Australian Bank USD AT1s – WSTP 5% Perps, ANZ 6.75% Perps, and MQG 6.125% Perps
Our view has been that all three of these will get called, subject to an Australian-specific problem causing the Australian banks to be in meltdown requiring equity conversion. The Australian banks also need to raise more Tier 2 to meet total loss absorbing capacity (TLAC) going forward (APRA has dictated Tier 2 over Additional Tier 1). Thus, it would make sense when these instruments fall due to refinance in the Tier 2 market rather than the Additional Tier 1 market.
The WSTP 5% perps trade lowest in price terms than ANZ 6.75% and MQG 6.125% purely due to the reset levels / and thus implied call risk which may/may not eventuate.
Security Specifics
The USD AT1 security is a CoCo. It has an equity conversion feature which kicks in at a CET1 ratio of 5.125%. However, there is no point of non-viability trigger. Coupons can be deferred and are non-cumulative. Importantly, coupons are not franked. The typical buyers are institutional investors.
The AU hybrids also have an equity conversion feature with coupons that can be deferred and are non-cumulative. There is a point of non-viability trigger. Coupons are generally fully franked. The typical buyers are retail investors, including wealth and private banking firms.
What does this mean in practice? Well … technically APRA could deem a bank non-viable and AU hybrids could be converted to equity w/out USD AT1s being converted (assuming the CET1 ratio has not fallen below 5.125%). In principle however, the bank will most likely be non-viable and have a CET1 ratio below 5.125%, which is why it will need capital in a stressed scenario.
APRA Announcement
APRA is exploring numerous options to make AT1 capital more effective in absorbing losses.
- Increasing the CET1 ratio trigger from 5.125% to 7% (for e.g.)
- Making changes to the composition of capital to reduce reliance on AT1 (i.e., increasing CET1 and T2)
- Excluding retail investors from AT1 participation
In our view, regardless of what changes APRA decides upon, the existing AT1s will likely be grandfathered. So, any potential outcomes are likely to impact pricing on newly issued AT1 securities and not those already in the market.
Any changes to make newly issued AT1 securities more flexible will result in a pricing dislocation between grandfathered and new. This pricing differential should reflect the fact that grandfather AT1s will hold less risk (price tighter) than newly issued AT1 securities which hold more risk (price wider).
