Westpac shares kill hybrids

February 1, 2013, 1:47 pm Michael Pascoe Yahoo!7

Here we go again, another bank making a big fat hybrid securities offer, hoping punters are too scared of the stock market to realise they're being dudded.

This time round it’s Westpac, but it could be any of them. For people suffering from falling term deposit rates and with an irrational fear of owning shares, the deal might look attractive at first glance, but in my opinion, you’d have to be a mug to stick your hand up for Westpac Capital Notes, as they’re being called.

Let’s just use the example Westpac uses – and then destroy it. The notes will pay, on a quarterly basis, the bank bill rate plus a margin yet to be decided, but in the region of 3.2 per cent. However, that margin includes the value of franking credits to the investor. Thus, says Westpac, if:
  • the potential value of the franking credits is taken into account in full;
  • the 90 day Bank Bill Rate on the Issue Date was the same as on 23 January 2013, being 2.98% p.a.; and
  • the Margin is set at 3.20% p.a., then the Distribution Rate for the first quarterly period would be 4.33% p.a., which is equivalent to an unfranked Distribution Rate of 6.18% p.a.

And that looks pretty good compared with term deposits – but it’s positively ordinary compared with owning Westpac shares, which is what these capital notes eventually convert into anyway. What’s more, while that 6.18% is what will catch the punter’s eye, it’s the 4.33% that they will receive quarterly. You have to get the difference back from the tax man when you file your tax return many months later.

Westpac shares enjoyed a nice Santa Claus rally and a very nice January surge – let’s call it the Australia Day rally. As I write, they’re trading at $28.07 cents but that still means a dividend yield of 5.9 per cent fully franked. Add on the franking and it’s more like 8.3 per cent. So, it’s 8.3 versus 6.18 – a no brainer.

But wait, it gets worse. Hold your breath and try to swallow the full description of Westpac Capital Notes. They are “fully paid, non-cumulative, convertible, transferable, redeemable, subordinated, perpetual, unsecured notes issued by Westpac Banking Corporation” which means they are only fractionally better than owning Westpac shares. Like shares, they’ll trade on the ASX and rise and fall in price. Those quarterly distributions are at Westpac’s discretion – no more guaranteed than dividends – and when it comes to security, in the real world, if Westpac shares were going to be wiped out, unsecured notes are gone too.

So why would anyone touch them? My suspicion is that some investors will by blinded by the idea of quarterly payments giving them money to live on, but they will be paying a hefty price for money that comes every three months rather than twice a year.

There’s reason to buy them if you believe interest rates are about to skyrocket, which would boost the distribution rate, but it’s hard to see the scenario anywhere on the horizon. As we’ve all discovered, nothing seems to be impossible on the financial markets, but Australian rates are much more likely to stay where they are or fall a little more than rise in the next few years.

Some punters might go with the idea of diversification for the sake of diversification, but such hybrids really aren’t much of a diversification at all.

Which leaves the possibility that individuals who think shares are dangerous and hybrids are not will be the ones who get sucked in. For the sort of people most likely to be attracted to such notes, share price gyrations don’t really matter as long as the dividends can be at least sustained and, hopefully, grow over time.

Of course, a cynical soul might even suggest there’s the odd broker who will sell them to punters just because they can be sold and earn a commission – but I wouldn’t want you to think that I was cynical.

More from Michael Pascoe:
The RBA guide to housing prices
Australia's stronger immigration - the other inflation dampener
States and retailers fooling themselves over GST

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