New Issue: Police & Nurses Wholesale Capital Note
Police & Nurses (P&N) are looking to issue a new wholesale capital note. P&N Limited (the issuer) has an S&P rating of BBB/Positive and we believe the credit is well positioned in the BBB category. The issue will not be rated. However, given the structure, subordination, discretionary distributions, and perpetual nature, this security would sit somewhere in the BB space.
We believe the capital note should price around the 5.75% over 3m BBSW area for a 5-year first call (see below for more thoughts on relative value). Based on current 5y ASW, the yield to maturity (%) would equate to c.9.35% (this is on a franked basis).
IAM Capital Markets View
P&N has is a well-capitalised entity with a strong balance sheet to ride out any unforeseen challenges. The loan portfolio is very conservative, illustrated by the low level of arrears which is a function of the underwriting process (no loc doc loans, restriction of certain postcodes, nonstandard income discounts, etc.). We believe the credit is well positioned in the BBB category.
The portfolio has a reasonably high concentration to WA, albeit one which is experiencing growth in house and unit pricing from a low base. However, this is largely offset by the high proportion of loans which have an LVR < 80%.
Effectively, over 80% of loans have an LVR < 80%, which would limit the impact in a stressed scenario if delinquencies were to rise. P&N’s weighted average LVR is 65.9%. Retail delinquencies are very low with total arrears at 60bps, consisting of 20bps in the 90+ day category.
Credit Fundamentals
P&N are a customer-owned bank that operates under the principle of mutuality, ‘one member, one vote’. It is recognised as an ADI under the Banking Act and regulated by APRA. The customer-owned banking model focuses on value to members rather than profit to shareholders. Profits get filtered back into the business to support growth/members. Generally, customer-owned banks have a long history of being socially responsible lenders and were not caught up in the issues facing the major banks.
As a sector, customer-owned banks have combined assets of AUD148bn. Mutuals comprise 2.8% of total assets across all ADIs in Australia at 30 June 2021. The customer-owned banking sector continues to consolidate as companies look to build scale to compete with major banks. The Treasury Laws (Mutual Reforms) Act 2019 enshrined the definition of a mutual entity within the Corporations Act, removed inadvertent triggering of demutualisation rules, and provided access to CET1 via Mutual Capital Instruments (MCIs).
Chart 1. Underwriting Process
Source: P&N Investor Presentation
P&N has over 163,000 members and AUD7bn in assets across WA, NSW, and QLD. The company was part of a successful merger in 2019 between Police & Nurses Limited and Banana Coast Community Credit Union. In essence, it provides retail banking, business banking, and insurance.
Chart 2. P&N Operating Model
Source: P&N Investor Presentation
Key Metrics
Table 1. Key Ratios
| AUD’000 | Jun-21 | Dec-21 | |
|---|---|---|---|
| ROE | 3.68% | 4.14% | |
| ROA | 0.25% | 0.29% | |
| NIM | 2.06% | 2.07% | |
| CTI | 88.70% | 82.20% | |
| PAT | 16,156 | 9,766 | 6 months to Dec-21 |
Source: IAM Capital Markets
Table 2. Balance Sheet (AUDm)
| Jun-21 | Dec-21 | |
|---|---|---|
| Loans | 5,364 | 5,563 |
| Deposits | 5,472 | 5,548 |
| Loan/Deposits | 98.03% | 100.27% |
| Total Capital | 461 | 472 |
| CET1 | 13.55% | 13.45% |
| Total Capital % | 14.08% | 14.06% |
Source: IAM Capital Markets
Capital includes AUD1.7m in a share capital reserve at Dec-21. The capital note will be used to help with the digital transformation program. Between Jun-21 and Dec-21 earnings and securitisation RWA accounted for around 83bps of capital improvement. Whereas between Jun-21 and Dec-21, the transformation program, treasury RWA, and loan growth RWA accounted for around 85bps of capital depletion.
P&N have successfully originated four securitisation issues together with a self securitisation trust (SST). P&N currently manages and services three RMBS issues, an SST, and a funding warehouse. Trusts consists of prime residential mortgages.
