Case Studies & Checklist

Case Studies

The following Case Studies are for illustrative purposes only. Any rates or calculations on which the Case Studies are based are for illustrative purposes only and do not indicate actual payments or rates and are not based on real market conditions. The Case Studies are not a guarantee or forecast of the actual payments or rates that may be achieved. Past performance is not a reliable indicator of future performance.

Case Study 1 provides an example of how to calculate distribution rates and distribution amounts for a Tier 1 Bank Hybrid where distributions are fully franked. Distributions are only payable subject to the satisfaction of the distribution payment conditions Distribution payment conditions There are certain conditions that must be satisfied before distributions can be paid, including (i) that the payments are at the discretion of the bank, (ii) that the payments will not result in a breach of the bank’s regulatory capital requirements or in the bank becoming insolvent, and (iii) that APRA does not object to the payment. . Franking credits Franking credits Franking credits represent each holder’s share of tax paid by the issuing bank on the profits from which the distributions are paid. are generally taken into account in calculating distributions on Tier 1 Bank Hybrids.

For example, if

margin Margin The margin is fixed at the time of issue and typically reflects the risk premium of a Bank Hybrid above a floating market rate (e.g., BBSW) at the time of issue. = 3.00% per annum
BBSW BBSW BBSW is a key benchmark interest rate for the Australian money market that moves over time in line with market conditions and monetary policy. It is typically the 90 day bank bill swap rate. = 2.00% per annum
face value Face value The face value is typically the issue price, which will be reduced by any partial conversion or write-off. of Tier 1 Bank Hybrid = $100
Step 1
the equivalent unfranked distribution rate = BBSW + margin
= 2.00% + 3.00%
= 5.00% per annum
Step 2

The equivalent unfranked distribution rate is then adjusted down to take account of the franking credits to be attached to the distribution to arrive at the cash distribution rate:

cash distribution rate = equivalent unfranked distribution rate × (1-tax rate)
= 5.00% × (1.00 - 0.30) (assuming a corporate tax rate of 30% and expressed as a decimal in the calculation)
= 3.50% per annum
Result

In total the investor will receive in percentage terms:

3.50% as a cash distribution on the distribution payment date and
1.50% as franking credits

cash distribution rate 3.50% per annum
multiplied by the face value of each Tier 1 Bank Hybrid × $100.00
multiplied by the number of days in the relevant distribution period (assuming 90 days for a quarterly distribution period) × 90
divided by the number of days in the year ÷ 365
Cash distribution amount for each Tier 1 Bank Hybrid = $0.8630

Amount of franking credits per cash distribution amount = cash distribution amount ×
)
corporate tax rate
) ÷ (
1 - corporate tax rate
)
= $0.8630 ×
(
0.30
) ÷ (
0.70
)
= $0.3699


In total, the investor receives in dollar terms:


The investor will receive for each Tier 1 Bank Hybrid of $100: $0.8630 as a cash distribution on the distribution payment date and
$0.3699 as franking credits

cash distribution amount $0.8630 × 500 = $431.50
franking credit amount $0.3699 × 500 = $184.95

Please note that the ability of an investor to use franking credits, either as an offset to a tax liability or by claiming a tax refund, will depend on each investor’s individual tax position. Any benefit will only be received after an investor’s tax return is lodged.


View Case Study 2: Non-viability

Case Study 2 provides an example of how to calculate the number of ordinary shares that an investor might receive following conversion of a Bank Hybrid after the occurrence of a non-viability trigger event Non-viability trigger event A non-viability trigger event will occur when APRA notifies a bank in writing that it believes (i) conversion to ordinary shares of some or all of its Bank Hybrids or (ii) a public sector injection of capital or equivalent support, is necessary to prevent the bank becoming non-viable. See non-viability trigger event. .

