Westpac's long-anticipated hybrid

PORTFOLIO POINT: The market had been waiting for this one, and it may be popular, but better offerings are likely to follow.
Following its acquisition of St George Bank last year, Westpac advised that it would be redeeming the $875 million of outstanding St George hybrids by March 31 this year. It also noted that it would consider issuing a replacement security.

Clearly, though, in an environment where capital is scarce, the bank was always going to offer an alternative to straight cash redemption; it was just a matter of at what margin and credit markets stabilising somewhat. The lodgement by Westpac last week of a prospectus for the issue of its Stapled Preferred Securities is just what the market has been waiting for.

St George holders now have the option of receiving the face value of their holding as cash or “rolling” into the new Westpac hybrid, which incidentally is the first hybrid deal for 2009.

So what is Westpac offering and how does it work? It is a stapled security, convertible into the bank’s ordinary shares on September 30, 2014, and will pay investors a floating rate, fully franked distribution each quarter. At the time of writing the final distribution rate had not been set but the pricing range was 3.7–4% over the bank bill rate.

Based on the current 90-day bill rate, which is sitting at about 3.15%, the initial annualised gross yield will be in the order of 6.85–7.15%. Compared to a Westpac term deposit it doesn’t look too bad, but remember: hybrids are not term deposits and obviously carry a higher level of risk, albeit a risk most investors consider acceptable given the credit rating and level of profitability of our banks.

But what other comparisons are relevant? Well, the running yield as shown below looks reasonably attractive compared to its peers and, based on the market’s expectations of future bank bill rates (5-year swap rate), puts it at around 5.5%.

The gross yield (including franking) though at about 8% (based on the 5-year swap rate) is less attractive than many of the currently listed bank hybrids. The main reason seems to be that those issues have been sold down aggressively in recent times, however only some of this move can be justified.

Clearly, as global credit conditions have deteriorated, credit spreads have widened resulting in prices falling; this is rational. What is not rational is holders selling at already discounted prices with the intention of taking up new offers such as the Westpac SPS, something I think is happening now.

Current cash running yield (orange) and the current yield to maturity (blue).

For existing St George hybrid holders, the Westpac offer makes some sense when compared to the securities currently held; increasing cash flow, lower risk, an easy re-investment process and one would expect better liquidity.

New investors should consider the universe as it stands now in terms of the broader array of yields on offer and the prospect of other new issues coming to market. One would assume that if they’re not bank issuers the margin available will be even more attractive. The most sensible approach though is to continue to diversify; investors who hold well diversified portfolios are better able to weather the storm and if something really bad does happen (we saw a few cases in point last year) the overall portfolio impact is less severe.

Always seek advice and consider your own circumstances.

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