By Paul Rickard

Yield starved retail investors are set to embrace the return of ASX listed bank subordinated notes. Yesterday, the National Australia Bank launched the first retail offer in some years with an issue that is set to raise at least $750m.

Investors are being offered a note that pays interest quarterly at a fixed margin of 2.2% over the 90-day bank bill rate. With the 90-day bank bill rate around 1.75%, this means an interest rate of 3.95% for the first 90 days. Thereafter, the interest rate will be reset each quarter based on the then current 90-day bank bill rate. For example, if the bank bill rate rises to 2.5%, investors will receive 4.7% for the quarter, if it falls to 1.0%, investors will receive 3.2% for that quarter. 

NAB Subordinated Notes 2 will be quoted on the ASX and trade under stock code NABPE. They will be NAB’s first Basel III compliant retail Tier 2 instrument. Holders of NABHB (an earlier issue of subordinated notes made in 2012 which is not Basel III compliant) will be invited to re-invest into the new notes.

Subordinated Notes vs Capital Notes

Subordinated notes differ to the more familiar bank hybrid or capital notes issues, such as NAB Capital Notes, Westpac Capital Notes, Commonwealth Bank PERLS, etc., and pay a lower effective interest rate. The main differences are:

  • unlike bank hybrids, which are perpetual, they have a fixed term. In this case, the term is 11.5 years;
  • in the event of a wind-up, they are ranked higher than bank hybrids. Because they are Tier 2 capital instruments, they rank ahead of all Tier 1 capital instruments such as bank hybrids or ordinary shares;
  • the interest payment is not discretionary, and is cumulative. It is, however, still subject to a general solvency condition;
  • there is no mandatory conversion into ordinary shares which could happen with hybrid issues if the bank breaches a capital ratio. However, there is a non-viability trigger event condition, where APRA may require the conversion of the notes into ordinary shares if NAB gets into severe financial difficulty.

The 2.2% margin on these notes compares to the circa 3.8% margin that bank hybrids are trading at. At the other end of the risk scale, the major banks are paying retail investors around 2.0% on 90-day term deposits, a margin of 0.25% over the 90-day bank bill rate. While term deposits are effectively government guaranteed, there is considerable re-investment risk as the rate must be re-negotiated every rollover.

Offer Details

The notes have a fixed term of 11.5 years and mature on 20 September 2028. In addition, NAB has the right to redeem the notes after 6.5 years on 20 September 2023 at par, and thereafter on each quarterly interest date. This option is only available to NAB - noteholders cannot request that the notes be redeemed early. Other details are set out in the table below.

How to invest

In addition to a broker firm offer (brokers nominated include Morgans, Macquarie and JB Were), NAB shareholders and holders of National Income Securities or NAB Capital Notes can invest through the security-holder offer. There is no general public offer. 

A re-investment offer is being made to holders of NAB’s existing subordinated notes, NABHB. While participation is voluntary, NAB has indicated that it will most likely exercise its right to redeem these notes early on 19 June 2017.

The offer is due to open on Thursday 16 February.

Bottom Line

While secondary market bank hybrids arguably represent better value (3.8% compared to 2.2% for not that material a difference in risk profile), considerations such as brokerage and thin markets also need to be taken into account. Further, with many investors being so cashed up and the banks really squeezing cash deposit rates, this issue will find broad appeal.

ImportantThis content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.