Considerations for investment – a closer look at ANZ CPS 2

Key point:

1. Three key considerations for assessing investments:
   1. Does the return compensate for the risks involved?
   2. Compare similar securities in the market and their margins over BBSW
   3. Revise your current portfolio

Last week ANZ announced its intention to issue new Capital Notes to raise fresh Tier 1 hybrid capital as well as replace the existing ANZ Capital Notes 1 (ANZPB) which are eligible for call or mandatory conversion in June 2014.  

ANZ aim to raise $1bn but the amount may be more or less depending on demand. The new Capital Notes 2 are considered higher risk than the older notes as they contain a non viability provision (like the Bendigo and Adelaide subordinated debt discussed last week) as well as a common equity capital trigger, where the notes would convert to shares should ANZ’s Common Equity Capital Ratio fall below 5.125 per cent. ANZ can redeem the Capital Notes 2 after eight years and mandatorily convert the Notes to ANZ ordinary shares after 10 years, subject to certain provisions.

The offer is open to retail and wholesale investors and the notes will be listed on the ASX. Indicative margins are between 3.25 per cent and 3.40 per cent (including franking credits) per annum. Using the current 180 day bank bill swap rate (BBSW) of 2.67 per cent, the estimated income (gross of franking credits) for the first quarter will be 5.92 per cent to 6.07 per cent. The rate is attractive and ANZ are a large reputable institution, and for some this will be sufficient to make an investment decision, but I think a few more considerations should be taken into account.  

How do you begin to assess the investment?

1. Ask yourself if the return compensates for the risks involved

The ANZ offer document outlines all the risks and is worth taking the time to read those sections. The most significant risk is the capital trigger and conversion to shares. A breach of the 5.125 per cent level would be widely reported and the conversion to shares would occur to increase that ratio back to more acceptable levels. The second assessment of risk is the consequence for your investment. Should the trigger be breached and the hybrids convert, investors would likely lose some if not all of their investment. Lastly, you need to make a judgement about the likelihood of it occurring. In this instance, I would say it is very low.  Other risks include: non viability, loss of income and the possibility of the notes being perpetual (have no repayment date) should the earlier repayment or conversion clause not occur.

2. Compare similar securities in the market and their margins over BBSW

The ANZ Capital Notes (ANZPD) issued last year, with similar terms and conditions are trading at a margin of 3.38 per cent, towards the high end of Notes 2 range. NAB’s two note issues NABPA and NABPB are trading at margins of 3.23 per cent and 3.27 per cent respectively; the difference due to shorter terms until redemption or conversion of six years for NABPA and seven for NABPB. By this stage you should have an appreciation of the risk and return and relative value, but there are a few personal steps I would recommend.

3. Revise your current portfolio

One of the keys to success in investing is diversification. Spreading risk between asset classes, geographical locations, industrial sectors, and individual companies is the key to success. What is your current allocation to major banks: term deposits, bonds, hybrids and shares? Research from Bank of America Merrill Lynch stated local banks account for nearly 60 per cent of Australian shareholder’s direct share holdings and that’s without deposits or hybrids. Are you comfortable with a higher allocation?

How does the investment impact the overall risk of your portfolio? Does the return and the level of income help meet your objectives?

While the ANZ CPS 2 risks are high, they are unlikely. ANZ has always called (repaid) their securities at the first opportunity. The return, given similar securities, is deemed fair value. Is the ANZ CPS 2 appropriate for your portfolio? Only you can make that call.

Note: Tier 1 means that the notes contribute to ANZ capital requirements. They are issued to help protect the bank and investors higher in the bank’s capital structure.