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Perls VI - The newest regulatory hybrid

by Emma Jenkin | Sep 05, 2012

CBA have launched their much anticipated Perls VI – the latest bank hybrid that will qualify as Tier 1 capital under the Australian bank regulator’s (APRA) draft Basel III standards. The CBA are looking for $750m but if previous issues are a guideline investors should expect to see a number print at $1.5bn+. This offer is open to the general public and also provides investors of Perls IV the option to roll-over into the Perls VI or have their securities redeemed.

The Perls VI have been structured under the new global banking regulations (Basel III) created in response to the global financial crisis to increase the strength of the banks and their ability to withstand adverse events, without requiring the government to step in, to survive. The relevance for hybrid investors is that Basel III requires securities to have increased loss absorption features – for investors this means securities will convert into equity in times of distress and this may be accompanied by a loss of capital if the share price has decreased substantially (typically more than 50 to 80% from time of issue). While under current market conditions this is unlikely for the CBA it is a risk that investors should assess when deciding if the coupon compensates for the risk involved.

The key terms of the Perls VI are

  • A discretionary distribution of BBSW + 3.80%-4.00% including franking. There is a dividend stopper on ordinary shares, however, it only applies until the next Perls VI distribution payment is made (three months). This is an APRA requirement and provides investors with less protection than the 12 month dividend stopper applied to older Tier 1 securities (including ANZPA, CBAPA & WBCPB)
  • Mandatory conversion into ordinary equity on the 15 December 2020 subject to ordinary share price hurdles set around $30. Where this is not met the Perls VI will remain on issue until the share price is above the hurdle on a subsequent distribution payment date and then they will convert
  • CBA has an option to redeem the Perls VI on 15 December 2018. This is CBA’s “absolute discretion” and subject to APRA approval. The market expects CBA to redeem on this date and the securities are priced to this date, however, investors should be aware that it isn’t certain in times of difficulty. If for whatever reason the first call date is missed, the securities face mandatory conversion to equity on 15 December 2020, subject to conditions stated above
  • Conversion into ordinary shares if CBA becomes non-viable or the Core Tier 1 equity falls below 5.125%. These are both referred to as trigger events and are the key loss absorption features that investors need to assess before purchasing the hybrids. If either of these events occur, investors may receive less than $100 of shares per $100 hybrid value. The non-viability trigger is a new term and there is no precedent for these trigger events. The definition of the non-viability trigger includes a public sector injection of capital or equivalent support to prevent the bank becoming non-viable and is at APRA’s discretion. Investors should be cognisant of this risk and on this point CBA states, “it is important for investors be comfortable with the fundamental strength of the bank”

The Perls VI deal is the first issue from one of the big four banks that complies fully with the new regulatory regime and is being offered at levels that partially reflect the additional risks that investors are taking. Similar issues earlier this year were priced at BBSW + 3.25% and have cheapened with the yield moving out to BBSW + 3.8% to 4.0%. In the absence of a large institutional component driving the pricing in the bookbuild process it is difficult to assess the additional return investors should receive for these new loss absorption features. The over-the-counter (OTC) point of comparison is the more debt-like old-style Tier 1 step-up security, the NAB Caps, that are trading in the secondary market at Swap + 4.2% suggesting there remains a gap between retail and institutional markets on the price of risk.

For more information about NAB Caps, please call your local dealer.