Strong start for listed debt market

The ASX-listed debt securities market has got off to a stronger start in 2017 than it did last year. That said, 2016 followed a poor 2015 that saw a significant correction in risk appetite.

As a result, this time last year only one new issue had been announced, the Commonwealth Bank's PERLS VIII hybrid note issue. The bank went on to sell $1.45 billion of the securities, paying a spread of 520 basis points over 90-day bank bills. 

That was the high point for credit spreads. Credit spreads on subsequent issues were set at progressively lower levels.

And in the secondary market, securities that had been trading below par for the most part saw their prices move back to par and beyond over the course of the year.

Now only a handful of notes are trading below par, most are trading above par, and some are trading well over $105 against a face value of $100. These conditions ensured strong support for new issues at the start of 2017. 

National Australia Bank got the year underway with its new $800 million, Subordinated Notes 2 issue, which we wrote about two weeks ago. Last week, Commonwealth Bank launched its well flagged $750 million PERLS IX note issue, and this week Challenger launched a $350 million, Capital Notes 2 issue.

Moreover, these last two issues have already been upsized with the credit margins to be paid on each set at the bottom of the indicated range.

On Tuesday, CBA announced that the bookbuild completed the day before had resulted in the size of the PERLS IX issue being increased to $1.45 billion. The announcement was consistent with the rumour that by the close of business on the previous Monday (the day the issue was announced), the sponsoring brokers had already taken orders for more than twice the $750 million minimum set by the bank.

Not surprisingly, the bookbuild saw the credit margin set a 3.9 per cent per annum, against the indicated range of 3.9 per cent to 4.10 per cent. 

Holders of the $1 billion of soon-to-be-called Colonial subordinated notes (CNGHA) will be given priority if they wish to roll over into the PERLS IX notes. And CBA shareholders and other security holders can participate in the PERLS IX issue if they wish to do so, but as with NAB's Subordinated Notes 2, there will be no public offer.

The PERLS IX notes will be callable in March 2022 and mandatory conversion into ordinary equity will take place in March 2024. The offer is now open tomorrow and will close on March 24.

Deferred settlement trading will begin on the ASX on April 3, under the ticker CBAPF.

It was also on Tuesday, that Challenger announced its $350 million Capital Notes 2 issue, with an indicated credit margin range of 4.4 per cent to 4.6 per cent per annum. This is a new issue and not a replacement for an existing security issue. 

The proceeds from the issue will be used to subscribe for Additional Tier 1 capital issued by Challenger's wholly-owned life insurance subsidiary. As such the notes come with all the features or detractions of Additional Tier 1 capital, as issued by banks.

The notes are perpetual but can be called in May 2023, APRA permitting, and mandatory conversion into ordinary shares in Challenger will occur in May 2025, if the notes have not been called. Distributions will be paid quarterly and should be fully franked, but distributions are discretionary and non-cumulative.

The only significant difference in this case is that there is no Capital Event trigger for mandatory conversion into ordinary equity. Being Additional Tier 1 capital raised by an insurance company, there is only a non-viability trigger.

Should APRA determine at any point while the notes are outstanding that the life company has become non-viable, the notes will immediately convert into ordinary equity to recapitalise the company.

Of course, all of this is now quite standard and in no way curbed investor appetite for the Capital Notes 2. The very next day (Wednesday) Challenger advised the ASX that the bookbuild for the issue had already been completed with the issue size being increased to $450 million with the credit margin set at 4.4 per cent per annum.

Challenger expects to allocate a further $20 million to existing Challenger security holders. Again, there is no public offer.

The offer closes on March 31 and deferred settlement trading will begin on the ASX on April 10 under the ticker code CGFPB.    

Allowing for some oversubscriptions to the three issues discussed here, $3.5 billion or more of new securities could be sold into the ASX-listed debt securities market by the end of the first quarter (or shortly thereafter). At the end of the first half of 2016, only the $1.45 billion, PERLS VIII issue had been completed.   

However, the secondary market is already showing some signs of softness with the price of many securities moving off recent highs, especially among bank hybrid notes.   

Dr Philip Bayley is a former director of Standard & Poor's and now works as an independent consultant to debt capital market participants. He is associated with Australia Ratings.