Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 330

Should you buy CBA PERLS XII Capital Notes?

Commonwealth Bank of Australia (CBA) will raise $1.25bn via a Tier 1 hybrid issue, to be listed on the ASX, called CommBank PERLS XII Capital Notes. This issue will provide Additional Tier 1 (AT1) regulatory capital. The offer comprises a broker firm offer and an eligible securityholder offer. Unlike recent PERLS issues, this note is not a replacement of an existing issuance, hence there is no reinvestment offer.

CBAPI is a fully paid, convertible, transferrable, redeemable, subordinated, perpetual, unsecured note with a $100 face value and mandatory exchange date of 20 April 2029. Mandatory exchange is subject to several exchange conditions. CBAPI may be exchanged earlier as a result of a trigger event or CBA exercising an option to call the security two years early on 20 April 2027. Distributions are discretionary, noncumulative and fully franked with a dividend stopper. Distributions will be paid quarterly in arrears, based on the 90-day Bank Bill Swap (BBSW) rate plus a margin of 3.00% per year. For example, using the current 90-day BBSW rate of 0.85%, this equates to a gross running yield of 3.85% per year.

Key takeaways

  • We recommend investors subscribe to the offer for CBAPI. CBAPI’s issue margin of 3.00% provides a relatively attractive premium to our current fair value curve of major bank AT1 securities in the 7.5-year term to call range.
  • Following completion of the bookbuild, CBA has finalised the issue size at $1.25bn and a margin of 3.00%. Initially only seeking $750m and an indicative margin range of 3.00% to 3.20%, investor demand was clearly strong. The hunt for yield continues, triggered by low cash rates and growing expectations the RBA will cut further and even implement some form of quantitative easing in Australia.
  • Our near-term outlook for hybrid pricing remains constructive. The major banks are profitable, have strong AT1 capital positions and need to raise more Tier 2 Capital. Supply should remain tight in the near term, as corporate issuances have dried up with little signs of revival and major banks face a near-term shortage of AT1 reinvestment opportunities. Risks include a global backdrop of increased market volatility, or a major bank AT1 supply spike in the next six months should the banks take advantage of the prevailing low rate environment to execute large, long-dated deals.
  • It is important to reiterate hybrid securities should not be viewed as traditional fixed-income products, nor should they be considered a substitute for low-risk investments such as term deposits. We consider hybrid securities suitable only for investors with a medium to high risk tolerance due to their subordination on the capital structure.

Recommendation

We assign CBAPI a medium investment risk rating, the same as other Basel III-compliant Tier 1 major bank hybrids. The terms and conditions, such as nonviability and capital conversion triggers, in this new breed of hybrid securities make them more equity-like and, consequently, riskier than the “old-style” issues. Investors should understand these risks and be incrementally compensated in return. Nevertheless, for investors willing to take a position on the lower end of a company’s capital structure, hybrid securities can represent an attractive yield investment.

Domestic major bank AT1 hybrids have performed well since 2016, thanks to the search for yield amidst geopolitical/economic uncertainties, as well as record low interest rates globally. While the hybrid market has had a challenging close to 2018, 2019 has been very strong as markets embraced more risk following the Coalition’s victory in May. While average major bank trading margins moved out to 4.00% towards the end of 2018, they have just as rapidly recovered those price falls and at the time of writing sit around the 2.40% mark.

We believe a key reason for the CBAPI issue is to space out the maturity profile of the bank’s hybrids and avoid having clustered, mega deals as it did previously. With more than $14.5bn of major bank hybrids, of which around $6.1bn are CBA’s, due to be called in 2021–2022, future issues could: i) involve having to “outbid” issuers via higher margins; or ii) risk not being fully absorbed by the market. The more clustered the terms to call, the higher the refinancing risk.

Of the four major banks, National Australia Bank (NAB) has the biggest near-term refinancing needs, with both NABPB and NABPC due to be called in 2020. We expect NBA to refinance both hybrids in new issues in 2020, though it (or any other bank) could follow CBA’s lead and launch long-dated, “new money” issues early in order to pre-emptively meet APRA’s requirement for the major banks to have AT1 ratios of at least 1.5% by 2024. 

The timing of the CBAPI issue is practical, particularly given favourable funding conditions which are expected to persist. The distribution rate for hybrids are linked to the BBSW has plummeted over the course of 2019 following the repricing of cash rate expectations. The 90-day BBSW has more than halved from 2.08% at the start of January to around 0.85% currently.

Barring an unexpected bout of inflation, we do not envisage a spike in the BBSW in the near term given the RBA’s apparent intentions to ease monetary policy further.

