Genworth's tier two issue may be an abuse of the write-off provision

An issue of tier two capital from Genworth Financial Mortgage Insurance Australia Limited has set an unfortunate precedent in not providing for conversion to equity if a point of non-viability is triggered.



On Friday, Genworth announced that it had sold A$200 million of A- rated tier two subordinated notes at a margin of 350 basis points over bank bills. The notes will mature on July 2025 and can be called in July 2020.



The notes were issued by wholly-owned subsidiary Genworth Financial Mortgage Insurance Pty Ltd and will be written-off at the point of non-viability. There is no provision for conversion into equity.



Yet, Genworth Financial Mortgage Insurance Australia Limited (GMA) is an ASX listed company. At the point of non-viability the notes should convert into GMA shares.



Macquarie Group Limited does this with the hybrid notes issued by Macquarie Bank. But the Genworth notes will place shareholders ahead of noteholders at the point of non-viability.



Unless there is some other protection built into the notes, noteholders will be wiped out but, if viability is then restored, shareholders will remain intact and will go on to receive dividends.



Noteholders face the moral hazard that shareholders have no incentive to avoid an event of non-viability. Indeed, it may well be in shareholders' interest that this occurs.



Surely this is an abuse of the write-off provision. At the very least, it is an unintended consequence.

Imagine if we could all borrow knowing that if things go badly we can simply write-off the debt.