Following recent 'hybrid' issues from ANZ (ASX: ANZ) and Westpac (ASX: WBC), now the Commonwealth Bank (ASX: CBA) is seeking to raise $750m through its sixth series of Perpetual, Exchangeable, Resaleable, Listed, Subordinated ("PERLS VI") unsecured notes. These have a $100 face value and are a floating rate note with a margin to be determined by a "bookbuild" this week and due to be announced on the 11th September. The margin is expected to be around 3.7% – 4% which is added to the then current ninety-day bank bill swap rate to determine each quarterly distribution.
The offer is structured such that certain applicants have priority. Holders of the older PERLS IV are at the top of the list giving them a chance to roll over their investment because PERLs IV mature in October. Clients of syndicated brokers are next in line, followed by Commonwealth Bank shareholders and note holders then customers and then everybody else who is resident in Australia. Even though the bank has the option to increase the size of the issue and is expected to do so, lower priority applications may be scaled back. If you decide that you are interested in applying, you might want to do this through a broker rather than directly. For example, E*Trade is encouraging clients to pre-register any interest.
When it comes to getting your money back, you don't have any opportunities to redeem your PERLS VI but CBA may redeem them practically whenever it wants. Although they are called "Perpetual", the documentation flags a probable redemption for cash in December 2018, or, if that hasn't happened, a conversion into ordinary shares two years later. In the meantime, the notes will be listed on the ASX so you can always sell them but the price can vary. Recent offerings such as ASX: ANZPC from ANZ currently trades at $96.65, ASX: TAHHB from Tabcorp (ASX: TAH) at $99.50 and ASX: AGKHA from AGL Energy (ASX: AGK) at $100.15.
There is a lot of small print in the offer documents and we would encourage you to read and understand all the conditions before investing but let's highlight a few salient points:
- While you might not think that it is very likely that the Commonwealth Bank is going to get into financial trouble, if that does happen these notes are going to convert into ordinary shares. A new and unusual feature of this offering is that the bank regulator, APRA, has a role to play. APRA is particularly keen to protect depositors and, if various bad things happen to the bank, can convert these notes to shares to shore up the bank's capital base. While examples of some of the bad things that would cause this are listed in the offer document, it also goes on to say "Whether a Non-Viability Trigger Event occurs is at the discretion of APRA – there are currently no precedents for this"!
- There are some conditions as to how many shares are issued on conversion. If the share price is too low in 2020, conversion may be delayed but there are circumstances where your note is converted into less than $100 worth of CBA shares.
- The quarterly payments are non-cumulative. If the bank doesn't make a payment, it does not have to make it up. If this happens, the bank cannot pay dividends to ordinary share holders until it recommences payments but can keep making payments on its older notes so, in some sense, this PERLS VI ranks behind other outstanding PERLS.
- The distributions are franked which means that you don't get the headline rate immediately. The rate quoted includes the franking, it doesn't come on top, so you get the cash distribution less the company tax rate (currently 30%) each quarter and then you claim the franking credits from the ATO when you submit a tax return.
Foolish takeaway
The most likely scenario is that investors in PERLS VI notes get their money back in 2018 without any drama and a margin of about 3.8% is probably fair enough for the real risks involved.
However, if you really want safety, with a guaranteed return of capital, you should be looking at term deposits.
If you want yield and you think that the bank is safe, last year the Commonwealth's ordinary shares paid a $3.34 fully franked dividend which grossed up represents a yield of 8.4% on a share price of $55. These notes have a lower yield than that if the bank swap rate is 3.56% and the margin is 3.8%.
You would expect the share price for the notes to be less volatile than the price of the normal shares but, while you reduce the downside risk, you haven't eliminated it. If serious problems happen, the equity style risk is still there and you have given up the possibility of any real capital gains.
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Motley Fool contributor Tony Reardon owns the recently issued hybrids from ANZ and Westpac mentioned in the beginning of this article, as well as shares in ANZ and CBA. The Motley Fool's purpose is to help the world invest, better. Take Stock is The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it's still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
