Noting the fine print in Westpac issue

We look at why Westpac’s SubNote issue is paying less than its peers.

Summary: There are clear reasons why Westpac’s subordinated note issue is paying less than ANZ’s capital note issue, as Westpac has attached a common equity capital trigger to them. However the question remains whether a 110 basis point difference is justified.
Key take-out: Westpac’s subordinated bond issue is paying significantly less than the alternatives.
Key beneficiaries: General investors. Key category: Fixed interest.

Westpac launched its first Basel III compliant subordinated note issue last week. The size of the issue was set at a minimum of $750 million and the credit spread range is 2.30% to 2.45% per annum.

Following a bookbuild today, the issue size was increased to a minimum of $850 million and the credit spread for the coupon was set at the low end of the range. 

Westpac sold A$1.7 billion of subordinated notes to retail investors last year but this latest offer has some differences, as the latest offering is fully Basel III compliant. The main differences are the inclusion of a Non-viability trigger and the ranking of these notes behind the subordinated notes issued last year, in a winding-up of Westpac.

Both issues have a ten year, non-call five years maturity structure, which means the notes will mature after ten years and will be repaid in cash, subject to Westpac being solvent at the time. And Westpac also has the option to redeem the notes after five years, if APRA approves. 

The coupon payments on both issues are also subject to a solvency test and are cumulative. So coupons cannot be paid if Westpac is insolvent but will accumulate until the bank is solvent again and the coupons can be paid. How does this work?

Solvency has the usual definition of being able to meet liabilities as and when they fall due, and assets must exceed liabilities. Therefore, if Westpac is no longer solvent, it is insolvent and certainly not viable.

Whether coupons can accumulate in this situation will depend on how the non-viability of the bank is resolved. The subordinated notes will only convert to equity after Additional Tier 1 capital is converted and only if more capital is required, as determined by APRA.

If conversion is not required by APRA, then the subordinated notes will remain subordinated notes and coupons can accumulate until the effective recapitalisation of Westpac is completed.

Are the notes good value? There are two issues to consider here.

First, the Suncorp subordinated notes sold in April were priced at 285bps over the 90 day bank bill rate and have since moved wider. The credit quality of Suncorp is only marginally less than that of Westpac, therefore the Suncorp subordinated notes (SUNPD) appear a better buy.

The second consideration is a price comparison with the ANZ Capital Notes issue that opened last week. The notes are offering a spread over the bank bill rate that is 110 basis points less than what the ANZ capital notes will pay (bearing in mind that the ANZ capital notes coupon should be paid on a fully franked basis).

Some will argue that as both notes include a Non-viability trigger the risk profile is the same. Therefore, why accept a return that is 110bps less?

The argument is incorrect because it ignores the Common Equity Capital trigger that also attaches to the capital notes. It also ignores differences in the terms and conditions attaching to coupon payments.

But it does raise the question of whether the subordinated notes should pay 110bps less because the Common Equity Capital trigger is not included.

In theory the Common Equity Capital trigger should be pulled first and the capital notes converted to equity at this time. At this point the subordinated notes would remain outstanding and will only convert to ordinary shares, if the Non-viability trigger is subsequently pulled.

However, if a bank is in trouble, pulling the Common Equity Capital trigger may be insufficient to recapitalise the bank, therefore the Non-viability trigger will be pulled at the same time. 

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.

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