  • John invests $10,000 in Bank Hybrids (100 Bank Hybrids at a face value Face value The face value is typically the issue price, which will be reduced by any partial conversion or write-off. of $100.00 per Bank Hybrid).
  • The bank experiences severe financial difficulty and APRA APRA The Australian Prudential Regulation Authority. determines that a non-viability trigger event has occurred.
  • Following the non-viability trigger event, John’s entire investment is converted into ordinary shares.
  • Conversion in the case of a non-viability trigger event does not require conversion conditions Conversion conditions Conversion of some Bank Hybrids may be subject to conversion conditions set out in the prospectus for the particular Bank Hybrid. See Case Study 3, including a worked solution, for further detail. to be satisfied prior to conversion.
  • On conversion, the number of ordinary shares John will receive will be the lesser of:
    • the conversion number (see Formula A below) and
    • the maximum conversion number Maximum conversion number The maximum conversion number is a limit or cap on the number of ordinary shares of the bank that may be issued on conversion. For a scheduled or mandatory conversion, the maximum conversion number reflects 50% of the bank's ordinary share price at the time of issue of the Bank Hybrid. For conversion following a non-viability trigger event or a capital trigger event, the maximum conversion number reflects 20% of the bank's ordinary share price at the time of issue of the Bank Hybrid. (see Formula B below).

For example, if

face value Face value The face value is typically the issue price, which will be reduced by any partial conversion or write-off. = $100.00

VWAP = $2.00 (calculated as the VWAP VWAP Generally, the average of the daily volume weighted average sale price of the bank's ordinary shares sold on ASX over a relevant period. during the 5 business days prior to conversion, not including the date of conversion)

Conversion discount = 1% (reflected as 0.99 in the formula below)

conversion number per Bank Hybrid =
(
face value
) ÷ (
0.99 × VWAP
)
=
(
$100.00
) ÷ (
0.99 × $2.00
)
conversion number per Bank Hybrid = 50.5051 ordinary shares

The 1% discount on conversion is designed to compensate investors for transactions costs (i.e., brokerage costs) which may be incurred on the disposal of ordinary shares the investor receives on conversion.


The maximum conversion number Maximum conversion number The maximum conversion number is a limit or cap on the number of ordinary shares of the bank that may be issued on conversion. For a scheduled or mandatory conversion, the maximum conversion number reflects 50% of the bank's ordinary share price at the time of issue of the Bank Hybrid. For conversion following a non-viability trigger event or a capital trigger event, the maximum conversion number reflects 20% of the bank's ordinary share price at the time of issue of the Bank Hybrid. in this example is based upon the issue date VWAP Issue date VWAP Generally, the volume weighted average sale price (or VWAP) of the bank's ordinary shares sold on the ASX over the 20 business days prior to the issue date of the Bank Hybrid. . The issue date VWAP is then multiplied by a factor of 0.20 as required by APRA APRA The Australian Prudential Regulation Authority. (i.e., to broadly reflect 20% of the bank's ordinary share price at the time of issue of the Bank Hybrid).

For example, if:

face value Face value The face value is typically the issue price, which will be reduced by any partial conversion or write-off. = $100.00

issue date VWAP = $20.00

maximum conversion number per Bank Hybrid =
(
face value
) ÷ (
0.20 × issue date VWAP
)
=
(
$100.00
) ÷ (
0.20 × $20.00
)
maximum conversion number per Bank Hybrid = 25 ordinary shares

conversion number per Bank Hybrid = 50.5051 ordinary shares
maximum conversion number per Bank Hybrid = 25 ordinary shares
  • On conversion John will receive the lesser of the conversion number and the maximum conversion number Maximum conversion number The maximum conversion number is a limit or cap on the number of ordinary shares of the bank that may be issued on conversion. For a scheduled or mandatory conversion, the maximum conversion number reflects 50% of the bank's ordinary share price at the time of issue of the Bank Hybrid. For conversion following a non-viability trigger event or a capital trigger event, the maximum conversion number reflects 20% of the bank's ordinary share price at the time of issue of the Bank Hybrid. of ordinary shares. As the share price has fallen significantly from the issue date of the Bank Hybrid, the maximum conversion number of ordinary shares will apply and John will receive 25 ordinary shares for each Bank Hybrid.
  • For 100 Bank Hybrids, John receives 2,500 ordinary shares (100 × 25 ordinary shares). If the market price of ordinary shares at the time of conversion is $2.00 per ordinary share, the value of John’s investment will be approximately $5,000 (2,500 ordinary shares at $2.00 per ordinary share).
  • If John sells his ordinary shares when he receives them he will realise a loss of $5,000 on his initial investment of $10,000.

