Australian Discos

In considering whether to exercise their call option, the banks need to balance the loss of regulatory capital treatment, the benefit of retaining the debt funding, and the reputational issue of non-redemption. We think the likelihood of call should be higher than 75% and so we see value in the WSTP and ANZ Float PERP$s. They have also cheapened up since they were last reviewed in September 2021.

We shouldn’t forget: Australian banks have a flawless/excellent history of redeeming regulatory capital instruments when they no longer meet the regulatory requirement and/or no longer provide regulatory capital value. This is an important consideration in whether to exercise their call option.

Prior to COVID-19, the low cost of this legacy debt versus alternative senior debt provided some potential benefit to the banks to consider not calling on purely economic grounds. However, since COVID-19, the cost of alternative senior debt has fallen significantly, while customer deposit funding has increased significantly at a very low cost. Thus, calling on purely economic grounds has lost it strength as a potential argument for the banks.

The final argument would revolve around reputation – and on this one, we think it’s simple. The banks have had enough reputational damage over the years to last a lifetime. With impending capital needs to come following Basel IV, the banks need a liquid, accessible, and open debt capital market. Why would they want to jeopardise this through failing to call?

Based on the current pricing of 92.5px, the market is currently assigned a probability of around 75% that these notes will be redeemed in March/April.

We think the likelihood should be higher than 75% based on the discussion above and so we see value in the WSTP and ANZ Float PERP$s. They have also cheapened up since they were last reviewed in September 2021.

Base Case

• Highly likely the notes are called
• Notes repaid and funds returned in March/April
• FV plus final coupon
• Outlay: AUD92.5px – upside: close to 10% return for 1 month

Downside Case

• Notes are not called
• Notes remain subordinated debt, with no regulatory capital benefit
• Notes will reprice to reflect a margin somewhere between near-term funding cost and the cost of perpetual debt (subordination), as well as a liquidity cost – around 70px (BBG)
• Notes would be only realisable in the secondary market