New ATO Ruling Could Yield Billions for Australian Banks

Banks haven’t fared well in the market this year. All four major banks are down around 10%. And a large reason why is the global boycott on banks. This isn’t helped when banks underperform on results, either.

However, soon banks might start to experience a boost in capital. The Australian Tax Office (ATO) recently issued a private ruling that allows banks to issue hybrids via an offshore branch. By issuing these offshore, banks won’t have to attach franking credits to their interest payments. This new cost saving rule will lower issuing costs for banks by 30%.

The new ruling could open the door to tens of billions of dollars in global funding for banks. ANZ Banking Group [ASX:ANZ] has already planned a US-dollar hybrid of at least US$750 million.

But before we delve any deeper into the specifics, what’s a hybrid?

A company can issue more than just stocks. But for now let’s just focus on equities (common stocks) and debt (bonds). The term hybrid relates to a security which includes elements of equities and debt.

Just like a bond, a hybrid can promise to pay a rate of return. This return can be fixed or floating, and is valid until a certain date. In ANZ’s case the return will be 5.50% above the bank bill swap rate which is sitting around 1.84% to 2.11%.

Straight away this looks attractive to yield hungry investors. Five year term deposits within the market are yielding around 3.6%. As you can imagine, a hybrid security yielding 7.6% is expected to be well received.

Hybrids can also be greatly affected by stock prices. The main reason is because they can be converted into ordinary shares. In ANZ’s case, their hybrids are ranked ahead of shares. They pay distributions to holders unless the bank is under stress. And if ANZ’s capital ratio falls below 5.125% then their hybrids will be forcibly converted into ordinary shares.

These hybrids will be issued with a 5–10 year call date. This just means ANZ can purchase them back from holders within 5–10 years. And the issue will be a first from a major bank since the global financial meltdown.

ANZ has already begun marketing their new US-dollar deal. On Monday, Standards & Poor’s (S&P) assigned ANZ’s new hybrid securities a ‘BBB-‘. Some believe this new incentive will encourage others to issue offshore hybrids. This would effectively reduce supply of domestic hybrids, and in turn support their prices.

Commonwealth Banks of Australia [ASX:CBA] and Westpac Banking Corp [ASX:WBC] recently closed successful hybrid deals with ASX. Both banks saw a significant take-up by institutions. This was no surprise; its normally institutional investors who dominate the primary market.

But what does this all mean for us retail investors in the secondary market?

Some are predicting we’ll see a surge in offshore hybrids. If this were to happen then it could negatively affect secondary markets. How? Institutional money is a large part of the market. If they start placing their capital in offshore hybrids instead of ordinary shares, volume and liquidity could take a dive.

But realistically it might not mean too much. Share prices might just stagnate for a while. Time will tell if ANZ’s issue will disadvantage retail investors or not.

Härje Ronngard,
Junior Analyst, Money Morning

PS:  Sometimes investing can seem complicated. But the article above shows how financial jargon can be made simple. And the easier it is to understand concepts, the better your investment choices will be.

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