It is not possible to predict the price of a bank’s ordinary shares or whether a market would exist for a bank’s ordinary shares following a non-viability trigger event.


View Case Study 3: Scheduled conversion

Case Study 3 provides an example of how to calculate the number of ordinary shares an investor will receive following scheduled conversion.

  • Bank XYZ issues Tier 1 Bank Hybrids in September 2015.
  • Shirley purchases $10,000 of Tier 1 Bank Hybrids on the ASX ASX The Australian Securities Exchange. in November 2015.
  • At the time of purchase the market price is $100.00 per Tier 1 Bank Hybrid. Shirley receives 100 Tier 1 Bank Hybrids.
  • The Tier 1 Bank Hybrids have the following key dates set out in the prospectus:
September 2020 September 2022
Bank can elect to:

  • convert into bank ordinary shares (subject to the conversion conditions Conversion conditions Conversion of some Bank Hybrids may be subject to conversion conditions set out in the prospectus for the particular Bank Hybrid. See Case Study 3, including a worked solution, for further detail. )

    or

  • redeem for cash (subject to APRA’s APRA The Australian Prudential Regulation Authority. prior approval, which APRA may withhold)
Scheduled or mandatory conversion into bank ordinary shares (subject to the conversion conditions)
  • On the optional redemption / conversion date in September 2020, the bank elects not to redeem or convert the Tier 1 Bank Hybrids to ordinary shares. Shirley decides to continue to hold her investment until the scheduled or mandatory conversion date Scheduled or mandatory conversion date A date on which conversion of a Tier 1 Bank Hybrid is expected to occur (subject to the conversion conditions being met) and set out in the prospectus for the particular Bank Hybrid. See scheduled conversion. of September 2022 rather than sell the Tier 1 Bank Hybrids on the ASX ASX The Australian Securities Exchange. at the prevailing market price.
  • In September 2022 on the scheduled or mandatory conversion date, a number of conversion conditions need to be satisfied for Shirley’s Tier 1 Bank Hybrids to be converted into ordinary shares.
  • If the conversion conditions are not satisfied on the scheduled or mandatory conversion date, conversion will not occur on this date and will be retested on the next distribution payment date.
  1. Condition 1 -

    the VWAP VWAP Generally, the average of the daily volume weighted average sale price of the bank's ordinary shares sold on ASX over a relevant period. of ordinary shares on the 25th business day before (but not including) the potential scheduled or mandatory conversion date Scheduled or mandatory conversion date A date on which conversion of a Tier 1 Bank Hybrid is expected to occur (subject to the conversion conditions being met) and set out in the prospectus for the particular Bank Hybrid. See scheduled conversion. must be greater than 56.12% of the issue date VWAP Issue date VWAP Generally, the volume weighted average sale price (or VWAP) of the bank's ordinary shares sold on the ASX over the 20 business days prior to the issue date of the Bank Hybrid. ; and

  2. Condition 2 -

    the VWAP of ordinary shares during the 20 business days before (but not including) the potential scheduled or mandatory conversion date must be greater than 50.51% of the issue date VWAP.

The conversion conditions are intended to ensure that upon conversion on the scheduled or mandatory conversion date, investors will receive bank ordinary shares worth approximately $101.01 for each Tier 1 Bank Hybrid held (based on a face value Face value The face value is typically the issue price, which will be reduced by any partial conversion or write-off. of $100 per Tier 1 Bank Hybrid and taking into account a 1% discount to the relevant VWAP).

For example, if

face value = $100.00

issue date VWAP = $20.00

  1. Condition 1 -

    VWAP of ordinary shares on the 25th business day before (but not including) the scheduled or mandatory conversion date = $30.00 (which is greater than 56.12% of the issue date VWAP) calculated as

    56.12% × $20.00 = $11.22

  2. Condition 2 -

    VWAP of ordinary shares during the 20 business days before (but not including) the scheduled or mandatory conversion date = $32.00 (which is greater than 50.51% of the issue date VWAP) calculated as

    50.51% × $20.00 = $10.10

Both conversion conditions Conversion conditions Conversion of some Bank Hybrids may be subject to conversion conditions set out in the prospectus for the particular Bank Hybrid. See Case Study 3, including a worked solution, for further detail. are met, therefore conversion will occur on the scheduled or mandatory conversion date.


