Mason Stevens
Fixed Income
25 Nov, 2022

On Melbourne Cup day APRA released a letter to authorised deposit-taking institutions (ADIs), general insurers and life insurers (together ‘insurers’) to reinforce the existing prudential requirements for additional Tier 1 capital or Tier 2 capital instruments. This letter was only a restatement of existing rules but led to a major hiccup for both the Hybrid (listed or otherwise) and Tier 2 issuance markets.

Spreads widened across the board and specific issues widened to their peers because the nature of the note was to warn investors that there needs to be a clear reason for the institution to call the bond if the economic incentives were to not call. This puts into focus the treatment of that note once it has passed the call date from a capital perspective as well as the return it would deliver holders if left outstanding. The market needed to relook at each issue on its own merits to determine if there should be a risk premium added for the likelihood it was not called.

The listed and unlisted hybrid market saw sellers emerge and a deal of nervousness around the likelihood of at least 2 pending call dates. MEBank had a Tier One bond with a margin of BBSW +5.25 due to be called on 28 November, but it is now the successor entity Bank of Queensland (who bought ME Bank). As BOQ had recently issued new listed Tier One at +3.40 there was clear incentive to call which was duly exercised by the issuer. The main effect of the reminder might be to create a floor for new issuance spreads as investors will be wary of investing at a low margin in current markets that could widen significantly at a future time leaving the call process in doubt. We feel it is likely that major bank issuance will rarely move outside a BBSW +280 to BBSW +330 range in the future.

Tier 2 is actually a bigger market and the issuance spreads have had a great deal more volatility. The most obvious disincentive to call is where an issuance was done some time ago at much lower credit spreads. As an example, CBA has a 2031 maturity Tier 2 bond that has a call date of 20 August 2026, but if not called the bond remains on issue at a spread of BBSW +132. The bond remains a Tier 2 instrument in full for the first year after the call date has passed from APRA’s point of view, but it amortises the percentage that can be included by CBA as T2 on a straight-line basis to the eventual maturity date in 2031. Current Senior Major Bank Debt (NAB issued a new 5-year on 22 Nov) is priced at BBSW+120, and CBA’s most recent T2 issuance was on 27 October at BBSW +270. Were markets to be at these levels in 2026 CBA would be pressed to convince APRA that they were better off to call these notes than keep them outstanding.

As markets digested these messages, the spreads for other lower coupon bonds rose compared to other bonds as the premium for non-call rose. The attached table prepared by Citibank shows certain T2 bonds have more uncertainty around their potential call than others.

ISINBondResetFirst Call Date
Major Bank
AU3FN0073029CBAAU Float 11/09/322709-Nov-27
AU3FN0070330ANZ Float 08/12/3227012-Aug-27
AU3FN0070199NAB Float 08/03/322803-Aug-27
AU3FN0069381MQGAU Float 06/07/322707-Jun-27
AU3FN0067989CBAAU Float 04/14/3219014-Apr-27
AU3FN0051587NAB Float 11/18/3120218-Nov-26
AU3FN0062600CBAAU Float 08/20/3113220-Aug-26
AU3FN0061065MQGAU Float 06/17/3115517-Jun-26
AU3FN0055687ANZ Float 02/26/3118526-Feb-26
AU3FN0058129WSTP Float 01/29/3115529-Jan-26
AU3FN0057402NAB Float 11/18/3017018-Nov-25
AU3FN0055992CBAAU Float 09/10/3018010-Sep-25
AU3FN0054284MQGAU Float 05/28/3029028-May-25
AU3FN0049672WSTP Float 08/27/2919827-Aug-24
AU3FN0049128ANZ Float 07/26/2920026-Jul-24
AU3FN0048195NAB Float 05/17/2921517-May-24
AU3FN0043238WSTP Float 06/22/2818022-Jun-23
AU3FN0040754WSTP Float 02/16/2814016-Feb-23
AU3FN0064408BQDAU Float 05/19/3217519-May-27
AU3FN0063467BENAU Float 10/14/3114814-Oct-26
AU3FN0060091BQDAU Float 07/29/3116029-Jul-26
AU3FN0057410BENAU Float 11/19/3019519-Nov-25
AU3FN0046066BENAU Float 11/30/2824530-Nov-23
AU3FN0042339BQDAU Float 05/01/281851-May-23
FR0014003XD4BNP Float 12/11/3115511-Dec-26
AU3FN0056685DBSSP Float 04/08/311908-Apr-26
AU3FN0041406DBSSP Float 03/16/2815816-Mar-23
AU3FN0072732RABOBK Float 10/26/3229526-Oct-27
AU3FN0045746AMPAU Float 11/15/2827515-Nov-23
AU3FN0057691AMPLF Float 12/09/353309-Dec-25
AU3FN0054433GNW Float 07/03/305003-Jul-25
AU3FN0055497IAGAU Float 12/15/3624515-Dec-26
AU3FN0047544IAGAU Float 06/15/4523516-Jun-25
AU3FN0041687IAGAU Float 06/15/4421017-Jun-24
AU3FN0067906SUNAU Float 06/01/372301-Jun-27
AU3FN0055802SUNAU Float 12/01/352251-Dec-25
AU3FN0044251SUNAU Float 12/05/282155-Dec-23
AU3FN0055489QBEAU Float 08/25/3627525-Aug-26

Source: Citibank

Another consideration is whether the call is able to be exercised multiple times or only once. A multiple-call option makes the economics of leaving the bond outstanding or not more murky as the issuer can recalculate the incentive on multiple occasions. A single shot call means the investors and issuer can clearly see whether the dilution effect of the diminishing amount of subordination taken into account by APRA over the whole remaining life of the bonds means to leave the notes on issue would result in effectively overly expensive senior funding.

We expect to see a transition to one-time-only call structures in the Australian T2 market as is common in offshore markets but not here to become the market standard over time. We also expect to see pricing differentials on existing Tier 2 deals where the reset margin is below current market T2 pricing to reflect extension risk. We also expect to see Listed Hybrid issuance from the Major Banks stay within a relatively tight range, and also a move towards much shorter periods between call dates and final maturity for Insurance issuers of booth T1 and T2 bonds.

The views expressed in this article are the views of the stated author as at the date published and are subject to change based on markets and other conditions. Past performance is not a reliable indicator of future performance. Mason Stevens is only providing general advice in providing this information. You should consider this information, along with all your other investments and strategies when assessing the appropriateness of the information to your individual circumstances. Mason Stevens and its associates and their respective directors and other staff each declare that they may hold interests in securities and/or earn fees or other benefits from transactions arising as a result of information contained in this article.