Apples for apples retail bonds off the table at BNZ; Senior bonds most likely replacement for NZ$350 mln called subordinated issue

By Gareth Vaughan

BNZ won't be replacing a NZ$350 million subordinated bond issue it's calling on June 15 with the same type of bonds, with an issue of senior debt the most likely replacement, should the bank go ahead with a fresh issue.

On May 21 BNZ confirmed it would call the retail bonds on their first call date. Issued in the high interest rate environment of 2007, the bonds have been paying an interest rate of 8.42% per annum.  Although BNZ could have reset the interest rate - at 75 basis points over the five-year swap rate - and kept the bonds on issue for another five-years, this type of subordinated, or tier two capital, bond is not expected to be recognised as capital under the Reserve Bank's Basel III bank capital adequacy standards, instead being regarded as debt.

On top of this the current low interest rate environment would've seen investors' receiving a much lower interest rate, just 3.8% based on yesterday's five-year swap rate. Aside from the regulatory factor, this big drop in swap rates over recent months is the other factor bank issuers are wrestling with, given bonds are typically issued at a margin over swap rates. At 3.05% yesterday, the five-year swap rate was down 32 basis points since January 6. And at 3.41%, the seven-year swap rate was down 37 basis points.

Other bank bonds that won't be regarded as capital under Basel III and are callable this year include a NZ$350 million ANZ bond issue paying 8.23% with a call date on July 23, and a NZ$370 million ASB issue paying 8.77% callable on November 15. In normal circumstances the general market expectation would be that these callable bonds would be called on their first call date and replaced with a similar type of issue by the banks. However, given the new regulatory treatment and the low interest rate environment, the picture isn't so clear.

A problem in this environment, as one market source put it, is that a seven-year bond issue paying 5% interest per annum doesn't hold great appeal to retail investors with 6% still seen as a "magic number." At yesterday's rates, to get a seven-year bond issue to 6% a bank would have to pay investors' a margin of 259 basis points over swap. See more here in what lower for longer means for retail bonds.

Last month BNZ said it was considering a new retail bond offer to coincide with the early repayment on June 15 and is likely to announce early next week whether it'll go ahead with any such issue. If it does so, the most likely option would be a senior debt issue with at least a five-year term, although BNZ, ANZ and Rabobank have all issued seven-year retailable bonds in recent months. BNZ raised NZ$200 million at 6.10% in December, ANZ raised NZ$250 million at 6.25% in March having called a separate NZ$250 million subordinated bond on March 2 that was paying 7.6%, and Rabobank raised NZ$250 million at 6.10% in March.

The ANZ March issue was priced at its 6.25% minimum rate, given this was higher than the alternative option of the aggregate of the seven-year swap rate plus a margin of 210 basis points at the time the rate was set. The Rabobank issue was priced at its minimum rate given 6.10% was higher than the alternative of the seven-year swap rate plus 190 basis points, and the BNZ issue also went for 6.10% given this was higher than the swap rate plus a 200 basis point margin.

When announcing it would call the bonds on June 15, BNZ also said if bondholders invest their bond money in a BNZ term deposit for at least 30 days, they'll get an increase of 20 basis points to the advertised rate. See all advertised bank term deposit rates here.

Meanwhile, Kiwibank called a NZ$75 million unsecured subordinated bond, that was paying 7.72% per annum, on its March 20 call date. It hasn't yet revealed any plans to replace it. A spokesman for Kiwibank yesterday told interest.co.nz the bank was continuing to monitor debt market opportunities.

"While NZ banks are currently able to issue subordinated debt under the Reserve Bank’s transitional arrangements, there is merit in waiting for the Reserve Bank to finalise their Basel III policy before coming to market. So essentially we are still keeping our options open," the Kiwibank spokesman said.

The Reserve Bank recently pointed out that some banks will need to raise new regulatory capital to comply with the Basel III standards and said it aimed to consult on its draft Basel III standards around mid-year. However, it also recently pushed out its timeline for the introduction of Basel III meaning most unsecured subordinated bank bonds will retain some capital value through until 2018.

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