Inside the EYF - successfully navigating an ever-changing regulatory world

Inside the EYF: ANZ and Westpac bonds – successfully navigating an ever-changing regulatory world


Back in the mid to late 1980’s, at the direction of the Australian Prudential Regulation Authority (APRA), Australia’s major banks had to come up with new sources of long dated funding that sat between their senior bonds, and their equity. 

One such structure was a floating rate Perpetual bond. At the time, these bonds were issued with very small floating rate coupons – i.e., very small - only 0.15% above cash small!

Over time, the price of these bonds drifted lower and lower as the market demanded a bigger and bigger discount to their par value to compensate investors for the very small coupon yield.

Fast forward to the 2010 - 2020 decade, and the Basel III committee on global banking supervision was formed, in the post GFC world. In an attempt to shore up bank balance sheets, the Basel III committee recommended to banking regulators that any funding that sat below senior debt should be able to be converted into shares, in order to create additional equity in the event that a bank’s equity capital was diluted in a crisis.

These bonds were not convertible into equity. 

The Investment

This new development resulting from Basel III’s recommendations to the regulators was what caught our eye. These particular bonds were trading at very large discounts to their $100 par value – yet in theory, at some point they needed to be redeemed - and replaced with something more Basel III friendly.

In late 2018 we built a position in both ANZ and Westpac’s bonds at approximately $70 –a ~30% discount to their $100 par value - on the basis that both banks would ultimately redeem or repurchase these bonds at or close to par, and issue something more in line with Basel III guidelines. 

Over the past couple of years, numerous banks around the world have been redeeming these bonds at or near their par values. In that time, the prices of just about all bonds in this category had been increasing.

Earlier this year, the price of both the ANZ and the Westpac bonds rose well above $90 after yet another bank redeemed its bonds, and thus we sold our investment. At this point we had generated a return of ~8% p.a. - not bad when you consider that the average RBA cash rate over this period was ~1%! 

This “outside the box” investment is a good example of the sort of investments that we look for to add to the PM Capital Enhanced Yield Fund. 

The nature of why they represented a prudent investment required intense research, and a detailed understanding of global banking regulation. It also required the development of key banking relationships in order to source the bonds. 

These particular bonds were issued decades ago, had a complicated history, and were subsequently written off by many investors – but not by us. 

About the Author

Jarod Dawson is the Global Yield Portfolio Manager.

More information on the PM Capital Enhanced Yield Fund is available here. Alternatively, see more insights related to the Enhanced Yield Fund here.

This insight is issued by PM Capital Limited ABN 69 083 644 731 AFSL 230222 as responsible entity for the PM Capital Enhanced Yield Fund (ARSN 099 581 558, the ‘Fund’). It contains summary information only to provide an insight into how we make our investment decisions. This information does not constitute advice or a recommendation, and is subject to change without notice. It does not take into account the objectives, financial situation or needs of any investor which should be considered before investing. Investors should consider the Target Market Determinations and the current Product Disclosure Statement (which are available from us), and obtain their own financial advice, prior to making an investment. The PDS explains how the Fund’s Net Asset Value is calculated. Past performance is not a reliable guide to future performance and the capital and income of any investment may go down as well as up.