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News and Education

First time to market offers value

by Eliabeth Moran | Feb 11, 2014

Key points:

  1. Generally a new issuer or new bond structure will mean the issuer will pay a premium to ensure the bond’s success. This can mean a quick profit for investors who buy into the new issue.
  2. The current spread of the Bendigo and Adelaide subordinated bond is around 235bps and indicative of where other regional banks could issue.

First time issuers of bonds or new bond structures draw attention in bond markets. Generally, anything new will mean the issuer will pay a premium to ensure the bond’s success. Late January, Bendigo and Adelaide Bank (Bendigo) became the first bank to test the wholesale market with a new subordinated bond.

The bond meets new global standards aimed at increasing minimum reserves (capital requirements) to reduce the risk of failure of banks and contagion to governments. In the past, bank subordinated bonds had similar terms and conditions to the higher ranking senior bonds, but now differ and must include a “non-viability” clause. The clause gives the Australian Prudential Regulation Authority (APRA) the right to deem a bank “non-viable” and this in turn would mean these securities would either convert to shares of the bank or be written-off, based on the terms of the particular issue.

The clause presents a new risk that needs to be compensated for in the return offered.

Prior to the new issue, the market was uncertain wholesale investors would bid for the bonds with many believed to be constrained by the possible, but unlikely, conversion to shares. With no direct comparables in the market, Bendigo offered an attractive rate of return to ensure the bond’s success.

Bendigo sought to raise $200m of floating rate notes with a first call in 2019 (Bendigo has the option to repay at that time) and final maturity in 2024 (if not called). Pricing guidance was in the range of 285 basis points (bps) (100 basis points = 1 per cent) to 300bps over the benchmark bank bill swap rate (BBSW).

The floating rate bond, unusual in current markets where many recent issuers have taken advantage of low rates to lock in fixed price borrowing, coupled with the fact the bond was the first at the subordinated debt level to be issued under new Basel III regulations in the wholesale market, meant the bond had scarcity value.

Demand for the bond was $500m, significantly higher than the $200m sought and Bendigo upsized the issue to $300m; still leaving some pent up demand. Further, demand also warranted a reduction in the spread (cost of borrowing), below the indicated range at BBSW+280bps.

The current price of the bond has risen as investors are prepared to pay more and earn less, giving those that bought the bond at first issue a profit if they decide to sell. The current spread is around 235bps and indicative of where other regional banks could issue. Equally, it provides a guide to the major banks on the pricing the market would accept if they were to issue a new subordinated bond in the wholesale market.

Bendigo and Adelaide Bank subordinated floating rate bonds retains their scarcity value being one of the few longer-dated floating rate bonds available to retail investors with a decent projected return, currently around 6.17%.

The major banks will take heart from the new Bendigo issue. The first major bank to issue subordinated bonds in the wholesale over the counter market may offer a premium to ensure its success; worth watching if you are an investor.

Note: This article was written for The Australian last week. Prices quoted were accurate as at 6 February and may have changed.