Australia's first Basel III-compliant Tier 2 hybrid explained

Author: Ashley Lee | Published: 18 Apr 2013
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KEY TAKEAWAYS

  • Suncorp's hybrid issue is the first Basel III-compliant hybrid to raise Tier 2 regulatory capital in the Australian market;
  • Australia's prudential regulator, the Australian Prudential Regulation Authority, has been a global leader in the implementation of Basel III, which took effect on 1 January 2013;
  • It is unclear whether there will be a raft of Basel III Tier 2 hybrids ahead. Counsel say that it heavily depends on the pricing between Tier 1 and Tier 2 hybrids.

Suncorp's hybrid issue marks the first Basel III Tier 2 hybrid in the Australian market. But it is unclear whether copycat deals will follow.

The Australian Prudential Regulation Authority (Apra) has been a leader in the implementation of Basel III, requiring banks to be fully compliant by 1 January of this year. In conjunction with its interpretation of Basel III, Apra laid out strict guidelines for bank hybrid offerings, including a non-viability conversion.

While there have been issues of Basel III compliant hybrid bonds in the Australian market, such as the Commonwealth Bank of Australia's $1 billion PERLS VI issue last year, all of them have been to raise Tier 1 capital. Suncorp's A$500 million subordinated notes due 2023 is the first to raise Tier 2 regulatory capital.

King & Wood Mallesons' Ian Paterson said that the Australian market is used to securities that convert to equity under certain triggers.

He noted that the Australian market saw retail Tier 2 deals that were Basel II-compliant last year, as well as Tier 1 deals with the Basel III-compliant non-viability conversion included.

"This deal combines elements of both," he added.

New product

Apra's guidelines for hybrid bonds issued by banks are very specific, and they require a non-viability trigger. The trigger is activated when Apra determines that a conversion is necessary, because otherwise the bank would be non-viable without a public sector capital injection or similar capital support.

The market is familiar with non-viability triggers, as investors have seen Basel III-compliant issues as well as issues before Basel III that included variations of non-viability triggers. Further, the Australian market for hybrid and equity-linked deals is very active.

Even so, deal counsel had to ensure that all parties, especially regulators and investors, were comfortable with the offering.

Paterson said that new product always face the challenge of meeting all the requirements of Australia's complex regulatory environment while remaining attractive to the issuer and investors.

But King & Wood Mallesons' Evie Bruce said that the market's response depended on the product's pricing.

"It will be interesting to see how the transaction will go, and we hope to see more issuances," she said.

Paterson agreed. He added that the most important point in seeing more Tier 2 issuances is that issuers believe that they were more advantageous than Tier 1s.

"In particular, issuers will want to see a pricing benefit," he said. "If Tier 2 instruments are priced like Tier 1s, they will issue more Tier 1s."

Market trends

Although Apra's regulations ensure onshore bank hybrid issuances are straightforward, Paterson predicted that instruments issued for offshore markets may see more innovation.

He said that some investors may not be used to seeing mandatory convertible securities or have mandates that restrict their ability to invest in ordinary equity.

If these factors come into play, he said, there might be pressure for Tier 2 issuances with an alternative loss absorption feature to conversion but which meets Apra's loss absorption requirements.

Australia's vibrant corporate hybrid market has also slowed.

Bruce said that she hadn't seen much interest in corporate hybrids as it had been quite difficult to get the equity credit treatment which had historically been given on these products from ratings agencies.

Although the government is also looking to boost the retail corporate bond market, its plan for doing so have not yet been finalised.

Tear sheet

Clayton Utz acted for the joint lead managers and King & Wood Mallesons acted for the issuer.

A link to the prospectus can be found here: http://www.suncorpgroup.com.au/announcements-pdf/398696

Related links:

How Australia hybrid first clarifies Basel III implementation http://www.iflr.com/Article/3088063/How-Australia-hybrid-first-clarifies-Basel-III-implementation.html

Why Australia's proposed corporate bond boost won't work http://www.iflr.com/Article/3151127/Why-Australias-proposed-corporate-bond-boost-wont-work.html

Afma's retail structured product approval principles explained http://www.iflr.com/Article/3175975/Afmas-retail-structured-product-approval-principles-explained.html