SMSFundamentals | Feb 22 2012
By Greg Peel
After two RBA cash rate cuts late last year those investors looking ahead to term deposit rollovers are bracing for new rates up to 50 basis points lower than the rates on previous investments. Cash management trust rates will also have been marked lower.
With some solid (and in many cases fully-franked) yields going begging in the stock market this may be the time to start looking once again at riskier investments but for those still nervous about Europe and stocks in general, or those sensibly looking to retain a level of lower risk assets in a diversified investment portfolio, a new note issue from Colonial might be worth a look.
Colonial Holding Company, or the “Colonial Group”, is a leading Australian provider of wealth management and insurance products under recognisable brands such as Colonial First State Investments. It is a fully owned subsidiary of the Commonwealth Bank ((CBA)). Colonial is looking to issue $500m or more of subordinated notes which rank below other senior debt and unsecured creditors but above preference shares and equity. The face value of the note will be $100 and minimum investment parcel $5000. The notes will be listed on the ASX following issue.
Depending on volume of demand, the yield on the notes will be set within a range of 325 to 375 basis points above the Australian three month bank bill swap rate (BBSW). Note that while the RBA sets the overnight cash rate, this rate in practice reflects only cash excesses or shortfalls held by banks at the end of each trading day. The more realistic benchmark for bank short-term funding is BBSW which is why the great bulk of floating rate instruments are priced with BBSW as a base.
On the day of writing three month BBSW is trading at a midpoint of 4.60%. Thus the coupon on Colonial notes would be set in a range of 7.85% to 8.35% depending on demand were it to be priced today. Thereafter the coupon, paid quarterly, would “float” on movements of BBSW with the initial premium fixed. Like any rate the movement of BBSW will be influenced by the RBA cash rate.
The coupon payments are not franked hence the Colonial notes are akin to a three month term deposit rate. Unlike bank term deposits, note issues are not government guaranteed to any level but FIIG argues that the Colonial notes are effectively CBA guaranteed. It is considered “very remote”, suggests FIIG, that CBA would (a) sell off or (b) fail to support Colonial in the “unlikely event” it was needed.
Strictly the Colonial notes are classified as a “hybrid” but there is no conversion to equity element involved. The “hybrid” tag is given because while the notes have a legal maturity of 25 years they are callable after five years. This makes the notes more “old style”, suggests FIIG, rather than “new style” and unfamiliar. Colonial (and thus CBA) has a “strong incentive”, suggests FIIG, to call at the first opportunity on both a reputational basis and on the basis a lack of call would impact on CBA's Standard & Poor's credit rating.
While payable quarterly, the coupon payments can be deferred by Colonial but must remain cumulative. If Colonial fails to make payments in five years the notes will default, but given such an action would impact on CBA's ability to pay dividends to shareholders this is again considered a very unlikely scenario.
So in simple terms what we really have is five year fixed income instrument offering quarterly reset coupons based on BBSW plus a premium set at issue of 3.25-3.75%. The instruments will be listed after issue and thus able to be traded just like shares.
The opening date for applications is February 24, closing on March 21. Listing is set for April 4 and first interest will be paid on June 30.
FNArena strongly recommends interested investors seek advice from their broker financial adviser before considering such an investment.
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