Yesterday I received an offer – through my brokerage account – to participate in Westpac Banking Corp's (ASX: WBC) 'Capital Notes III', a hybrid security capital raising.
What's that?
A 'hybrid' is a financial device, so named because it combines elements of debt and equity instruments. Investors 'loan' money to a business in return for an agreed interest rate in return; the debt is packaged in a form that allows it to be traded like a stock.
Westpac's offering is similar to Commonwealth Bank of Australia's (ASX: CBA) better-known PERLS series and the purpose is the same; to raise further capital in order to fulfil its regulatory requirements by tapping retail investors.
What's on offer?
- Quarterly distributions, fully franked
- Paid at a rate of (90 day bank bill rate + Margin) x (1 – tax rate) – more on this below
- Possible 'Redemption' (repayment of notes) at bank discretion in 2021
- Possible 'Conversion' of notes into shares at bank discretion in 2021 or 2023
- If not Redeemed or Converted, notes will last in perpetuity
- Automatic conversion into shares if bank becomes unviable or its capital buffer becomes too low
- Reading the prospectus is a MUST for interested investors
Should I participate?
No. Like most other hybrids, they're not a good opportunity for the average investor because it's the bank getting a good deal here, not you.
Quarterly distributions sound nice but ordinary shares pay better. Currently, the 90 day bank bill rate is 2.13%, the Margin offered by Westpac is 4-4.2% and Westpac's tax rate is 30%. Using the prospectus formula to calculate potential payments I get:
(2.13 + 4.2) multiplied by (1 – 0.3) = 4.55%. That's a decent yield and it's fully franked, but ordinary Westpac shares right now pay 5.4% – also fully franked. Put one red cross beside the hybrid offer.
The bank might redeem your notes and refund your money in 2021 – or they might not. Alternatively, Westpac might convert your notes into shares in 2021 or 2023. They'll convert into ordinary shares at a 1% discount to the Volume-Weighted Average Price in the weeks leading up to the conversion date.
If the bank is deemed by the Australian Prudential Regulatory Authority (APRA) to be unviable or if its capital buffer falls below a certain amount, the notes will be converted into ordinary shares.
This isn't necessarily a desirable thing and it looks as though with these Capital Notes investors are being landed with all of the risks of ordinary shares and none of the benefits. Capital Notes are likely to be thinly traded, accentuating the difficulties in selling out.
Additionally, you're missing the benefits that regular shares can deliver by growing earnings over time. Seriously, if you want to own Westpac shares you're better off just buying ordinary Westpac shares.
If you want a high-yielding investment, you're better off with ordinary Westpac shares.
If you want a complicated, less rewarding, illiquid investment subject to loads of terms and conditions, then Westpac Capital Notes III is right up your alley.
