ANZ makes a CPS offer

Just a month after Westpac issued its ASX-listed hybrid security, ANZ has announced that it too intends to raise new regulatory capital by issuing about $500 million of convertible preference shares (CPS). The securities will count as Tier-1 regulatory capital for the bank and support its general banking activities.

As one of the big four banks, ANZ has a diverse business and revenue base assuring its solid profitability even in these tough times. This is reflected in its AA credit rating from Standard & Poor’s. Its major business streams include general banking and financial products to retail, small business, corporate and institutional clients in Australia and New Zealand, but it is also increasingly focused across the Asia-Pacific region, the UK and the US.

ANZ recently elected to convert its $1 billion StEPS issue (ANZPA) rather than repay investors. However, investors have been able to sell their holdings (and can continue to do so until close of business on September 5) on the ASX, effectively realising their investment for cash instead of taking ANZ shares under the conversion offer. This has meant that the bank can retain what is regarded as valuable capital and income investors have an out – a win-win.

Ordinary shareholders though will have to bear the brunt of the dilutionary impact of the exchange. As an aside, some of the recent weakness in the ANZ share price might well be attributable to this conversion process. (ANZ has fallen from about $27 in February to about $17 now.)

The CPS offer will open tomorrow, September 4. Interested investors can apply through their broker for a minimum allocation of $5000 worth of securities. The securities will have a mandatory conversion date of June 16, 2014, but are subject to a few conversion tests, which basically require that at that date the ANZ share price is above 50% of its current price. At this time, holders will either be repaid $100 cash or have the CPS converted into ANZ ordinary shares at a 2.5% discount to the then share price.

Effectively, if this happens they will receive $102.56 worth of ANZ shares. Given that the CPS ranks behind ANZ deposit obligations and debt liabilities, as do all bank hybrids, distributions to investors will be paid at the discretion of directors out of distributable profits and are subject to approval by the Australian Prudential Regulation Authority.

Notwithstanding the discretionary nature of the dividends, prospective investors can look to the fact that the securities will be investment grade rated by Standard & Poor’s at A . This means that barring a significant fall in ANZ profits and its long-term viability, distributions will be paid and holders will have the benefit of exiting the securities by way of conversion or cash. As an added protection, should for what ever reason CPS dividends not be paid, then ordinary shareholder dividends cannot be paid either.

So if we assume that the security structure is acceptable, then what about the return? Well, like most hybrids there’s little or no prospect of upside in the price. Dividends will be quarterly and are floating rate, adjusting each quarter in line with movements in the 90-day bank bill rate. Though at the time of writing the final margin had not been set, it is expected to be in the range of 2.5–2.9% over the 90-day bank bill rate.

Assuming the 90-day bill rate is 7.25%, this would mean gross distributions including franking of between 9.75% and 10.15% pa. This compares favourably with recent issues such as the Westpac hybrid, which is priced at a margin of 2.4% and has actually traded tighter since its issue. This has been a good outcome for Westpac hybrid holders but it really doesn’t make sense in this capital-hungry environment. Banks here and overseas need capital and this should really keep pressure on spreads staying wider, not contracting at this time. Rather than being concerned about this though, investors should consider taking advantage of the situation and diversifying their portfolio and locking in the wider credit spreads while they last.

All in all, this looks to be an attractive opportunity for income investors seeking the certainty of an investment-grade rated security with regular cash flow but, as always, consider your circumstances, read the prospectus and seek appropriate advice.

Steven Wright is a director of fixed interest at ABN-Amro Morgans, a co-manager to the issue of ANZ CPS.