Peter Switzer: Hello, and welcome to Switzer Investing Insights, brought to you by nabtrade. And today we're going to talk about CBA's new PERLS XII hybrid issue. Paul, give us an update on hybrids.
Paul Richard : Yeah, before I get to the actual issue, just a quick recap on a hybrid security. It is a cross between a capital and debt-like security, so it counts as capital for the bank. It's not a deposit, but the debt-like features, it does pay a distribution. That's a fixed margin over the benchmark interest rate, which in this case is the 90 day bank bill rate. Usually, that's fully franked. The distribution is reset each quarter, Peter. Look, while it's perpetual and has no term, the expectation is that the security will be redeemed for the initial $100 you invest, and it's classified as Tier 1 capital for the bank's purposes.
Peter Switzer: Okay, so talk about the PERLS now, in particular.
Paul Richard : Yeah. Look, it's a $100 dollar note. It's an unsecured, subordinated note issued by the Commonwealth Bank. Gross distribution of 3% over the 90 day bank bill rate, and issue size of at least one and a quarter billion dollars. It will trade on the ASX under the stock code CBAPI. Has a mandatory exchange into CBA shares in about nine-and-a-half years' time, 20th of April, 2029, but also CBA can call the issue and give you the $100 back. That's probably the expectation. That would happen in seven-and-a-half years' time, but there are these non-viability and capital trigger events that can cause automated exchange into CBA ordinary shares, so you need to understand that example.
Peter Switzer: Okay, let's go to the next important point: explain example piece by piece, Paul.
Paul Richard : Yeah, let's go ahead and work out the distribution. I said it's set over the 90 day bank bill rate. That's sort of a key, benchmark interest rate. Let's assume the 90 day bank bill rate at the moment is about 0.85%. That means the gross distribution, Peter's, going to be the margin of 3% plus the bank bill rate, giving you a total of 3.85%. Now it is going to be fully franked. That's one of the great advantages of these hybrid securities, but they are adjusted for the benefit of the franking credit. So the actual cash distribution is actually multiplied by 0.7 to mean that the cash distribution in this case will be 2.7%, but that will be fully franked. So that's going to be attractive, Paul-
Peter Switzer: [crosstalk 00:02:20] cash, the rest will come in their tax return.
Paul Richard : Yeah, and then that's going to be attractive to particular low rate taxpayers. If bank bill rates ... So this is done each quarter, so let's move a quarter ahead and let's assume the bank bill rate has increased because market thinks interest rates might be on the way up a little bit to 1%. That means the gross distribution rate for the following quarter would be 4%. But if the market thinks interest rates are going down or the IBA's cut rates and the bank bill rate has fallen to, say, 0.5%, the gross distribution for that quarter would then be 3.5%.
Peter Switzer: So a better economy, better return. So how does all this stack up?
Paul Richard : Yeah look, it's set at a margin at 3%. On the screen in front of you, you can see PERLS issues over the last six years, and you can see the fixed margin has varied from a higher 5.2% down to 2.8%. This is at the bottom end of the range. It's a slightly longer security, but things have changed a bit in the hybrid securities markets. First of all, because we had a big scare over franking credits last year, which impacted the hybrid market. Secondly, there's just not a lot of alternatives around for investors to consider. And thirdly, and perhaps most importantly, bank capital ratios have really improved. This is sort of the level up. So banks actually have a much stronger balance sheet. So the chances of actually the bank having to, say, do one of these non-viability triggers has reduced. So your securities have-
Peter Switzer: And [crosstalk 00:03:39] relatively more secure.
Paul Richard : Yeah, relatively more secure. That's right.
Peter Switzer: Okay. So let's look at the important dates.
Paul Richard : Yeah. The offer opens, closes I should say, on the 8th of November. ASX is listing it, so you'll be able to, if you don't like the investment, it will be tradable, and so you will be able to trade it from the 15th of November on the ISX.
Peter Switzer: You can get out if you have to.
Paul Richard : If you have to, right. Minimum application of $5,000, so it's 50 PERLS and then the multiples of 10 PERLS. They're both broker firm and securityholder offers. That means lots of brokers will have stock available, but also the securityhold offer is available to anyone who owns CBA ordinary shares, or is an investor in the PERLS VII, VIII, IX, X and XI issues.
Peter Switzer: Okay Paul, so lets have the risks, as well.
Paul Richard : Yeah look, like any investment, really important to understand the risks. This is not a bank deposit, Peter. There is no government guarantee, right? And if CB-
Peter Switzer: You get a higher return.
Paul Richard : Yep, and if CBA gets into serious trouble, or there is an Australian banking crisis, investors could lose some or all of your capital. In particular, if one of these trigger events is triggered and there's automatic exchange into CBA shares, the maximum number of CBA shares you'll get back is capped, and that could be worth a lot less than the $100 per note. So look, you need to go into this with your eyes wide open.
Paul Richard : And finally, distributions; look, there's no requirement for CBA actually to pay a distribution. They're not cumulative, and if they're not paid, they won't [inaudible 00:05:00] being paid. So there is a risk around these things and you shouldn't underestimate that.
Peter Switzer: Okay. So you think this issue will go well?
Paul Richard : Look, I think there's going to be a lot of demand for this, Peter, simply because of the margin and the demand for these types of securities. There hasn't been any other big offer hit the hybrid market for some time. So it will be really well-supported, but importantly, before investing, always important to read the prospectus first, and if you don't understand hybrids, don't invest. If you want to learn about it more, things like ASIC, for their MoneySmart website, that's a government-run website, it has some really good information on understanding the basics of hybrid securities.
Peter Switzer: Okay. So that's Switzer Investing Insights, brought to you by nabtrade. Thanks for joining us.