CBA’s jumbo issue will be gobbled

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Yield investors are set to plough into the latest hybrid issue from Commonwealth Bank, PERLS VII Capital Notes. The $2BN + issue is set to be a record for the hybrid market, as it is accompanied with a re-investment offer for the holders of the PERLS V securities.

At a likely margin of bank bill plus 2.8%, this is lower than recent new issues (Westpac issued in June at a margin of 3.05%), although due to the insatiable demand for yield, it is above where hybrid securities have been trading recently on the secondary market through the ASX. To give a slightly longer-term perspective, CBA issued PERLS VI at this time two years ago – then paying a margin of 3.8%.

The PERLS VII Capital Notes are structured to ensure that they qualify as ‘Additional Tier 1 Capital’ for the Commonwealth Bank, and employ very similar structures to the Westpac Capital Notes (WBCPD or WBCPE), ANZ Capital Notes (ANZPD or ANZPE), National Australia’s CPS (NABPA or NABPB) and Commonwealth’s PERLS VI (CBAPC).


PERLS VII will pay a quarterly floating rate distribution, which is expected to be fully franked. The distribution is set every three months at a fixed margin over the 90 day bank bill rate, and then adjusted for the company tax rate (to take into account the franking credit benefits). The indicative margin for this issue is in the range of 2.80% to 3.00%.

With the 90-day bank bill rate around 2.64%, this implies a gross distribution rate of 5.44% pa for the first three months (2.64% plus 2.80%). The actual distribution in cash, which is fully franked, would then be 5.44% x (1 – Company Tax rate) = 5.44% x 0.70 = 3.81% pa.

The payment of any distribution is discretionary and subject to the distribution payment conditions being satisfied. If a distribution is not paid, it doesn’t accrue and won’t subsequently be paid. To protect PERLS VII holders from this discretion being miss-applied, if a distribution is not paid, CBA is restricted from paying a dividend on its ordinary shares.

Exchange into CBA shares

PERLS VII Capital Notes are perpetual and have no term. However, CBA must (subject to a test) exchange the Notes into ordinary shares on 15 December 2024 (in about 10 years). If exchange occurs, holders are issued CBA ordinary shares at a 1% discount to the then weighted average market price. The test for the exchange is the price of CBA ordinary shares at the time – provided they are higher than approximately $44.80, exchange occurs – otherwise, it is retested on the next and subsequent distribution date(s) until the test is met.

To qualify as Additional Tier 1 capital, there are two further mandatory exchange events – a ‘capital trigger event’ and a ‘non-viability trigger event’. Under these tests, the Australian Prudential Regulatory Authority (APRA) can require CBA to immediately exchange the Notes into ordinary shares if CBA’s common equity tier 1 capital ratio falls below 5.125% (the ratio was 9.3% as at 30/6/14, a surplus of about $14.1 bn), or if it believes CBA needs an injection of capital to remain viable. In these distressed circumstances, exchange would most likely result in a holder receiving considerably less than $100 of CBA ordinary shares as there is a cap on the maximum number of ordinary shares that can be issued.

CBA also has a “once” only call option on 15 December 2022 (in about eight years), when it can elect to redeem the Notes by paying holders the face value of $100.

Details of the issue are as follows:

The institutional book build next Monday will set the final margin (likely to be 2.80%).

CBA shareholders and PERLS Note holders are eligible to apply under the Securityholder Offer. Alternatively, most brokers in town are on the ticket – with firm offers available through Morgan Stanley, JP Morgan, UBS, Westpac, ANZ, Bell Potter, Deutsche and Ord Minnett.

Bottom Line

While this issue is attractively priced compared to issues trading on the ASX, at some point not too far into the future, we will reach the end of the cycle and the compression of spreads. For comparison purposes, equivalent pre-tax yields (with franking credit gross up) are a CBA 90 day term deposit at 3.0%, PERLS VII at 5.44% and CBA ordinary shares at 7.05%.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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