Suncorp notes: A risk equation

Suncorp’s notes issue will pay a lower coupon than the hybrids available … but there’s also less risk.

Summary: Investors considering Suncorp’s new subordinated notes issue will receive a coupon rate above those on offer from the big banks’ subordinated notes issues, but below the rates available on hybrid securities. However hybrids carry higher relative risk.
Key take-out: The adequacy of the coupon being offered needs to be considered in terms of the differences in risk that confront a potential investor.
Key beneficiaries: General investors. Category: Income.

Suncorp Group Ltd will open the first Basel III compliant, Tier 2 capital issue by an Australian ADI, on Thursday. Suncorp is seeking to raise about $500 million through the sale of Suncorp subordinated notes.

The proceeds will be used, at least in part, to redeem the financial services group’s $740 million of convertible preference shares callable on June 14. Holders of the convertible preference shares are being invited to roll over their investment into the subordinated notes.

As is typical of subordinated note issues, the notes have a set maturity date, in this case November 22, 2023, and are callable five years earlier. The notes are not perpetual like hybrid tier 1 capital issues.

The notes will pay cumulative cash coupons, rather than non-cumulative franked coupons, and the coupon is pitched at 2.85% to 3.10% over the 90-day bank bill rate. The margin will be determined in a book-build on Wednesday.

Inevitably, the coupon will be set at the low end of the range, in other words at 2.85% over the bank bill rate, but at this level it looks quite attractive compared with ANZ’s subordinated notes, which are currently trading around 1.92% over, and NAB’s subordinated notes, at 1.84% over. Both of these issues will mature in June 2022 and are callable in June 2017.

The coupon also looks comparatively attractive when compared with the hybrid notes recently issued by Westpac and NAB. These are currently trading at 3.15% and 3.10% over, respectively.

While the hybrid securities are offering higher coupons, it needs to be remembered that they also come with greater risks. Coupon payments can be suspended at any time, if considered appropriate by the issuer or demanded by the Australian Prudential Regulation Authority, and the coupons are not cumulative.

Also, the hybrid notes provide the issuer with “going concern” capital. If the capitalisation of the issuer falls below a trigger level, the notes will convert into ordinary equity and this is likely to result in a capital loss for the holder.

Given these additional risks, the Westpac and NAB hybrid notes don’t offer much of a premium. Perhaps a fairer comparison would be with Suncorp’s own hybrid notes issued last October, which are trading at 3.55% over banks bills.

Also, is the coupon on the Suncorp subordinated notes as attractive as it first appears, when compared with the ANZ and NAB subordinated notes? Again there are difference in the risk profile of the instruments and the issuers.

Dealing with the latter, and to state the obvious, Suncorp is not of the same high credit quality as ANZ or NAB. Secondly, the subordinated notes issued by ANZ and NAB are not Basel III compliant.

The key difference here is that the notes are not convertible into ordinary shares of ANZ or NAB, should either issuer become non-viable. If the issuer becomes non-viable, the subordinated debt remains debt that ranks above shareholders and behind senior debt holders in a winding-up of the bank.

The Suncorp subordinated notes provide Suncorp with “gone concern” capital. If Suncorp becomes non-viable, the notes will convert into ordinary shares, leaving noteholders with at least a loss of some capital, if not all of it.

The adequacy of the coupon being offered needs to be considered in terms of these differences in risk that confront a potential investor. On balance, the coupon still appears attractive but each investor needs to satisfy themselves on this point.

The offer will close to the general public on May 10.

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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