AMP leads, others will follow

AMP has stepped up to the challenge and is going to test retail investor demand for a listed corporate bond - and should be well rewarded for doing so. The coupon has been set at a level that will attract a lot of interest from mums and dads, struggling with bank term deposit rates, and the success of this retail corporate bond issue should attract more retail bond issuance from the corporate sector.

The financial services group has clearly observed the success of the retail corporate bond market in New Zealand and for its inaugural $300 million subordinated debt raising, it is opening the issue to investors in both New Zealand and Australia.

AMP has said it will accept "more or less" than $300 million, which is just as well because retail demand in New Zealand is likely to exceed $300 million alone - see below for details on the success of the Contact Energy retail bond.

AMP was also, no doubt, encouraged by the retail investor demand for Westpac's recently launched SPS II hybrid security issue, which was upsized to $700 million from $500 million, the week before last. But the AMP Notes, as AMP's retail bonds have been named, are a "plain vanilla" and extremely rare debt security in the Australian market.

Australian retail investors have had little opportunity in the past to buy corporate bonds being largely limited to hybrid security issues, which combine features of both debt and equity. A high coupon is paid but it may be paid on an after tax basis with franking credits attached. The debt is deeply subordinated, ranking usually just above shareholders and behind most other creditors. Coupons can be deferred without accumulating and the return of principal invested is typically in the form of shares in the issuer.

AMP Notes will pay non-deferrable coupons on a pre-tax basis, maximising cash flow to the bondholder, and principal is repaid at maturity in cash. The AMP Notes are a subordinated debt security but not as deeply subordinated as a hybrid security.

New Zealanders are familiar with subordinated bonds or capital notes as they are known there. Just last month, unrated Fletcher Building issued NZ$132 million of capital notes with five and seven year maturities and a 9 per cent coupon. New Zealand Post is about to launch a NZ$200 million capital note issue.

The rating agencies deal with the issue of subordination through the notching applied to the credit ratings assigned to specific debt securities. For example: Westpac has a senior unsecured credit rating of 'AA' from S&P, the SPS II notes are rated two notches lower at 'A+'; AMP is rated 'A' by S&P and the AMP Notes are rated only one notch lower at 'A-' because the AMP notes are not as deeply subordinated. 

The AMP Notes have a ten year term to maturity but are callable after year five. AMP will have an incentive to call the notes at the end of year five as the credit margin applied over the reference rate for coupon payments will double and also the capital benefit AMP derives from the notes diminishes after that time. 

The notes will pay a credit margin set at 4.25 per cent to 4.75 per cent over the bank bill rate for the Australian bonds and over the five year swap rate for the New Zealand bonds. At this level the notes would have yielded between 7.5 per cent and 8 per cent on the Australian notes and between 8.4 per cent and 8.9 per cent on the New Zealand notes, at the time of announcement of the issue.

Only last month AMP issued $100 million of senior unsecured five year bonds, guaranteed by the Australian government. AMP paid a margin of 107 basis points over the five year swap rate on those bonds and after allowing for the 100 bps guarantee fee that AMP pays to the government, the credit margin on the five year senior debt is 207 bps.

AMP Notes are offering a further 218 bps-268 bps to compensate for the risks associated with subordination. This is in line with the additional spread that Westpac offered on its SPS II notes and should ensure strong demand from retail investors. (Westpac is more highly rated but the SPS II notes are more deeply subordinated.)