PORTFOLIO POINT: Investors seeking better returns than those offered by term deposits, but with limited risk, should find much to like in NAB’s $500 million notes issue.
National Australia Bank (NAB) has finally joined in the recent hybrid security party, announcing a plan to raise $500 million with a subordinated notes issue. It’s the last of the big four banks to offer retail investors some kind of hybrid security, following a string of rival bank issues in February. Moreover, it is the first NAB retail offering since 1999.
NAB’s 1999 issue for retail investors was its first iteration of debt hybrids, the NABHAs, and these new notes will be listed on the Australian Securities Exchange under the code NABHB.
The securities are set up to pay an unfranked quarterly coupon of 2.75%-2.85% above the 90-day Bank Bill Swap Rate, which currently sits at about 3.83%.
Brokers have been broadly supportive of the offer so far, but it is worth digging in a little deeper to the detail of the issue, and where it will sit in NAB’s capital structure, as there are risks to consider and factor in.
The key to understanding the value – and the risk – of this offer comes from where the securities rank. The NABHB notes will rank below NAB’s secured debt (such as term deposits), and unsubordinated, unsecured debt such as bonds, but above NAB’s perpetual subordinated debt (i.e. the 1986 undated floating rate notes), preference shares, convertible notes and NAB’s ordinary shares.
A simplified structure looks like this:
- Secured debt & liabilities (e.g. term deposits)
- Unsubordinated unsecured (e.g. bonds)
- NABHB notes
- Preference shares or convertible notes
- Ordinary shares
FIIG Securities director of education and fixed income research – and Eureka Report contributor – Elizabeth Moran explains the importance of the capital structure.
“The capital structure is what happens when a bank gets into financial difficulty. If the bank got into trouble it would bring in receivers to sell assets – proceeds of those sales go to the top down, but losses are from the bottom up,” she says.
The NABHB notes rank higher in the structure than Westpac’s convertible preference shares, issued earlier this year, or ANZ’s convertible preference shares from September 2011, and are akin to ANZ’s subordinated debt notes from February.
This is important in understanding risk. As these notes are riskier than term deposits, they should provide a higher return.
While the fixed maturity date will be June 18, 2022, a 10-year term, NAB may redeem the securities on the fifth anniversary of issue – June 18, 2017 – and it is expected to do so. After the latter date, the classification of the capital as Tier 2 will diminish by 20% per annum, so there is a strong regulatory incentive for NAB to redeem then.
Some analysts suggest that because global financial markets are again in a very fragile state, the notes might provide a safe haven. However, they argue when credit spreads are moving wider on banks’ senior debt, a wider spread on subordinated debt is warranted.
Nonetheless, retail investors are expected to support the issue, with many assuming it is unlikely that an Australian bank will be allowed to default.
RBS Morgans analyst James Lawrence says the offer provides an “attractive margin for a subordinate note issue relative to historic levels and an opportunity '¦ to participate in NAB’s first retail offer since 1999”.
Lawrence says their estimates have a forecast yield to maturity of 6.51%, based on the lower end of the range, and a five-year swap rate of 3.76%. At the current BBSW rates, the initial coupon payment September 18, 2012 would be based on a rate of 6.58%.
NAB’s current 12-month term deposit rates are between 4.9% and 5%, depending on how often interest is paid.
FIIG Securities’ Moran says: “With the lower cash rate, everyone’s expectations of what they’re earning are going down as well. The market is already thinking there will be 50 basis points more in cuts, so some of that is being priced in as well.
“[The NABHB’s margin over bank bills] is where we think it should be at the moment,” she says.
Along with the return, the risks should also be considered. Lawrence writes that these include a fluctuating market price – so there is no guarantee they will trade at or above face value – as well as fluctuating interest rates and BBSWs, potentially low liquidity and the possibility of default or payment changes by NAB.
However, he also says NAB is the broker’s “preferred 'big four’ bank”, and broker EL&C Baillieu say “NAB is a strong, well-regulated household name”, making these securities “a safe haven for investors seeking income and low risk”.
Moran says the notes could provide diversification for investors.
“If they own the [NAB] shares as well, an attractive feature of this is that it’s sitting higher up in the capital structure,” she says.
“It’s really hard with a bank like NAB. The question is, are you being adequately paid for the risk that you’re taking?”
Moran says that if you have a term deposit rate with NAB, and are reasonably confident in the health of the bank, then this is an option to achieve a higher return.
The notes will be issued at a face value of $100 per security, with a minimum application amount of $5,000. Some brokers may have higher minimum application levels, such as FIIG Securities, which requires an investment of $50,000, so it’s important to check with your broker.
While NAB is looking to raise $500 million from the issue, but has the ability to raise more or less.
There is no mandatory conversion to ordinary shares, and the securities are redeemable a maximum of 10 years from the issue date, or a minimum of five years from the issue date and every coupon payment date thereafter. Capital will be returned in cash.
The offer is set to open next Monday, May 21, with an expected issue date of June 18.