Westpac joins the hybrid party

Westpac has announced it intends to issue about $600 million of stapled preference securities (SPS) for “general funding purposes”, noting that this transaction is independent of the proposed St George merger. The stapled securities are perpetual subordinated notes issued by Westpac’s New York branch stapled to a convertible preference share issued by the bank. This gives the bank tax effective Tier 1 regulatory capital without the dilutionary effect of issuing new ordinary shares at current depressed levels; remember Westpac’s ordinary share price is about 35% off its highs.

The SPS will be convertible into Westpac shares in five years time at a 1% discount to the then traded share price; alternatively the bank may at its discretion return $100 face value in cash to holders subject to APRA approval. In common with the Suncorp and Macquarie issues (see Suncorp offering with a bonus) there are some conditions that must be met before this can happen.

In essence, so long as at conversion time Westpac’s share price is trading at more than half of its current (issue date) level the securities can be converted. If not, then the bank will review at subsequent distribution dates. Like all current form hybrids, holders have no right to request conversion or redemption of the securities.

In terms of the yield, it will be a floating rate franked security set at a margin (to be announced on June 26*) over the 90-day bank bill rate. Using the recent Suncorp and Macquarie deals as a guide, the margin can be expected to be set at about 2.5% (plus or minus 10–20 basis points). With the 90-day bank bill rate about 7.80% this would mean an initial distribution rate of about 10.3% including the benefit of franking or 7.21% franked.

For investors more familiar with ordinary share investments, this means a “grossed-up” yield of about 10.3%. Remember, Westpac has a “AA” rating, which is higher than both Suncorp “A ” and Macquarie “A–” (which pays a cash yield) and so one naturally expects a lower margin over the bill rate.

Who should invest? Well, like all hybrids this is not for those looking for growth in their investments. If you the think Westpac looks cheap and will bounce back over time then buy the ordinary share. If on the other hand you expect Westpac will, as the old saying goes, ”keep on, keeping on” and want regular income then this probably isn’t a bad addition to your portfolio, but consider your own circumstances first.

So, with Westpac, Macquarie and Suncorp representing something of a rush into the hybrid note market, who’s next? Well, it seems to be a bit of global trend these days for banks to be raising new capital and by the looks of it, local banks are following suit. So while no one else has as yet officially put up their hand, we could reasonably assume others will follow. Clearly the others will be looking carefully at the market and how investor appetite holds up in this issue straight after Macquarie and Suncorp.

Current sharemarket volatility may well focus the minds of investors on securities such as hybrids and at current interest rate levels investors don’t have to look too far afield for attractive income opportunities.

* Following publication of this article, Wespac announced the margin over the ninety day bank bill rate will be 2.4%. The bank also said the issue would expand from $600 million to $950 million.

Steven Wright is a director of fixed interest at ABN-Amro Morgans.