Investors desperate for fixed interest style investments with a little bit of yield will gobble up CommBank’s new hybrid securities issue, PERLS XII. Set to pay a fixed margin of 3% over the 90-day bank bill rate and an offer size in excess of $750 million, the final terms of the issue will be announced after a bookbuild on Wednesday.
Historically, a margin of 3% would be considered to be on the light side, particularly for an issue with a term of almost 7.5 years to the call date (see table below of CommBank’s PERLs issues over the last 7 years).
However, the environment for hybrid securities is very different today. Firstly, banks are stronger and better capitalised following APRA’s requirement that they become “unquestionably strong”. Secondly, Bill Shorten’s loss at the Federal Election on May 18 eliminated the franking credit fear, which impacted the demand for hybrid securities and would have made them less attractive to SMSFs and other low rate taxpayers. Finally, the RBA’s move to cut interest rates by 0.75% and the subsequent collapse in government bond yields has meant that there is an enormous thirst for lower risk, yield based investments.
The hybrid securities market has been starved of new issues, and despite the term of PERLS XII, I expect the issue to be met by very strong investor demand. Here are the details of the issue.
CommBank PERLS XII
CommBank PERLS XII Capital Notes will pay a quarterly, fully-franked distribution. This is calculated at a fixed margin of 3% over the then 90-day bank bill rate, and then adjusted by the company tax rate (to take into account the benefit of the franking credits). The distribution is re-calculated each quarter based on the then current 90-day bank bill rate.
With the 90-day bank bill rate currently around 0.85%, this implies a gross distribution rate of 3.85% pa for the first 3 months (0.85% plus 3%). The actual distribution in cash, which is adjusted down for the franking credit benefits, would then be 2.7% (3.85% x 0.7 = 2.7%).
If at the next quarter the bank bill rate has moved higher to 1%, the gross distribution for that quarter will be 4%. On the other hand, if the RBA continues to cut interest rates and the bank bill rate has fallen to 0.5%, the gross distribution rate will be 3.5%.
Distributions are discretionary and subject to distribution payment conditions. If a distribution is not paid, it doesn’t accrue and won’t subsequently be paid. To protect holders from this discretion being misapplied, Commonwealth Bank is then restricted from paying a dividend on its ordinary shares.
Exchange into CBA shares or Early Repayment
PERLS XII are perpetual and have no term. However, CBA must (subject to a test) exchange the PERLS XII Notes into CBA ordinary shares on 26 April 2026 (in about 7.5 years’ time). If exchange occurs, holders are issued $101.01 of CBA ordinary shares for every PERLS XII Capital Note of $100 face value (which effectively means that they are issued CBA shares at a 1% discount to the then market price). The test for the exchange is the price of CBA ordinary shares at the time – provided they are higher than approximately $40, exchange occurs – otherwise, it is retested on the next and subsequent distribution date(s) until the test is met.
To qualify as regulatory capital for CBA, two further events cause automatic exchange – 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 PERLS XII Notes into ordinary shares if CBA’s Common Equity Tier 1 Capital Ratio falls below 5.125% (the ratio was 10.7% on 30/6/19 and 11.8% on a proforma basis adjusted for announced divestments), 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 shares that can be issued.
CBA also has an option to redeem the PERLS XII Capital Notes early on 20 April 2027 (in approximately 7.5 years’ time) by paying holders $100 per PERLS XII Capital Note. This is at the Bank’s sole option (not the investor’s option), and as all previous issues of PERLS and other major banks’ Capital Notes have been “called” early, the secondary market will initially trade and price PERLS XII on the assumption that the Notes will be redeemed early for $100 in April 2027.
The table below summarises the offer details:
How to invest
Following a bookbuild by institutions and brokers on Wednesday that will set the final margin (the Bank has indicated a range of 3% to 3.2%, but it is absolutely odds on that it will be 3%), the Offer will open on Thursday 17 October. It is scheduled to close on Friday 8 November.
There are two offers: a Broker Firm Offer and a Securityholder Offer. Several brokers and financial planners are involved in the issue, including CommSec, Morgans, Morgan Stanley, Bell Potter, UBS, Evans Dixon and Ord Minnett. If you are investing via a broker or financial planner in the broker firm offer, they are receiving a selling fee of 0.75% of the proceeds invested and, in some cases, may be willing to share some or all of this with potential investors.
CBA shareholders and holders of PERLS VII, VIII, IX, X and XI can also access PERLS XII Notes directly through a Securityholder offer at www.commsec.com.au (you don’t need to be a CommSec client).
Don’t invest in something you don’t understand
Hybrid securities such as PERLS XII are complex investments. If a banking crisis happened in Australia or Commonwealth Bank got into real financial difficulties, investors could potentially lose most, if not all, of their capital. So it is important to understand the risks of investing and how the securities work.
You can learn more about hybrid securities at ASIC’s MoneySmart website (go to https://www.moneysmart.gov.au/investing/complex-investments/hybrid-securities-and-notes). Commonwealth Bank has also developed an interactive module on bank hybrid securities, which is available at www.commbank.com.au/about-us/shareholders/securities/bank-hybrid-securities-basics.html
As the old adage goes, don’t invest in something you don’t understand.
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 regard to your circumstances.