Investors may have seen a lot in the news lately about the Big Four banks' 'capital requirements' and how each of the banks requires x many billion dollars to satisfy funding requirements.
(You can learn more about banks' capital requirements in this article here)
One of the ways that banks like Commonwealth Bank of Australia (ASX: CBA) and National Australia Bank Ltd. (ASX: NAB) are raising funds is through capital raisings, i.e. by issuing new shares to investors at a discount to the market rate.
Commbank is actually the most recent of the big four banks to undertake such a raising, following Australia and New Zealand Banking Group (ASX: ANZ) three weeks ago and NAB back in May. Readers can find out more about these raisings by following the hyperlinks to the articles.
Westpac Banking Corp (ASX: WBC) has taken a slightly different tack and elected to raise some funds in the form of a 'hybrid security' issue to retail investors. Called 'Capital Notes III', these hybrid securities are effectively a 'loan' from the investor to the bank, who agrees to pay a certain percentage of interest per annum and packages the loan like a stock, allowing investors to sell out of their debt when they choose.
The application for Capital Notes III closes at 5pm, August 27. Unfortunately, while the payments of 4.55% per annum sound appealing, there are a lot of drawbacks and I recommend that investors avoid them entirely:
- They rank slightly above ordinary shares, but below all other forms of debt
- In the event of Westpac becoming unviable or its capital buffer falling too low, hybrids are converted into ordinary shares
- Hybrid payments are quarterly and fully franked, but lower than Westpac's ordinary dividend which is 6%p.a. at the moment
- The bank might redeem your notes and refund your money in 2021 or 2023 – or it might not
- The bank might convert your notes into shares in 2021 or 2023 at a 1% discount – or it might not
- Additionally, you miss the exposure to growing earnings over time (though you are also protected – kind of – if earnings fall and Westpac's dividend drops below 4.5%)
- Payments are not guaranteed and in fact the decision to pay or not is solely at Westpac's discretion
In short, it looks as though investors are being saddled with all of the risks and none of the benefits of owning ordinary shares. As I wrote in my earlier article, if you're interested in exposure to Westpac you'll likely be better off just buying ordinary Westpac shares.
