Westpac CPS: Suckers wanted
Recommendation
Amid a flurry of subordinated notes offers, Westpac is trying its luck with Convertible Preference Shares.
These rank lower than subordinated notes, both in terms of their position in the event of insolvency and in priority of distribution/dividend payments. As their name implies, preference shares are more like equity than debt.
The reason for the offer is clear enough: Banks want cheap, tier 1 capital but it’s getting harder to secure (see ANZ Subordinated Notes, published 20 Feb 11), hence this offer of equity-like funding at debt-like prices.
Key Points
- Equity risks and optional dividends
- 3.2%-3.5% margin is inadequate compensation for risks
- For bank believers, ordinary shares provide a better bet
This offer doesn’t warrant a long critique. It’s unimpressive, similar in form and fine print to last year’s CPS3 offering from ANZ and one we suggested you Avoid.
The finer details are much the same. The security is likely to pay dividends equal to the 180-day Bank Bill Rate plus a margin of 3.2-3.5% (a little higher than the 3.1% margin on CPS3), with the final margin set by a bookbuild on 23 February.
Discretionary dividends
Dividend payments are subject to the absolute discretion of both the Westpac board and the banking regulator, Australian Prudential Regulation Authority. Should the bank get into a tight spot, both would have few qualms halting dividends, which are non-cumulative and thus lost forever.
Instead, you’ll get a few soothing words from the Treasurer about how sacrifices need to be made to strengthen the Australian banking sector. Try using that to buy your groceries.
The maturity conditions are equally lamentable. In the best and most likely scenario, the securities will convert to ordinary Westpac shares on 31 March 2020. Cash would be preferable.
Should Westpac’s tier 1 ratio fall below 5.125% at any time over the next eight years, the security will automatically and immediately convert to Westpac ordinary shares. At exactly the time the stock is sinking like a stone and ordinary dividends are cut to zero, investors in Westpac’s CPS will be converted into ordinary shareholders.
It gets worse. If Westpac’s share price is less than half today’s (quite possible in a capital emergency) when such a ‘Capital Trigger Event’ occurs, a complex conversion formula effectively guarantees an immediate capital loss on conversion. It’s quite similar to the conversion conditions on the ANZ CPS3 and equally unimpressive.
Westpac Convert. Pref Shares | ANZ CPS3 | ANZ Sub. Notes | |
---|---|---|---|
Price | $100.00 | $98.31 | $100.00 |
Official ranking | Preference shares | Preference shares | Unsecured, subordinated |
Risk characteristics | Equity-like | Equity-like | Debt-like |
Distribution rate | 6 month BBR 3.2-3.5% | 6 month BBR 3.1% | 3 month BBR 2.75% |
Distribution type | Cash franking credits | Cash franking credits | Cash |
Compulsory distributions? | No | No | Yes - subject to solvency |
Cumulative? | No | No | No |
Principal repayment | WBC shares | ANZ shares | Cash |
Maturity date | 31 Mar 20 | 1 Sep 19 | 14 Jun 22 |
Easy decision
If you’re happy with these conditions—and we’re clearly not—then why not own the ordinary shares?
Bookbuild | 23 Feb |
Margin announcement and offer opening | 24 Feb |
Closing date (securityholder offer) | 19 Mar |
Closing date (broker firm) | 22 Mar |
Begin trading (deferred settlement) | 26 Mar |
Normal trading | 3 Apr |
First interest payment | 30 Sep 12 |
First optional conversion date | 31 Mar 18 |
Scheduled conversion date | 31 Mar 20 |
They currently offer a fully franked yield which ‘grosses up’ to 9.6% versus a grossed up starting yield of roughly 7.5-8.0% for this preference share.
The preference shares might be better protected against higher interest rates, but the ordinary shares hold the potential for capital gains and are more likely to profit from lower rates, too.
This isn’t an endorsement of the ordinary shares, on which we have a Hold recommendation (see review of 20 Feb 12) but, compared with these preference shares, they’re a less worse option if you happen to believe the local banking sector is rock solid.
If you’re not of that opinion, why give a bank cheap equity funding with no guarantee of dividends or repayment of principal? The question answers itself. AVOID.