For example, if

  • face value Face value The face value is typically the issue price, which will be reduced by any partial conversion or write-off. = $100.00
  • VWAP VWAP Generally, the average of the daily volume weighted average sale price of the bank's ordinary shares sold on ASX over a relevant period. of ordinary shares during the 20 business days before (but not including) the conversion date = $32.00 (see above)
  • conversion discount = 1% (reflected as 0.99 in the formula below)
conversion number for each Tier 1 Bank Hybrid =
(
face value
) ÷ (
0.99 × VWAP
)
=
(
$100.00
) ÷ (
0.99 × $32.00
)
= 3.1566 ordinary shares

The 1% discount on conversion is designed to compensate investors for transaction costs (i.e., brokerage costs) which may be incurred on the disposal of ordinary shares the investor receives on conversion.


  • Under Step 1, both conversions conditions Conversion conditions Conversion of some Bank Hybrids may be subject to conversion conditions set out in the prospectus for the particular Bank Hybrid. See Case Study 3, including a worked solution, for further detail. are met and conversion will occur on the scheduled or mandatory conversion date Scheduled or mandatory conversion date A date on which conversion of a Tier 1 Bank Hybrid is expected to occur (subject to the conversion conditions being met) and set out in the prospectus for the particular Bank Hybrid. See scheduled conversion. .
  • Under Step 2, on the conversion date Shirley receives 315 ordinary shares (100 Tier 1 Bank Hybrids × 3.1566).
  • As Shirley would like to realise her Tier 1 Bank Hybrid investment, she sells the 315 ordinary shares on the ASX ASX The Australian Securities Exchange. at a net price of $35.50 per ordinary share, after brokerage costs:
    315 ordinary shares × $35.50 = $11,182.50
  • In this example Shirley receives $11,182.50 for her ordinary shares, which is a small profit on her original Tier 1 Bank Hybrid investment of $10,000.

If the market price for the ordinary shares is less than $31.75 at the time Shirley sells, she will incur a loss on her Tier 1 Bank Hybrid investment of $10,000.


View Case Study 4: Bank Hybrids on the ASX

Case Study 4 provides an example of an investor selling Bank Hybrids on the ASX.

Julie purchases 500 Bank Hybrids at $100 per Bank Hybrid for $50,000.

  • Two years later, Julie decides to sell the Bank Hybrids when the market price on the ASX is $99.50 per Bank Hybrid.
  • Through her broker, Julie sells the 500 Bank Hybrids and receives $49,750 after brokerage costs. Julie has made a loss on her principal investment of $250 although she consistently received distributions each quarter during the two years she held the Bank Hybrids.
  • If Julie sold the Bank Hybrids at a market price that was higher than the purchase price of the Bank Hybrids, Julie may have made a profit on her Bank Hybrid investment, after any brokerage costs.

Checklist

When considering an investment in a Bank Hybrid, you may want to consider the following questions and you should ensure that you understand the key features and risks of Bank Hybrids. You should also read the prospectus carefully, paying attention to the investment risks. In the event you need further information, you should seek professional guidance from your stockbroker, solicitor, accountant or other independent and qualified professional adviser.

