SYDNEY, Nov 26: Australian banks are preparing to issue a flurry of hybrid debt instruments in early 2014 thanks to red-hot demand from self-managed retirement funds and a quirk in the local tax code that makes hybrids a cheap way for banks to borrow.
Sales of listed hybrid securities are expected to kick off with gusto in 2014 after National Australia Bank (NAB), the country’s largest lender by assets, last week doubled its planned convertible preference share issue to at least A$1.5 billion ($1.37 billion). The deal will be finalised in mid-December.
Hybrid securities combine features of both debt and equity but those now being issued in Australia qualify as equity for accounting and tax purposes, and are traded on the Australian Securities Exchange.
This year has been big for listed hybrid issuance with Thomson Reuters data showing more than A$8 billion of issuance, mostly by Australian banks.
Issuance is likely to accelerate next year as a key group of investors — individuals who manage their own pension funds — keep asking for more.
‘I don’t see any slowdown in growth of self-managed pension funds and that money needs to be put to work,’ said Nick Chaplin, NAB’s head of hybrid and structured debt capital markets origination. He expects between A$9 billion and A$10 billion of listed hybrid offers in 2014.
About A$500 billion, or almost a third of the nation’s total retirement savings, is self-managed by investors who avoid paying fees to professional managers. Self-managed funds are the fastest-growing segment of the pension system and are tipped to rise to 40 percent of the total pool by 2018.
Even after NAB increased its issue and offered to pay the lowest possible margin from the offer’s initial marketing range, some investors could still not get as much of the issue as they wanted, a banker involved in the offer said.
Australian banks are expected to account for most of 2014’s local hybrid issuance because they need to boost their Tier 1 capital — secure liquid assets banks must hold to ensure minimum capital adequacy — which global regulators keep increasing to avoid a repeat of the 2008 financial crisis.
About A$5 billion of hybrid securities will mature in 2014, so a flurry of new issues is expected early in the year, said Phil Bayley, a debt capital market consultant at ADCM.
AMP Bank, Australia & New Zealand Banking Group , Westpac Banking Corp, Bendigo and Adelaide Bank and Commonwealth Bank of Australia have hybrids maturing in coming months, according to ThomsonReuters data.
The hybrid’s biggest drawcard for investors is its franking credit, a tax break mostly restricted to retail investors.
Introduced in the 1980s to encourage mums and dads to buy shares, franking credits exempt investors from paying tax on dividends if the company has already paid income tax.
Australia and New Zealand are the only two nations in the developed world that offer the benefit on equity investments.
Another big attraction underpinning demand for hybrid securities is the relatively high returns they offer.
‘In a low interest rate environment, they give people an attractive yield compared with term deposit rates,’ said Barry Sharkey, co-head of capital markets at UBS.
NAB’s hybrids are expected to pay an initial annual dividend of around 5.83 percent, compared with bank term deposit rates of about 4 percent.
But even with such a yield, NAB paid far less for its funds than it would have in international wholesale markets. For example, UK-based Barclays Capital this month issued US$2 billion of Tier 1 securities at a yield of 8.25 percent. (agencies)
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