Battle of the CPS: Bendigo vs Suncorp

Bendigo and Adelaide Bank CPS is an almost identical offering to Suncorp CPS2, reviewed in Suncorp CPS2: Hybrids change gear. It features similar structural improvements over earlier offers and an even higher indicative margin (see Table 1). But it isn’t enough for us to be able to recommend it, for reasons that will become clear.

If you are considering Bendigo CPS, please read last week’s article on Suncorp CPS2 because here, we’re just going to focus on the differences between the two.

Margin

The Bendigo CPS prospectus highlights an indicative margin of 5.0% to 5.5% a year. That sounds juicier than Suncorp CPS2 but was an exercise in puffery; the actual Bendigo CPS margin was—surprise, surprise—set at 5%.

Whilst Suncorp CPS2 was also set at the low end of its range (4.65%), there isn’t much difference in the final margins. Bendigo’s marketing department may have ‘puffed’ harder but a choice between the two should not be made on this basis alone. There are more important considerations.

Conversion mechanism

The Suncorp review highlighted the lower 20% ‘relevant fraction’ for calculating the 'Maximum Conversion Number'—the cap on the number of shares into which the CPS can convert—and how this reduces the risk of loss. Bendigo CPS includes similar terms, except that the switch to 20% (from 1 January 2013) is both locked in at the outset and applies to all conversions.

Bendigo deserves a pat on the back for providing greater certainty to investors, although it’s unlikely to be material to the relative merits of the securities (except in the unlikely event Suncorp didn’t switch to 20%).

Simlarly, whilst the application of the 20% relevant fraction to all conversions is helpful, it’s not critical. The conversion on a trigger event is a bigger concern.

Trigger events

So let’s examine that. A ‘trigger event’ is where APRA can force a conversion of CPS to ordinary shares. Bendigo CPS is back to having two triggers—the ‘Common Equity Trigger Event’ and ‘Non-Viability Trigger Event’, giving APRA two chances to impose losses on you compared with Suncorp CPS2’s one.

A fall below a Common Equity Tier 1 Ratio of 5.125% will automatically trigger conversion of Bendigo CPS. Suncorp CPS2 is only triggered upon ‘non-viability’, a fact that also applies to Bendigo’s offer.

What constitutes ‘non-viability’ is impossible to say. Investors are (worryingly) relying on APRA to tell them what that means. So far it hasn’t, nor is it clear when it is likely to. APRA would rather determine the meaning of ‘non-viability’ at the time than be pinned down by awkward criteria on which investors might happen to make important financial decisions.

In the end, the opacity may work against the regulator. When a government body seeks to impose financial losses on retail investors (and voters) there will be a lot of political heat if the circumstances are anything but clear, or truly dire. APRA not disclosing what may constitute a ‘non-viability’ event now may in the end undermine its ability to impose it.

The trigger events are the critical terms of these instruments. Bendigo CPS is, at best, no better than Suncorp CPS2 and, at worst, far worse. On this factor, Suncorp CPS2 is a clear winner.

The issuers

Another key difference is in the issuers. Again, Suncorp wins. It’s a much larger institution ($12bn to $3bn market capitalisation) with a higher credit rating (A versus A- according to S&P) and a more diversified business.

Both companies have made a similar investment in residential mortgages (over $30bn) but in Suncorp’s case the investment is only a third of its balance sheet. For Bendigo, it’s approaching 60%. Suncorp’s insurance business could be hit by a series of natural disasters but a diversified exposure beats putting it all on mortgage default rates, which is what Bendigo has done.

Let’s spell it out. A hit of less than 3% to the value of Bendigo’s residential mortgage book would eliminate its ‘excess’ Tier 1 Common Equity of $839m and probably lead to a 'Common Equity Trigger Event'. A 10% hit would exceed their entire market capitalisation and, most likely, wipe it out.

In the case of Suncorp, a 10% hit to its residential loan book would be bad but not necessarily disastrous. Dividend payments may cease but depending on other circumstances and APRA’s interpretation, it may not even trigger the ‘non viability’ clause of the CPS2, let alone destroy the entire company.

Ordinary share comparison

Suncorp CPS2 offers a dividend yield similar to Suncorp ordinary shares, making it a sensible alternative for those investing in Suncorp shares for yield, especially those looking to lock in recent price gains.

This analysis doesn’t hold for Bendigo. The ordinary shares are trading on a much higher yield than the CPS and ordinary shareholders are more likely to be sitting on losses given the poor recent performance than trying to lock in gains. Bendigo is another case where you should stay away or, if you are a fan of the business, buy the ordinary shares for the yield and upside.

Nothing to offer

Bendigo CPS offers a slightly higher margin than Suncorp CPS2 but it’s not enough to entice Suncorp fans away or get Bendigo ordinary shareholders to make the switch. Whilst we’re not recommending either of these hybrid issues, Suncorp CPS2 wins hands down on a head-to-head comparison. AVOID.

Richard Livingston is Managing Director of Intelligent Investor Super Advisor, Intelligent Investor's new publication about tax and SMSF investing. For a free trial, check the website.