Keeping up appearances on hybrid notes

Is the market for listed Additional Tier 1 capital notes (hybrids) issued by the banks suffering from indigestion?

How is it that ANZ Bank can announce yesterday that it had increased the size of its Capital Notes 3 issue to A$850 million from $750 million, and priced the issue at the tight end of the indicated 360 basis points to 380 bps credit margin range, when the price of the CBA PERLS VII hybrid notes closed on Tuesday at $95.75?

For PERLS VII investors the notes have delivered a capital loss of 4.25 per cent to date and, according to a rate sheet from Morgans (a joint lead manager to the Capital Notes 3 issue), at that price the trading margin on the notes sits at 370 bps - smack bang in the middle of where ANZ indicated it would price its Capital Notes 3.

For investors considering the Capital Notes 3, the PERLS VII notes offer a better return and a shorter term to maturity.

Typically a new note issue will price at a discount to comparable issues available in the secondary market. This encourages investors to make room in their portfolios to take up the new issue, which is offering a better return than the notes that are being held.

Clearly, this is not the strategy being pursued by ANZ. The bank expects its Capital Notes 3 to sell at a premium to comparable securities available in the secondary market.

Is this a vote of confidence in the salesmanship of the joint lead managers of the issue, or is it a cynical hope that the return being offered looks even better after a 25 bps interest rate cut by the RBA the day before, given an increasingly desperate search for yield? CBA PERLS VII investors did not think their hybrid notes looked any better after the RBA's rate cut.

Moreover, the 180 day bank bill rate on which the coupon will be based, has absorbed more than the 25 bps cut, as it has fallen since the Capital Notes 3 issue was first announced. On the Friday before the Australia Day long weekend, when ANZ announced its intention to issue the notes, the 180 day bank bill rate closed at 2.70 per cent per annum.

At that rate, the Capital Notes 3 issue was offering investors a pre-franking coupon of 6.3 per cent per annum, based on a credit margin of 360 bps. At the close on Tuesday, the 180 day bank bill rate had fallen 30 bps to 2.4 per cent per annum.

The initial pre-franking coupon being offered on the Capital Notes 3 is now just 6.0 per cent per annum. It will be even lower by the time the rate for the first coupon is set on March 5.

As pointed out in Banking Day on Monday, the listed interest rate securities market in which retail investors participate is becoming increasingly unbalanced.

Of the $32 billion face value of listed notes issued by financial institutions, 75 per cent are hybrid notes. This proportion is about to increase.

The question of how much more hybrid issuance the listed market can absorb remains a valid one to ask.
 
ANZ is clearly determined to sell its Capital Notes 3 in the volume specified and at the price set, but is this a case of trying to give the appearance of a successful issue? NAB, which is expected to announce its own hybrid issue today, may well benefit from ANZ's efforts to keep up appearances and try to do the same.

In the short term, ANZ has removed some of the pricing pressure that might have been felt when NAB announces the indicative credit margin for its new hybrid notes. NAB should also be able to undertake the bookbuild for its issue before the Capital Notes 3 start trading on the ASX.

But the extent of the market's indigestion from too many hybrid note issues will become apparent when trading in the new hybrid notes begins.