ultimate aim is to ensure financial promises made by the bodies it regulates are met within a stable, efficient and competitive financial market. It oversees, banks, credit unions, building societies, genenral insurance and reinsurance companies, life insurance, friendly societies and most members of the superannuation industry.
AT1
Contingent convertible capital instruments (CoCos) also known as Additional Tier 1 (AT1) bonds, are hybrid bonds that combine debt and equity elements.
BASEL III
Basel III is a comprehensive set of reform measures, developed by the Basel Committee on Banking Supervision, to strengthen the regulation, supervision and risk management of the banking sector.
BBSW
A compilation and average of market rates supplied by domestic banks in regard to the specific maturities of bank bills. BBSW is calculated at ten o’clock every morning and compiled by AFMA, however the adminstrator of BBSW will change to the ASX in mid-2017.
The purpose of BBSW is to provide independent and transparent reference rates for the pricing and revaluation of Australian dollar derivatives and securities.
Cumulative
Missed dividend payments/distributions must be made up at a later date.
PONV
Point of non viability, the point at which regulators decide a bank is no longer able to function. To count towards regulatory capital ratios under Basel III, subordinated bonds must be written down to zero or converted to equity when the trigger is hit.
Non cumulative
Missed dividend payments/distributions are forgone. The issuer of the security is not obliged to pay the unpaid amount to the holder.
Subordinated debt
A bond or loan that ranks below senior debt, loans and creditors. In the event of a wind up (insolvency) of an issuer, subordinated debt is not paid until all senior debt and unsecured creditors are paid first.