Narrow pricing on ANZ hybrid

Philip Bayley

The mismatch in the approach of banks, as borrowers, to retail and professional investors is getting a workout this week, courtesy of marketing for ANZ’s latest convertible preference share issue (CPS3).

ANZ announced its third hybrid security issue last Tuesday. The retail offer opens on Wednesday, though the bookbuild will take place tomorrow.

The bank is proposing that the CPS3 pay a coupon based on the 180-day bank bill rate, plus a margin of 310 to 330 basis points. (The coupon will be fully franked and therefore paid on an after-tax basis.)

Financial advisers and others marketing the hybrid are promoting the proposed interest rate as “high yielding”, a claim that requires some analysis. (The investment newsletter Funds Focus, from financial planner Wealth Focus, is an example of the genre.)

One rationale for the pricing relativity proposed by ANZ for the CPS3 may be the margin paid on the CPS2 hybrid securities, sold by the bank in late 2009. The CPS2 paid a spread of 310 bps, but this was over the 90-day bank bill rate and therefore paid on a quarterly basis. 

Moreover, when this margin was set, in November 2009, credit spreads for bank risk had contracted considerably from the widest levels seen at the height of the GFC. At that time, credit default swap spreads for five-year senior ANZ risk were running at around 70 bps.

CDS spreads for ANZ are currently at more than 190 bps, with spreads for subordinated debt risk at more than 280 bps.

The comparable SPSII hybrid securities issued by Westpac, in March 2009, were issued at a margin of 380 bps over 90-day bank bills. At that time, CDS spreads for five-year senior bank risk were around 190 bps, exactly where they are now.

On this basis alone, a more appropriate margin for ANZ’s CPS3 hybrid securities would be 380 bps over the bank bill rate, though this doesn’t allow for the increase in risk posed by the capital conversion trigger.

As for more attractive options available to retail investors, Commonwealth Bank’s PERLS IV hybrids are offering a gross yield to maturity that gives a spread of more than 350 bps over the 90-day bank bill rate, and they have only a little over two years to run before “conversion” and no capital conversion trigger of the type ANZ has had to include to meet Australian Prudential Regulation Authority requirements.

Another option for any investor considering the ANZ hybrid is ANZ shares. These are currently yielding more than 9.5 per cent per annum, after grossing up the franking credits and making the assumption that the ordinary dividend is as likely to be paid as that promised on the CP3 hybrid.