From a capital ratio standpoint, we do not believe any of the major banks are in urgent need of additional AT1 capital, bearing in mind there are limited scheduled redemptions in 2020 (apart from NABPB and NABPC). All four major banks currently have enough AT1 capital, need to raise more Tier 2 capital (which are cheaper than AT1 hybrids) and meet common equity Tier 1 requirements in the near term. So, while near-term supply levels should remain tight, the prevailing low rate environment and strong investor appetite for yield could entice issuers to tap the market anyway.

Despite the relative attractiveness of CBA’s equity dividend yield premium to CBAPI’s yield to call, we still see value in CBAPI due to its lower expected volatility. As we have seen in recent years, hybrid volatility has been significantly lower than that of the equity of the same issuer. The latter bearing the brunt of the headline risks the major banks continue to face.

Exhibit 1: Major Banks AT1 hybrid call dates

Source: Morningstar

Exhibit 2: Major banks AT1 hybrid trading margins vs term to first call date

Source: Morningstar

Adam Fleck is Regional Director of Equity Research, Australia and NZ, and Shaun Ler is Associate, Equity & Credit Analyst, both at Morningstar Australasia. This article is general information and does not consider the circumstances of any investor. Please consultant a financial adviser before taking investment decisions.

 

4 Comments
SD
August 24, 2021

I consider myself as a little above average than a normal num-dad type of investor. To date my investment strategy has been to buy in trough price range and sell at peak levels as per last 3 to 5 yr trend. To me the cap notes seem good return as most provide around 2.7 to 4% over BBSW and then I could sell if the pricing goes above 104-to 105. That way I have got a decent return of apx 7 to 9%.
This is my very basic understanding. Can someone explain me if I am wrong and if so where?
I dont understand the yield to maturity or any of the other complex numbers. would love to know what particular numbers one should focus on

Matt
April 26, 2020

Hi Dane,
Great comment, appreciate the insight

Larry Fine
November 02, 2019

The complexity of these items makes one wonder why First links can recommend!

Dane
October 31, 2019

If market commentators are comfortable recommending investors obtain exposure single-security idiosyncratic risk, then the level of exposure becomes of vital importance. This is what the article should focus on. Most 'mums and dads' who invest in these things don't understand them. If you asked them to explain the risks (i.e volatility, position in the the capital structure, trigger event process), you would draw blank looks. The asymmetric return profile on these things relative to equities looks ordinary. For some reason it's become accepted in Australia for unsophisticated investors to take concentrated positions in complex securities with risks they don't fully understand. Add to this, most investors already have significant exposure to the banks either via TD's, the sharemarket (~30% of ASX) and indirectly via the housing market. Perhaps diversifying would be an idea.

 

Leave a Comment:

RELATED ARTICLES

Is it time to sell bank hybrids?

Turbulence creates opportunities for bonds and hybrids

The dramatic tale of two hybrids, CBA VII versus VIII

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

UniSuper’s boss flags a potential correction ahead

The CIO of Australia’s fourth largest super fund by assets, John Pearce, suggests the odds favour a flat year for markets, with the possibility of a correction of 10% or more. However, he’ll use any dip as a buying opportunity.

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

Latest Updates

Investing

Designing a life, with money to spare

Are you living your life by default or by design? It strikes me that many people are doing the former and living according to others’ expectations of them, leading to poor choices including with their finances.

Investment strategies

A closer look at defensive assets for turbulent times

After the recent market slump, it's a good time to brush up on the defensive asset classes – what they are, why hold them, and how they can both deliver on your goals and increase the reliability of your desired outcomes.

Financial planning

Are lifetime income streams the answer or just the easy way out?

Lately, there's been a push by Government for lifetime income streams as a solution to retirement income challenges. We run the numbers on these products to see whether they deliver on what they promise.

Shares

Is it time to buy the Big Four banks?

The stellar run of the major ASX banks last year left many investors scratching their heads. After a recent share price pullback, has value emerged in these banks, or is it best to steer clear of them?

Investment strategies

The useful role that subordinated debt can play in your portfolio

If you’re struggling to replace the hybrid exposure in your portfolio, you’re not alone. Subordinated debt is an option, and here is a guide on what it is and how it can fit into your investment mix.

Shares

Europe is back and small caps there offer significant opportunities

Trump’s moves on tariffs, defence, and Ukraine, have awoken European Governments after a decade of lethargy. European small cap manager, Alantra Asset Management, says it could herald a new era for the continent.

Shares

Lessons from the rise and fall of founder-led companies

Founder-led companies often attract investors due to leaders' personal stakes and long-term vision. But founder presence alone does not guarantee success, and the challenge is to identify which ones will succeed in the long term.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.