Basel III is having a profound impact on the sort of debt instruments that Australian fixed income investors can access. All capital bonds in a Basel III-compliant environment need to carry a contingent clause that imposes losses on investors under certain conditions.
Until Basel III is fully implanted in Australia it means that ‘old style’ legacy Tier 2 bonds will become an increasingly scarce commodity. This is because Australia has adopted a mechanism that phases out outstanding securities that were issued under the old rules. Over time they will gradually lose their capital-qualifying status and become less attractive to the issuer. The total value of eligible pre-Basel III securities can be calculated using the total amount of outstanding pre-Basel III securities as of 1 January 2013 and then reducing the figure by 10 per cent for each year until 2022. For Tier 2 securities, the amount of the instrument eligible for inclusion as regulatory capital will continue to be amortised at 20 per cent per annum.
In practice, debt instruments that were issued before Basel III rules applied will not qualify as capital under APRA’s rules after their first call date. This tends to suggest that issuers of pre-Basel III securities will call them on their first call date. Over time pre-Basel III securities will be called, mature or will lose their capital status and will be replaced by Basel III compliant securities.
APRA says that Australian banks must have a minimum Common Equity Tier 1 (CET1) ratio of 4.5 per cent, Tier 1 ratio of 6.0 per cent and a Total Capital Adequacy ratio of 8.0 per cent from January 2013. APRA also requires banks to hold an additional 2.5 per cent CET1 capital as a Capital Conservation Buffer from January 2016.
What does this mean for investors?
Under Basel III, in order to qualify as regulatory capital, Tier 1 and Tier 2 securities must carry a contingent clause that imposes losses on investors under a variety of conditions. Such conditions include incidences when APRA determines that the bank has reached a point of non-viability and when the bank’s financial condition is deemed to have deteriorated to a specified level. For investors this could mean that they see their hybrid holdings converted into common equity or written down, although all Basel III compliant securities issued to date by Australian banks use the conversion into equity as the main form of loss absorption. As a guide for investors, credit rating agencies notch Basel III compliant securities lower than equivalent Basel II securities and lower that the issuer rating.
Outstanding Basel III compliant securities issued by Australian banks:
| Issuer | Name | Tier type | Audience | Size (m) | Date | Coupon Skip | Mechanism write-down or conversion | Loss Absorption |
| CBA | PERLS VI | Add’nl Tier 1 | Retail | 2,000 | Oct-12 | Yes, non-cumulative | Full or partial conversion | CET1 <5.125%; Non viability |
| BEN | CPS | Add’nl Tier 1 | Retail | 269 | Nov-12 | Yes, non-cumulative | Full or partial conversion | CET1 <5.125%; Non viability |
| Suncorp | CPS2 | Add’nl Tier 1 | Retail | 560 | Nov-12 | Yes, non-cumulative | Full or partial conversion | Non viability |
| BoQ | CPS | Add’nl Tier 1 | Retail | 300 | Dec-12 | Yes, non-cumulative | Full or partial conversion | CET1 <5.125%; Non viability |
| Westpac | WCN | Add’nl Tier 1 | Retail | 1,384 | Mar-13 | Yes, non-cumulative | Full or partial conversion | CET1 <5.125%; Non viability |
| NAB | NAB CPS | Add’nl Tier 1 | Retail | 1,514 | Mar-13 | Yes, non-cumulative | Full or partial conversion | CET1 <5.125%; Non viability |
| ANZ | ACN | Add’nl Tier 1 | Retail | 1,120 | Aug-13 | Yes, non-cumulative | Full or partial conversion | CET1 <5.125%; Non viability |
| NAB | NAB CPS II | Add’nl Tier 1 | Retail | 1,717 | Dec-13 | Yes, non-cumulative | Full or partial conversion | CET1 <5.125%; Non viability |
| ANZ | ACN2 | Add’nl Tier 1 | Retail | 1,610 | Mar-14 | Yes, non-cumulative | Full or partial conversion | CET1 <5.125%; Non viability |
| Suncorp | CPS3 | Add’nl Tier 1 | Retail | 360 | May-14 | Yes, non-cumulative | Full or partial conversion | Non viability |
| Westpac | WCN2 | Add’nl Tier 1 | Retail | 1,311 | Jun-14 | Yes, non-cumulative | Full or partial conversion | CET1 <5.125%; Non viability |
| CBA | PERLS VII | Add’nl Tier 1 | Retail | 2,000 | Aug-14 | Yes, non-cumulative | Full or partial conversion | CET1 <5.125%; Non viability |
| Issuer | instrument | Tier type | Audience | Size (m) | Date | Coupon Skip | Mechanism write-down or conversion | Loss Absorption |
| Suncorp | Sub Notes | Tier 2 | Retail | 770 | May-13 | No | Full or partial conversion | Non viability |
| Westpac | Sub Notes II | Tier 2 | Retail | 925 | Aug-13 | No | Full or partial conversion | Non viability |
| BEN | Sub Notes | Tier 2 | Retail | 300 | Jan-14 | No | Full or partial conversion | Non viability |
| Westpac | Sub Notes | Tier 2 | Retail | 1,000 | Mar-14 | No | Full or partial conversion | Non viability |
| ANZ | Sub Notes | Tier 2 | Wholesale | 800 | Mar-14 | No | Full or partial conversion | Non viability |
| Westpac | Sub Notes | Tier 2 | Wholesale | 1,000 | Mar-14 | No | Full or partial conversion | Non viability |
| ANZ | Sub Notes | Tier 2 | Wholesale | 750 | Jun-14 | No | Full or partial conversion | Non viability |
| ME Bank | Sub Notes | Tier 2 | Wholesale | TBA | Aug-14 | No | Full or partial conversion | Non viability |
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Paul McNamara is an editor and journalist with over 20 years’ experience. His career includes spells with the Financial Times, Euromoney, BRW Media, Asia-Inc and Banker Middle East. At present he is editor of YieldReport. YieldReport is a digital newsletter that carries comprehensive pricing and commentary on Australian interest rate securities in a monthly and weekly report. Each issue covers bank bills, cash accounts, term deposits, government bonds, semi-government and corporate bonds, hybrids, ETFs, managed funds and more. Click here for a free trial subscription. |
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