CBA launches first Basel III compliant Tier 1 hybrid
* Bonds majors to have a gauge of cost of capital under new rules
By John Weavers
LONDON, Sept 7 (IFR) - Commonwealth Bank of Australia is about to provide Australian banks with a proper gauge of how much it will cost to raise capital at home under new banking rules. The lender has launched the first Basel III compliant Tier 1 hybrid issued by an Australian bank in the local market.
The first impression is that it will not be cheap. No official price talk was included in the prospectus for CBA's Perpetual Exchangeable Resaleable Listed Securities (PERLS VI), but guidance has been released to institutional investors at 380bp-400bp over BBSW.
With three-month bank bill rates quoted late last week at 3.59%, guidance indicates the new notes will pay 7.39% to 7.59% initially. In comparison, five-year major bank senior unsecured paper yields less than 4.75%.
The new format also looks pricey when compared to old-style capital-eligible bonds. ANZ issued a USD750m 3.45% 10-year non-call five Tier 2 on July 31 at 290bp over Treasuries, while Westpac raised USD800m from a similar, 3.65% 10.5-year non-call 5.5 offering three weeks later at the same spread.
For now, the subordinated Tier 2 instruments qualify as transitional capital under Basel III until their first call dates. After January 1 2013, only more expensive, loss-absorbing subordinated bonds, like the new CBA Tier 1 hybrid offering, will count as capital.
Hence, CBA's PERLS VI are being closely watched by local banks. APRA rules require Australian ADIs to meet the revised Basel III minimum capital ratios and regulatory adjustments in full from January 1 2013, and to comply with the capital conservation buffer in full from January 1 2016.
The deadlines are two and three years earlier than the Basel III requirement, respectively. Under the accords, banks are to achieve a minimum Core Tier 1 (common equity) capital ratio of 4.5% by January 2015 and the additional 2.5% buffer (or 7% in total) by January 2019.
This is not a big burden in Australia, because the Core Tier 1 capital ratios of the Big Four Australian banks - ANZ, Commonwealth Bank of Australia, National Australia Bank and Westpac - already exceed 7% while these highly profitable banks can add up to 50bp to capital each year.
But, to add assets as they continue to grow, the banks may have to raise capital, making CBA's PERLS VI an important reference point for the fundraisings that will follow after January.
ANZ had already dabbled in Tier 1 capital. It issued AUD1.25bn (USD1.275bn) in hybrid Tier 1 convertible preference shares (CPS3) in September 2011. The securities, however, are not Basel III compliant because they do not include a required non-viability trigger event in addition to a capital-trigger event.
The CBA bonds, however, include a capital trigger, converting them into equity if the lender's common equity Tier 1 capital ratio falls to or below 5.125%, a clause that is already finding resistance among investors.
As of June 30 2012, CBA's common equity Tier 1 capital stood at AUD23.7bn and its common equity Tier 1 capital ratio under APRA's provisional Basel III rules 7.5%.
This represents a near 2.4% surplus above the capital trigger event. For the event to be activated CBA's common equity Tier 1 capital would have to fall by AUD7.5bn, to AUD16.2bn.
While holders of CBA's earlier subordinated bonds that are maturing in October can roll their bonds into the new PERLS VI, some are saying they will pass on the opportunity despite the buffer.
Almost AUD1.5bn of PERLS IV notes will be called in October and holders can reinvest their face values into PERLS VI. Those who do not wish to participate can sell their PERLS IV on ASX for cash by October 24, the notes' expected last trading day.
One investor who holds PERLS IV said he will not be reinvesting his money into PERLS VI. Given the level of risk, he intends to sell his PERLS IV and buy CBA shares with the proceeds. "They pay about 10% through dividend and franking credits versus the 7.5% or so that the significantly less liquid PERLS VI will deliver," the investor said.
"Although it provides more comfort than recent corporate hybrids, PERLS VI is still a deeply subordinated instrument that includes risks that coupons won't be paid and also, ultimately, that the principal may be lost.
"Its saving grace is that it is APRA-regulated with event risks clarified by Basel III regulations, while in the worst case scenario the notes will be converted to CBA shares so most of the capital outlay should be retrievable."
CBA said it intends to issue AUD750m (USD769.5m) but has the ability to raise more or less. However, expectations are for a larger deal.
Standard & Poor's has assigned a BBB- rating to the notes, four notches below CBA's standalone ratings with the agency of A and six notches below its AA- ratings for senior unsecured CBA bonds.
S&P stated that the rating reflects the securities' risk of subordination, the risk of partial or untimely payment, the distributable profits payment test and a contingency clause requiring mandatory conversion into common equity on the activation of a non-viability trigger.
The PERLS VI notes are callable on December 15 2018, while there is a mandatory exchange date on December 15 2020. The proceeds of the offer will be used to refinance PERLS IV with any excess to meet general corporate needs.
The margin is to be announced on September 11, once the bookbuild is completed. The offer opens on September 12 and closes at 5pm Sydney time on October 5 with the notes to be issued on October 17.
CBA and Morgan Stanley are arranging the offer with lead managers including ANZ, Goldman Sachs, Macquarie Capital, RBS Equities (Australia) and Westpac. Bell Potter Securities, Evans and Partners, Deutsche Bank, Ord Minnnett and RBS Morgans are co-managers.
(Reporting by John Weavers, Editing by Chris Langner, Steve Garton)
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