Macquarie's hybrid needs more margin

Macquarie Group has positioned itself to be the last issuer of ASX listed hybrid notes in 2015. As expected, Macquarie launched its Capital Notes 2 (MCN2) issue on Monday.

Macquarie is aiming to raise $400 million but will accept more or less and has set a tight timetable to see the notes trading under the ticker code MQGPB, before Christmas. The bookbuild is scheduled for Friday and the offer will officially open next Tuesday.

Issuance volume of ASX-listed debt has been light this year. At present total issuance for 2015, including this offer and assuming no increase in current incomplete offers, will come in at a little more than $5.8 billion.

This is the lowest annual total since $13bn of ASX-listed debt securities were sold in 2012. In isolation, this should ensure strong demand for the MCN2s but conditions in this market have been soft this year, in line with the weakness in bank share prices.

The features of Additional Tier 1 (AT1) capital, as the MCN2s are, have become highly standardised. The MCN2s are perpetual, mandatorily convertible, exchangeable, and callable, with deferrable, non-cumulative dividends.

The only differences relative to other bank issued AT1 capital are that there is no Common Equity conversion trigger because Macquarie Group is a bank holding company, and given Macquarie's extensive international business activities, dividends will not be fully franked. At present franking is expected to be to 40 per cent, in line with that on the group's ordinary dividends.

There is one other curious difference that has not been explained. Where other AT1 capital issuers will have an optional call date on which notes can be redeemed, subject to APRA's approval, and a mandatory conversion date two years later, the MCN2s have three optional call dates, spread over a period of 12 months.

The MCNs can be called in March 2021, September 2021 and March 2022, at Macquarie's discretion but subject to APRA's approval. Mandatory conversion, if the notes haven't been called, is scheduled for March 2024.

Presumably, Macquarie has good reason for seeking such flexibility over optional call dates but it does create some pricing confusion for investors looking for relative benchmarks against which to assess the 515bps to 535bps credit margin being offered on the MCN2s.

The yet to be settled, AMP Capital Note issue has a call date of December 2021, right in the middle of the latter two dates proposed by Macquarie. The credit margin on AMP's capital notes has been set at 510bps.

Perhaps Macquarie is hoping that the low end of its indicative range will appear to be comparatively fair. However, while both are holding companies, the former an insurance holding company, and the latter a bank holding company, the credit risk profile of each is quite different.

AMP has a long-term credit rating of “A” from Standard & Poor's, while the long-term rating assigned to Macquarie is three notches lower, at “BBB”. AMP's capital notes are rated “BBB” to reflect the level of subordination in the capital structure of AMP.

Macquarie's MCN2s are not rated. But if they were, the rating would be “BB”, following S&P's rating convention for AT1 capital.

This is sub-investment grade.

While the margin at the wide end of the indicated range would be the largest yet seen for an AT1 capital issue, it doesn't seem to really compensate for the additional credit risk of Macquarie or the note's more unusual features, at current market levels.

Moreover, the existing Macquarie Capital Notes (MQGPA) have a trading margin of 513bps according to Morgan's rate sheet, and a call date as soon as June 2018!

More margin is needed.

The offer is open to Australian residents with Macquarie security holders being preferred. The general offer will close on December 15 and deferred settlement trading will commence on the ASX on December 21.   

Philip Bayley is a former director of Standard & Poor's and now works as an independent consultant to debt capital market participants. He also writes on matters concerning debt capital markets and banking for various publications and is associated with Australia Ratings.