Suncorp CPS3: A toast to the hybrid market

Suncorp CPS3 is a classic case of doing a deal because the going’s good. Good for Suncorp that is.

Key Points

  • Suncorp CPS3 is a replica of Suncorp CPS2 with a lower margin
  • Higher Suncorp ordinary share price means greater risk
  • Earlier hybrids more attractive in comparison

Suncorp is back with a new hybrid: margin to maturity of just over 3% (reflecting CPS2’s shorter remaining ‘term’).

What’s caused the margin to plummet? CPS3 is not a vastly superior proposition to CPS2. What's different is the current demand for anything paying a yield higher than term deposits. That’s what Suncorp is capitalising on here.

When reviewing CPS2 we said that Suncorp ‘isn’t necessarily more exposed than the big four [to macro risk factors] but it is paying a return as if it were’. The pricing of CPS3 flips that sentiment on its head, making the currently listed big four bank hybrids attractive by comparison.

Table 1 compares CPS3 to CPS2, the recent Non-Viability Trigger Event has occurred.

CPS3 highlights this point. If the current share price ($12.79) remains until the CPS3 are issued then a fall back to the Suncorp share price of May 2012 ($7.59) would see holders nervously eyeing the charts. The share price dropping into the low $6 range (less than half the issue date price) would cost us our ‘mandatory conversion’ protection, meaning we’d be stuck with lowly-ranked preference shares, paying dividends at Suncorp’s discretion, for longer than expected (possibly much longer).

The share price (technically called ‘issue date VWAP’) when CPS2 were issued was $9.49. So the share price would need to trade around $4.75 for CPS2 to suffer the same fate. That was touched briefly in the aftermath of the GFC but before that, Suncorp last traded at this level back when Jerry Maguire was showing us the money (1996).

Not that we’re keen on CPS2. Again, we’ll stick with our sensibly diversified Conservative Portfolio rather than take part in this offer. But if we were forced to pick from the new hybrids, we’d opt for the relative extra safety of CPS2 (or an issue from a big bank, like PERLS VI) over the extra half a per cent a year offered by CPS3.

A single A (credit rated) institution issuing junk bonds at a margin almost one and a quarter per cent lower than an earlier issue could be a sign of the market reaching a peak, although we’ve thought that previously and the craziness continues. Fortunately, if you stick to sensible, conservative investing, it really doesn’t matter if, or when, this bubble pops.

In the end, Suncorp may be saying ‘why not?’ but a better question for prospective investors is ‘why bother?’.

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