Sizing up Bendigo and Adelaide Bank's hybrid

Bendigo and Adelaide Bank (BEN) has announced a $200 million Convertible Preference Share offer (CPS2).

The terms of the offer of the hybrid securities at first sight look attractive, with the pricing of the notes to fall within a range of 320-330 basis points (bps) above the 180-day bank bill swap rate (BBSW) – which equates to a gross yield of between 5.85% and 5.95% (actual yield of between 4.1% and 4.2%), and a gross yield to the first call date (YTC) of around 6.12%. (Yield to call is the expected return based on the current price, assuming all distributions are made through to conversion or call, and the face value of the security is realised at maturity or call).

Current holders of BENPC, which matures this year, will be able to reinvest in the new issue, as well as shareholders and the general public. Currently the new offer looks more attractive than BENPD, which is trading on a lower YTC of around 5.9% and matures in 2017.

Margins contracting amid yield appetite

The demand for yield remains strong, especially for listed securities that are paying a relatively higher yield than the current interest rates from term deposits. Recently, the issue sizes of both CBA PERLS VII (CBA PERLS Vii isn’t a pearler) and Challenger capital notes (Challenger’s hybrid issue stacks up) were increased due to demand.

Future margins above BBSW are likely to continue to contract, especially for further issues by the big four banks as demand outstrips supply. Issues from smaller regional banks or finance companies are likely to be more attractively priced due to the lower perceived quality of the issuer.

The current issue by BEN will be priced closer to Challenger’s issue which was set at a 340 bps margin over the BBSW, compared to CBA’s issue which was priced at 280 bps. A recent issue by Westpac was priced at 305 bps (see Caution note on Westpac’s newest hybrid), while other issues earlier this year were priced at 325 bps by ANZ, and priced at 340 bps by Suncorp. The total amount raised by hybrids so far in 2014 is over $6 billion.

The reason for BEN’s issue is to fund the $100 million redemption of BEN Step Up Preference Shares (BENPC) and provide additional Tier 1 capital, which currently is 8.02%, above the Australian Prudential Regulatory Authority acceptable level of 5.125% (see figure 1).

Figure 1: Common Equity Tier 1 ratio

^{Source:  Bendigo and Adelaide Bank}

Acceptable pricing, but liquidity may be low

The pricing of BEN’s issue will not be as attractive as Challenger’s but is not far off the mark. The issue is small, like Challenger’s; although this may provide support to the share price due to demand when it is listed, it could also mean potentially lower liquidity. BENPC suffered from lower liquidity, especially during the Global Financial Crisis (GFC), and the price was slow in recovering above the face value (see figure 2).

Figure 2: Price and volume of BEN Convertible Preference Shares (BENPC)

_{Source:  Bloomberg}

Good value compared to shares and other hybrids

The franked dividend yield of BEN’s ordinary shares is 7.14% – 1.3% higher than the expected gross yield of the preference share offer. An expected gross YTC of around 6.1% is attractive relative to other hybrids on issue, due to the yield compression on the other hybrids based on their recent strong price performance. 

Demand for this issue has already been strong with indicative demand of $250 million from brokers. The bank has confirmed that a general public offer will go ahead, opening on September 11 and closing on October 3, and the total offer size has the ability to be flexible with the final amount considered once the offer is closed.

The prospectus can be viewed here.