Income you can bank on

August 14, 2015

The rush of substantial bank capital raisings, triggered by the Australian Prudential Regulation Authority’s (APRA) recent announcement, is proving to be highly dilutive for bank ordinary shareholders, but a positive for holders of bank debt and hybrid securities. While most bank share prices have tumbled 15-20% over recent weeks as the market digests the placement of around $13.5 billion of new equity, the market for financial hybrid securities has remained relatively stable. The higher levels of capital will not allow the banks to grow their lending aggressively, but rather strengthen their balance sheets against their current loan books.

The banks improved capital positions has increased the stability and safety of the banks and, in particular, the attractiveness of their debt and hybrid securities. In contrast to the volatility being experienced by its issuer, the latest major bank hybrid security offer, Westpac Capital Notes 3 has been priced at an attractive margin and the capital raising was increased in size by $500 million to $1.46 billion. The final margin has been set at 4.0% over the 90 Day Bank Bill Swap rate (BBSW) giving a yield of 6.12% based on the $100 issue price.    This is great income when the RBA rate is 2.00%, with much lower risk than bank ordinary shares.

Investing for income is about preserving your capital and the volatility of recent weeks again reinforces this. Higher yields come with commensurate risk. While inflation can eat heavily into cash and term deposit returns, buyers of higher yielding bank shares need to astutely evaluate the associated risk to ensure that the offer price adequately compensates for any potential downward movement in the value of the business and prices of ordinary shares.

This is general advice only and you should not act on it without consulting your financial adviser. Call us on 03 9859 7899 if you would like advice particular to your own financial circumstances.