Australian banks ANZ and Westpac are said to be preparing Basel III-compliant bond issues in the domestic market as soon as this week, hoping to overcome the recent capital markets volatility by tempting domestic investors with a unique opportunity to achieve higher yields, say dealers.
On July 2, ANZ submitted filings to the Australian Stock Exchange (ASX) to sell an AUD750 million (US$687.8 million) Basel III-compliant bond to raise additional Tier I capital. The bond has a mandatory conversion date of September 1, 2023.
The bank released guidance of 3.4%-3.6% for the hybrid note, which will be sold on July 9. The structure includes a mandatory conversion clause to equity if ANZ’s core capital adequacy ratio should fall below a predetermined level or the Australian Prudential Regulation Authority’s (APRA) deems the bank unviable, in accordance to Basel III rules.
Westpac is rumoured to be following with Australia’s first domestic Basel III-compliant bond aimed at raising Tier II capital, as soon as this week, say Australia-based debt capital markets (DCM) bankers. A representative from Westpac declined to comment on the issue.
“There are a couple of rumoured issues in the domestic market which may appeal to retail investors who still have an appetite for yield,” said a Sydney-based debt banker at a bank considering an issue. “The markets have been more challenging following the FOMC [Federal Open Market Committee] meeting [on June 18 and 19] but there are opportunities for the high-grade banking names despite these conditions.”
Appetite for risk
In the direct aftermath of the FOMC meeting — in which US Federal Reserve (Fed) chairman Ben Bernanke discussed conditions which will lead the Fed to taper its quantitative easing programme — 10-year Australian Treasury bond yields rose 25 basis points (bp) to 2.67% on June 24 while the S&P/ASX 200 index dropped 4.7% to 4,632.3 points between June 19-June 24.
Corporate bond yields also rose to an average of 4.4% by the end of June from 4.1% by the end of May, according to Bank of America Merrill Lynch.
But as markets begin to recover from the June slump, helped by positive news out of China and Japan, dealers say high-quality banks have a favourable window to sell Basel III-compliant debt as investors look to reorganise their portfolios and refresh investment quotas after the 2012/2013 fiscal year’s end on June 30.
“We’ve seen that the search for yield has continued and there are some investors switching into equities, but there’s enough cash to invest into bonds, too,” said one Sydney-based DCM banker. “Investors are still cash-flush in the country. The investment environment has stabilised a bit in the past few days so it makes sense to look for the next opportunity.”
Basel III-compliant bonds carry higher coupons than vanilla bonds due to their riskier structures, which include compulsory write-down features to zero or a conversion into equity if a banks’ core capital adequacy ratios fall below a predetermined level or market regulators deem the bank unviable.
The latter feature is not included in Basel II-compliant structures, such as ANZ’s US$1.25 billion five-year fixed Tier I hybrid bond that it sold in November 2011 to global investors. This note, which yields 2.4%, contains a conversion to equity if the bank’s capital adequacy ratios fall below a predetermined point but does not if market regulators label the bank non-viable.
But despite the added risks, investors are keen to tap these higher yields as rates elsewhere remain low. And these upcoming bonds are particularly expected to attract retail investors as Australian deposit rates have dropped by approximately 1% in about eight months following the Reserve Bank of Australia’s four interest rate cuts through 2012 and one in May 2013 bringing rates to a record-low 2.75%.
“The fact that you get lower yields for your savings has really driven a lot of retail demand into the debt sector,” said the Sydney-based banker. “The interest is still predominantly driven by the excess cash in the system and then the very low deposit rates are still coming down. And that interest is going to continue while investors have difficulty finding yield anywhere else.”
Demand to drive pricing
Robust demand is also expected to help issuers. One banker noted that Commonwealth Bank of Australia (CBA), which sold an AUD2 billion Basel III-compliant, Tier I perpetual bond on September 12, 2012, paid 380bp above bank bill swaps (BBSW).
He expects ANZ to pay around approximately 300bp-330bp over BBSW, in line with Tier I bonds’ trading in the secondary market. And Westpac’s Tier II bond may look to margins of about 220bp-230bp.
“In the past six months spreads have come down a lot,” said the DCM banker. “There’s demand for something that’s a bit higher-yielding these days, and there’s especially interest for the big banking names which still feel are very safe. They have the easiest access the market because they’re well-known, which is quite important... Seeing a few of these names out of the gates may also mean others will follow, if they can price cheaply enough.”
ANZ, Citigroup, Commonwealth Bank of Australia, J.P. Morgan, National Australia Bank and RBS Morgans will act as joint lead managers for ANZ’s Tier I hybrid bond. Bell Potter, Morgan Stanley Wealth Management and Ord Minnett have been appointed as co-managers.