Chart 3. Geographic Segmentation of Loan Portfolio (AUDbn)
Source: P&N Investor Presentation
Chart 4. Retail Loan Portfolio by LVR (AUDm)
Source: P&N Investor Presentation
This book is very clean from an impairment perspective. Impairments, both specific and collective, only total c.AUD1.7bn at Dec-21. NPLs are c.63bps at Feb-22. This is a function of the retail lending book – mostly P&I, owner-occupied loans as opposed to I-only, investor loans respectively.
The business book is also very safe with total arrears at 190bps, consisting of 30bps in the 90+ day category. The weighted average dynamic LVR is 58% as at Dec 2021. The business book is broken down as follows:
Table 3. Business Book by Industry Sectors
| Industry Sectors | % Exposure |
|---|---|
| Accommodation and Food Services | 4.9% |
| Agriculture, Forestry, and Fishing | 17.6% |
| Commercial Property Investment | 22.2% |
| Construction | 8.0% |
| Financial and Insurance Services | 3.5% |
| Manufacturing | 2.0% |
| Other | 6.5% |
| Rental, Hiring, and Real Estate Services | 6.4% |
| Transport, Postal, and Warehousing | 1.7% |
| Wholesale and Retail Trade | 2.2% |
| Property Development | 25.0% |
| Grand Total | 100.0% |
Source: IAM Capital Markets
Terms/Relative Value
We believe the capital note should price around the 5.75% over 3m BBSW area for a 5-year first call.
This is an interesting perpetual security to price. Distributions are discretionary, non-cumulative, and subordinated. However, distributions are franked. Based on current 5y ASW, the yield to maturity (%) would equate to c.9.35% (this is on a franked basis).
We believe the P&N Capital Note AT1 will offer a 310bps premium over the Big Four AT1 hybrid curve at the five year tenor (c.6.25%). Another comparable is Australian Unity, which has two senior unsecured bonds outstanding (ASX: AYUHC, AYUHD). Capital notes are structurally different to senior unsecured bonds notes, but the 3% plus yield step-up from senior unsecured to capital notes is more than sufficient.
A better comparison is the ASX: AYUPA (Australian Unity) which is an MCI. The 5% Perps currently have a yield to maturity (%) of 7.7%. However, MCIs are akin to preference equity and so even more subordinated than capital notes. The 1.5% yield step-up for P&Ns over AYUPAs would appear reasonable given P&N is a slightly weaker credit.
Chart 5. P&N Capital Note AT1 vs ASX Listed Capital Notes
Source: BondAdviser
Chart 6. Relative Value vs Australian Unity Senior Unsecured
Source: Bloomberg
The AYUPA price has come off since launch and is attributable to the significant rise in interest rates – e.g., the 10-year swap rate has increased 200bps since the new deal was launched – so it’s related to duration and not the underlying credit risk.
The AYUPAs offer a 150bps premium over the Big Four AT1 hybrid curve at the five year tenor (c.6.25%). However, relative value is difficult to measure as AYUPA is a true perpetual with no early call compared with P&N which has a 5-year first call. As discussed above though, AYUPA is a slightly better credit than P&N and so the P&N capital note should price wider.
We think a good switch for P&N capital note would be the Members Equity Perps (first call in November 2022 – ISIN: AU3FN0039459). These securities are only paying 3m BBSW + 5.25% and it is a very similar, previously customer-owned bank that is now owned by Bank of Queensland. This line will run-off soon and capital will need to be redeployed in the near term.
Chart 7. AYUPA Price Action
Source: Bloomberg
Key Terms
- AUD75m issue amount
- Floating rate with distribution calculated relative to 3m BBSW
- Perpetual, discretionary, non-cumulative, subordinated, capital notes which will constitute additional tier 1 (AT1) capital
- In a winding up of P&N, capital notes rank ahead of P&N MCIs but behind subordinated tier 2 instruments and senior creditors of P&N. However, in a winding up, it is likely a non-viability event will have occurred
- Capital notes will likely be converted or written off in a non-viability event
- Distributions on the capital notes carry franking credits
- P&N mutual capital instruments (MCIs) will only be issued if the capital notes are required to be converted
