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IAG – Insurance Australia Group Limited Subordinated Bond - Recommendation 

Insurance Australia Group Limited has announced the issuance of NZ$325m unsecured, subordinated, bonds. This security holds a credit rating of A- from Standard and Poors whilst the issuer rating is A+.

 Maturity Date:       15^th December 2036 

Call date:              15 December 2016 and each interest payment date thereafter. 

Interest Rate:        The interest rate until the first call date will be the initial interest rate. The interest rate for subsequent periods will be the sum of the benchmark rate on the rate reset date and the original margin. 

Initial Interest Rate: The Initial Interest Rate will be set on the rate set date at the greater of:

-       The benchmark rate on the rate set date plus the margin: and

-       The minimum interest rate (7.50%) 

Payments:             Quarterly in arrears in four equal payments beginning 15 March 2012 

Deferability:           The issuer has a general right to defer payment of interest. Any deferral of interest is not an event of default.    

We believe that the following factors need to be taken into account when assessing the worthiness of this subordinated bond in a fixed interest portfolio. 

1. The bonds are unsecured and subordinated and have been assigned an intermediate Equity Content until the first call date and nil thereafter. This has resulted in the security being assigned an A- credit rating as opposed to the issuer’s A+.  

2. The maturity date is 2036. This is a long dated security and whilst early redemption is likely, any early redemption is at the issuer’s request – not at the option of the investor 

3. Whilst the security is investment grade, we recommend investors look beyond the credit rating and take into consideration the level of subordination and the sector that IAG operates in.  

4. The issuer has the right to defer interest as per circumstances specified in the trust deed.  

5. We were surprised that the company issued in excess of the $250m (NZ$150m plus oversubscriptions of NZ$100m) as per their original term sheet. The final issue size of $325m was NZ$75m in excess of the issue amount including oversubscriptions. 

6. In general investors need to be wary of the level of subordination that is occurring in recent new issuance and ensure that they are aware of where their investment ranks in terms of security.  

7. Similar to the Contact Energy subordinated bond currently being offered in the market, the risk/reward equation for this security has to be a substantially higher yield to investors to compensate them appropriately for the second-line security position.

Contact Energy Capital Bond - Recommendation 

Contact Energy has announced the issuance of NZ$150m plus up to an additional NZ$100m of unsecured, subordinated, redeemable, cumulative, interest bearing debt. This security is expected to hold a credit rating of BB- from Standard and Poors. 

Maturity Date:       15^th February 2042 

Call Option:           Issuer call at par capital plus accrued quarterly from 15^th of February 2017 

Interest Rate:        From the Issue Date until 15^th February 2017:

                              A fixed rate set on the Rate Set Date as the higher of:

                              (a) the minimum interest rate (determined via bookbuild) and;

                              (b) sum of 5 year swap rate and the Initial Margin (determined via

                              bookbuild).

                              Thereafter until the Maturity Date:

                              Reset every 5 years to the 5yr swap rate plus the Step-up Margin 

Step-up Margin:    The Initial Margin plus 25bps 

Payments:             Quarterly from and including 15^th February 2012 

Deferability:           Interest will be deferred (cumulative) in certain circumstances:

                              (i)  if the Contact Energy’s S&P issuer credit rating is BB or lower,

                              (ii)  the issuer is insolvent or,

                              (iii) the payment of interest would cause the issuer to become insolvent

                              There is no dividend stopper so distributions can still be paid on the

                              company’s ordinary equity regardless. 

Control Change:    Issuer call option at greater of par capital plus accrued or market

                              Investor put option at par plus accrued under change of control and an

                              associated downgrade in Contact Energy’s issuer credit rating to less

                              than BBB (or unrated) 

Listing:                    NZDX 

We believe that the following factors need to be taken into account when assessing the worthiness of this subordinated bond in a fixed interest portfolio. 

1. The bonds are unsecured and subordinated and have been assigned a High Equity Content until 15 February 2022. This is likely to result in the bond being assigned a credit rating of BB- as a result. Therefore despite the issuer, being Contact Energy Limited, holding a BBB credit rating, the issue itself is sub investment grade. 

2. The maturity date is 2042. This is a very long dated security and whilst early redemption is highly likely, any early redemption is at the issuer’s request – not at the option of the investor 

3. We expect that due to the security being sub investment grade, the majority of the issue will be subscribed to by retail investors. Given retail issuance is generally bought and held through to maturity, a lack of market liquidity may be a factor over time. 

