Last October, Challenger flagged its intention to issue another capital note before June 2017. The company has now announced it intends to issue $350 million worth of Challenger Capital Notes 2 (ASX code: CGFPB), with the ability to raise more or less than this amount. Challenger Capital Notes 2 are subordinated, unsecured notes which will pay quarterly floating rate distributions. Challenger already has an ASX-listed hybrid (see tables) similar in structure to this latest offer. The proceeds will be used for funding its subsidiary life company.
The new capital notes will qualify as Additional Tier 1 (AT1) capital under the Basel III bank regulatory framework, which means they have the now-standard “trigger events” which may lead to early conversion into ordinary shares or a write-off of the notes. At the prevailing level of interest rates, they will pay around 6.20% (annualised) inclusive of franking credits. As interest rates change, specifically the bank bill swap rate, quarterly payments will also change.
Challenger’s existing Capital Notes pay quarterly distributions equal to 90 day BBSW plus 340bps, adjusted for franking. Challenger’s new capital notes have an indicative distribution of 90 day BBSW plus a margin of 440bps to 460bps. The final margin will be determined by a book build, which is a tender process managed by investment banks on behalf of Challenger. If recent history is any guide, the margin is likely to be set at the lower end of the indicative range. Distributions will be non-cumulative, at the discretion of Challenger directors and paid quarterly in arrears.
The first call date, the date on which Challenger can redeem or resell the securities, is on 22 May 2023 and, by convention, securities are typically redeemed on this date. If redemption does not occur, exchange for ordinary shares will occur on 22 May 2025, subject to the mandatory exchange conditions. If the mandatory exchange conditions are not initially met in May 2025, the conditions will be tested on each distribution date thereafter until exchange takes place.
The chart below shows the history of issue margins of hybrid securities over the last eight years, including the GFC period in 2008/2009. The new capital notes are shown at both the lower end of the indicative margin (440bps) and the upper end (460bps). Issue margins are set close to trading margins of comparable hybrids already listed on the ASX and, as margins of existing hybrids have fallen in the past year, the new Challenger hybrids are likely to lower than issue margins of recently issued hybrids such as Insurance Australia Capital Notes (ASX code: IAGPC). However, the issue margin will be higher than the issue margin of CBA PERLS IX (ASX code: CBAPF) as Challenger is a vastly smaller entity with a larger credit risk. From a historical perspective, it is clear margins of hybrids issued in the last year are higher than the bulk of hybrids issued from 2009 to 2015.
