Suncorp attracts a follower

Hot on the heels of the Suncorp Convertible Preference Share issue – expanded recently from $400 million to $700 million – Macquarie Group has jumped on the band wagon raising $600 million with a new hybrid note. The move by Macquarie represents the second significant note issue within weeks after a quiet start to the year.

In common with the Suncorp offer, the Macquarie note is a mandatory Convertible Preference Security (CPS) – note “security”, not “share”. This latter point relates to the more complex structure the group has chosen to use given Macquarie’s move to a Non Operating Holding Company (NOHC) corporate structure in November of last year. Notwithstanding this distinction, the securities will convert to Macquarie Group (MQG) shares in five years time, subject to three conversion tests. Basically these tests mean that Macquarie share price must be above 55% of its current price and the group must still be listed at the time; if so, then investors can expect to receive Macquarie shares at a 1% discount to the then traded share price as their exit mechanism.

The significant difference, though, between the Macquarie securities and the Suncorp deal is that the Macquarie distribution rate will be fixed rather than linked to the 90-day bank bill rate, currently at 7.70%

So come issue date the rate will be set for the full five years at a margin of 3.5% over the five-year swap rate, currently at 7.57%; this can be expected to set at about 11% pa. This is somewhat unusual as we haven’t seen a fixed rate hybrid offer for some years, which has made sense given the monetary policy path we have trod. However, at current levels the outlook for interest rates remains more problematic and so some fixed interest rate exposure starts to make sense.

The interesting thing to consider is that even if bank bill rates continue to rise, as some economists expect, it does not necessarily follow that longer-term interest rates will also move higher. The simple explanation to this reasoning goes as follows. The primary reason the Reserve Bank actually increases short-term interest rates is to dampen inflationary pressures and expectations; if it is successful, longer-term interest rates should reflect this by being lower than short-term rates. This is called an inverse yield curve. So while there may be some better floating rate offers coming if short term rates do rise, any new fixed rate offers could well be priced at similar levels to this deal.

A key consideration for investors should be the fundamental differences between the Suncorp bancassurance business and the Macquarie investment banking businesses. Suncorp is rated A by Standard & Poor’s, with its key business streams being insurance and banking. Macquarie, on the other hand, is a more complex business that sources its income from businesses as diverse as equity derivatives to mergers and acquisitions. This complexity, potential for variability in revenue and different capital structure, means Macquarie Group has a lower headline credit rating of A–, two notches lower than Suncorp. Based on the ratings agency’s standard methodology, the hybrid is rated at BBB, lower investment grade.

So if you understand the basics of the deal, the next question to ask is: What are these companies going to do with the money? Well, the Macquarie prospectus tells us that “Convertible Preference Securities are being issued as part of Macquarie’s ongoing capital management and funding strategy '¦”. However, the company has noted the internal temporary funding that was put in place as part of Macquarie’s transition to the NOHC structure last year. Effectively, the “bank” provided a bridging loan to the parent holding company, which was used to support the non-banking activities of the group. This bridging loan is amortising, which means it must be paid down progressively over a two-year period. These funds will clearly assist in that process.

So should you invest? Well like all new issues, you need to consider these offers in their entirety and specifically whether they suit your circumstances and risk profile.

Steven Wright is a director of fixed interest at ABN-Amro Morgans, which is a participating broker to the issue of Macquarie CPS.