Morningstar has recommended that investors not subscribe to the latest hybrid issue, Westpac’s Capital Notes 5, arguing that the indicative price range is “not compelling”
Westpac is raising more than $1 billion of new capital through an issue of perpetual, subordinated, convertible notes.
Investors will receive a margin over the bank bill swap rate of 3.2 per cent. The 90-day bank bill rate is currently around 1.8 per cent. Distributions are expected to be fully franked.
If the notes are issued at a margin of 3.2 per cent and the 90-day bank bill rate is around 1.8 per cent, taking the tax effect of the franking credits into account, the distribution rate would be around 3.5 per cent fully franked.
The notes will qualify as additional tier 1 regulatory capital and will comply with APRA prudential standards. This means that Westpac must convert all or some of the notes into ordinary shares if there is a capital trigger event or non-viability trigger event.
The notes have a scheduled conversion date of September 2027 and the bank has an option to convert or redeem the securities in September 2025. In effect, this gives them a seven and a half year term.
The offer opens on February 13 and closes on March 6. The first distribution will be paid on June 22.
In a review of the issue, Morningstar says: “We hesitate to recommend an issue that is offering a yield similar to comparable shorter-dated securities and lacks a new issue premium at a time of increasing global market volatility.”
It says there is not sufficient return for the “extra term to call risk” involved in the seven year-plus term.
It says its preferred exposure to Westpac’s capital structure is its ordinary shares, which are trading on a grossed-up dividend yield about 350 basis points higher than the hybrid yield to call.
Hybrid securities have been in demand over the past couple of years and this has brought down the margin on offer for investors. In March 2016, Commonwealth Bank issued PERLS VII Capital Notes with a margin of 5.2 per cent over bank bills.
Another factor in the tight pricing trend has been a fall in issuance. Morningstar expects that $1.5 billion to $2.5 billion of hybrids will be issued this year.
Morningstar does not expect this tight pricing to last.
“With a backdrop of potentially increasing long-term global bond yields, pressure will be on the minds of many issuers to consider coming to market before the minimum required rate of return increases too quickly.”