  • What are the risks of investing – now and in the future?
  • Will an investment in a Bank Hybrid help me achieve my long-term personal objectives and goals?
  • Does the investment suit my timeframe and personal risk profile?
  • How strong is the bank I am investing in?
  • Does the Bank Hybrid have a maturity date Maturity date The date on which a Tier 2 Bank Hybrid is scheduled to mature. or is it perpetual Perpetual If a security is perpetual, it does not have a fixed maturity date and could exist indefinitely. ?
  • Can the bank repay the investment early or could the Bank Hybrid remain on issue for a very long time or indefinitely?
  • Can I exit this investment if my circumstances change and will I be able to get my initial investment back?
  • If I sell the Bank Hybrid on the ASX, how does the price compare to what I paid and is there a liquid market for the Bank Hybrid?
  • Will the investment returns adequately compensate me for the risk of investing in the Bank Hybrid?
  • How does the distribution / interest rate compare with other bank investments, taking into account the different levels of risk?
  • Can other less risky or less complex bank investments provide similar or better returns?
  • Does the bank have to pay interest or distributions? If not, are missed payments cumulative Cumulative If interest is not paid in full, unpaid interest will accumulate and compound for payment at a later date if certain conditions are met. or non-cumulative Non-cumulative Unpaid distributions will not accumulate or be made up by the issuing bank. ?
  • Are there conditions that need to be satisfied prior to payment of any distribution or interest payment?
  • Is interest fixed for the term of the Bank Hybrid or calculated by reference to a floating rate?
  • If interest is calculated by reference to a floating rate, what is the benchmark Benchmark The market rate used to calculate the distribution rate for a Bank Hybrid. For example, BBSW (typically the 90 day bank bill swap rate). and what is the margin Margin The margin is fixed at the time of issue and typically reflects the risk premium of a Bank Hybrid above a floating market rate (e.g., BBSW) at the time of issue. ?
  • Will the distributions have franking credits Franking credits Franking credits represent each holder’s share of tax paid by the issuing bank on the profits from which the distributions are paid. attached and, if so, are they of value to me?
  • Does the bank have an option to convert, redeem or transfer the Bank Hybrid early?
  • Is redemption subject to APRA approval?
  • Will I be able to reinvest my principal at a similar rate of return at the time of early redemption or transfer?
  • Is there a scheduled or mandatory conversion date Scheduled or mandatory conversion date A date on which conversion of a Tier 1 Bank Hybrid is expected to occur (subject to the conversion conditions being met) and set out in the prospectus for the particular Bank Hybrid. See scheduled conversion. ? When is it?
  • How many ordinary shares do I receive on conversion? How is the number of ordinary shares calculated?
  • Do conversion conditions Conversion conditions Conversion of some Bank Hybrids may be subject to conversion conditions set out in the prospectus for the particular Bank Hybrid. See Case Study 3, including a worked solution, for further detail. need to be satisfied prior to conversion?
  • Is there a minimum or maximum number of ordinary shares I will get on conversion? Can I receive less than the face value Face value The face value is typically the issue price, which will be reduced by any partial conversion or write-off. of my initial investment?
  • At the scheduled or mandatory conversion date does the bank have a choice to either pay cash or convert the Bank Hybrid into ordinary shares?
  • What might happen to the Bank Hybrid if the bank experiences severe financial difficulty?
  • Are there trigger events in the Bank Hybrid that may result in the conversion into ordinary shares, or that may result in the Bank Hybrid being written-off completely?
  • What happens if a non-viability trigger event Non-viability trigger event A non-viability trigger event will occur when APRA notifies a bank in writing that it believes (i) conversion to ordinary shares of some or all of its Bank Hybrids or (ii) a public sector injection of capital or equivalent support, is necessary to prevent the bank becoming non-viable. See non-viability trigger event. or a capital trigger event Capital trigger event A capital trigger event occurs when the issuing bank determines (or is notified by APRA) that the bank’s common equity tier 1 ratio is equal to or less than 5.125%. See capital trigger event. occurs? Is conversion into ordinary shares or write-off Write-off If Bank Hybrids are written-off, investors will lose all of the value of their investment and they will not receive any compensation or unpaid distributions or interest. possible?
  • What are the terms of the conversion?
  • Is there a cap on the number of ordinary shares I will receive? Are there conditions that must be satisfied prior to conversion? Can I receive less than the face value Face value The face value is typically the issue price, which will be reduced by any partial conversion or write-off. of my initial investment?
  • Are there circumstances in which the Bank Hybrid might be terminated and I might receive no compensation for my investment?

Further guidance on investing in bank hybrid securities can be found on ASIC’s MoneySmart website. Their website also has a hybrid securities quiz that you can use to test your knowledge.

In addition, for further information see the ASX ASX The Australian Securities Exchange. website here.