Convertible Notes – ‘Rock Solid’ as Australian Government Bonds?

Financial Crime

If you’ve been wondering about the Australian dollar’s bi-polar nature these last few months, Katrina King of QIC has an explanation.

Hedge funds had piled into bets that a slowdown in China would cause the Aussie dollar to tank. Traders pushed the Aussie to 87 cents.

Then they changed their minds and decided Aussie interest rates are just too good to miss out on. So they piled into Aussie bonds, bidding up the dollar again to 94.5 cents. According to Australian statisticians, foreigners bought $25 billion in Aussie government bonds in the last 6 months — more than in the previous 15 months combined. But IMF data says foreign demand for our bonds actually weakened in 2013. Statisticians can’t even count these days…

Meanwhile, Australians are less enthusiastic about their local bonds. Our holding’s share of our government’s bonds has halved to only 30% over the last 14 years.

Westpac Bank is hoping to make the most of the demand for Australian interest rate securities. It will be listing between $500 million and a billion dollars in floating convertible notes. They’re being labelled ‘bail in securities’ by insiders. That sounds promising, doesn’t it? But what does it mean? Well, this gets a little complex. But the narrative is rather interesting for any Australian chasing yield.

Banks will be required to hold more tier-2 capital as part of the new global banking regulations. Tier-2 means that it’s capital which isn’t rock solid like government bonds *cough*, but is still quite reliable. In other words, banks need something they can rely on to provide them with cash or reduce their liabilities at short notice and without any liquidity or counterparty risk. They’re turning to convertible notes.

During good times, convertible notes behave like debt financing. They have an interest rate style distribution payment. But if there’s a bank crisis, the bank can convert those notes to shares, reducing its liabilities substantially and increasing its capital. The bank gets the best of both worlds. The investors end up with bank shares just when they don’t want them, hence the name ‘bail in securities’.

Not all convertible notes are of the ‘bail in’ kind though. Insurance and financial companies tend to use them in that way. Other companies can offer a good deal, as we explained in The Money for Life Letter.


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Nick Hubble
Nick Hubble is a feature editor of The Daily Reckoning and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about The Daily Reckoning, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.

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