4. Deferability of interest will occur if the company’s credit rating drops to BB.  

5. The all-up interest rate to investors must be well above 8.00% to reward investors for the very long-term commitment, the inferior security (ranking behind senior debt holders) and likely poor liquidity.

ANZ Bank Limited; Unsecured, unsubordinated Senior Bonds; Maturity 20 September 2018. (Updated 15 September 2011) 

ANZ Bank Limited has launched a 7 year unsecured, unsubordinated note at a margin of 1.80% over the 7 year swap rate. Based on current swap rates this would assume a coupon of approximately 6.10%. 

The bonds are fixed rate senior obligations of the bank and hold an AA credit rating with Standard and Poors – (Aa3 Moodys). The bond has a fixed maturity of 20 September 2018. The issue amount is $100m with provision for a further $150m in oversubscriptions).  

Offer Opens:            Tuesday 13 September 2011
Offer Closes:            Friday 16 September 2011
Issue Date:               Monday 20 September 2011  

The credit margin at 1.80% for 7 years appears fair relative to where senior debt should be trading in this maturity. Shorter dated secondary market senior bank debt has recently been trading closer to 1.50% above swap. 

We believe that based on the margin to swap the bond represents fair value. Once again we acknowledge the shortage of primary issuance and the current liquidity in the market based on recent maturities. The ANZ is issuing bonds in the domestic market as the margin of 1.80% is lower than what they would pay today in international debt markets. ANZ seven-year credit default swap margins (spreads) are trading closer to 3.00% in international markets.  

Fixed interest investors should take into consideration that this issue should be regarded as a longer term investment and there is potential for market yields to rise over coming years. If the bond is sold prior to maturity and market interest rates have increased since the purchase date, a capital loss is incurred.  

Notwithstanding, the security is of a good quality and for investors looking for longer term bond exposure it is a suitable addition to a fixed interest portfolio.

Air New Zealand Limited

Air New Zealand Limited has announced an offer of $150 million unsecured, unsubordinated fixed rate bonds that mature on the 15^th of November 2016. The offer will open on the 5th of September 2011 and remain open until the 23^rd of September 2011.

The interest rate has been set at 6.90%.

The bonds are unsecured unsubordinated fixed rate obligations of Air New Zealand and rank equally and without preference among themselves. The bonds also rank at least equally with all other unsecured and unsubordinated indebtedness of Air New Zealand, except indebtedness preferred by law.

Interest will be paid semi-annually with the first interest payment being paid to the original subscriber.

Conclusion:

The bond will be targeted at the retail market given it has no credit rating. Based on the recent issuance by Z Energy and yields currently attainable in the secondary market, it would appear that the bond will most likely be priced at approximately 250bps over swap. Whilst it is possible that Air New Zealand could raise the funds closer to 200 bps over the five year swap rate, we believe that the market will expect to see the coupon set at 6.50% or above.  The real test of the pricing will be seen in the post-issue secondary market. Should the bonds be issued at 250 bps over swap and then subsequently trade down to nearer 200 bps over, due to unfulfilled investors buying in the secondary market, Air New Zealand would have paid too much for its money!

Investors need to take into account the following points:

·         Whilst the bond itself is unrated, Air New Zealand (the company) holds a Moody’s Baa3 credit rating and is on negative outlook. The Moody’s rating equates to a BBB- investment grade rating with Standard and Poors. The Air New Zealand bonds are unsubordinated, however there are significant amounts of aircraft assets pledged as security over borrowing and aircraft leases. These specific securities reduce the assets available to repay bondholders and other unsecured creditors should Air New Zealand fail, and the assets have to be liquidated to repay bondholders.

·         Whilst the New Zealand government is a major shareholder in Air New Zealand, prospective investors should be aware that should the Crown sell down their shareholding, there is no change of control covenant in place to provide bond holders with the opportunity to redeem early.

·         Given the retail nature of the issue we would expect that the bonds will be fairly illiquid given many holders will retain to maturity.  

We are of the view that the bond, irrespective of what the final interest rate is when it is set, is of a higher risk nature. Whilst some investors will take comfort from the Crown’s current majority shareholding and the implied support that this may seem to provide; we don’t believe that this is enough to provide investors with the sufficient reassurance they require to invest in an unrated issue in the current environment.