Hybrids: ANZ cuts non-innovative premium
ANZ combined a number of features on its latest tier-1 deal that allowed it to cut the premium an issuer normally pays to access institutional investors without a coupon step-up at the call date. The £450 million ($898 million) tier-1 perpetual paper was ANZ’s first sterling capital security.
As more and more borrowers reach the 15% limit (of total tier-1 capital) for so-called innovative debt – that is, bonds with coupon step-ups – issuing non-innovative hybrids is the only option remaining.
Traditionally only retail investors have felt comfortable with the extension risk that the lack of a coupon step-up at the call date theoretically results in. Over the past three or so years, the sheer depth of demand for credit has encouraged institutional investor to accept this risk. However, they have demanded a premium
The ANZ deal, led by Citi, Deutsche Bank and UBS, takes advantage of the fact that Australian issuers are able to have features where the security converts into shares provided there is a limit to the amount of equity dilution that occurs at that point. So the bond has a mandatory conversion at year five subject to these dilution limits. If the mandatory conversion breaches the conversion limit, then the bond resets at the same spread for another five years.
This feature allows the bond to continue to qualify as tier 1 because conversion results in the security being replaced with high-quality equity capital. This structural feature gives investors confidence that the bond is highly likely to have a five-year maturity, with there being a small risk of extension in the event of a very poor share price performance by the bank.