Westpac Capital Notes: A fresh face but the same old story

Westpac are back with its snouts in the hybrids trough. When the dust finally settles on the junk bond party, will it get the prize for the issuer who made the most of the opportunity?

This time it's in the mood for a note issue and it has launched Maximum Conversion Number. However, for the Capital Notes, this falls to 20% on an early conversion caused by one of the triggers above. As we explained in reinvestment risk).

On the step-up date Westpac is required either to pay a 1% higher margin, redeem the TPS for cash, or convert at a 2.5% discount to the ordinary share price (two and a half times the 1% discount offered by the Capital Notes and the CPS). Best of all, each $100 TPS has a Maximum Conversion Number of 50, so the ordinary share price is almost taken out of the equation.

Of course, there has to be a catch. The catch here is that a portion of the returns from TPS are made up of a capital gain on redemption (or conversion). TPS were issued with a ridiculously low 1% margin, so they trade at a discount to their $100 face value (currently $92).  Depending on interest rates, investors receive four to five dollars in cash and franking credits annually, and (hopefully) eight dollars profit on the step-up date.

This means investors have to wait three and a half years for part of the return – the extra margin is a reward for patience.

Anyone looking at Westpac TPS shouldn’t forget the Bank of Queensland PEPs shemozzle, discussed in Banks caught bluffing. The risk with these ‘step-up’ hybrids is that the issuer is under no legal obligation to redeem and can simply choose to pay the step-up if they wish. It’s less of a risk here since TPS has a step-up (PEPs didn’t) and Westpac isn’t Bank of Queensland. But it’s a risk all the same.

Final word

Westpac’s hybrid has had a ‘notes’ facelift but the story remains the same: lots of downside risk, few legal rights and not a whole lot of extra return. If you’re keen to dance at the hybrid party, take a look at Westpac TPS as a ‘less worse’ option, otherwise continue to stay clear.