A well known commentator said “This is not a good product - why buy junk debt with minimal potential upside and lots of risk”. Yes, he called it junk.
The Financial Markets Authority (FMA) warned that “the offer was riskier than a bank deposit and the notes carried similar risks to buying shares in ASB but without the opportunity for growth. If ASB or parent company CBA* experiences severe financial difficulties, the ASB Notes may be exchanged for ordinary shares of CBA or written off.”
*The Commonwealth Bank of Australia - CBA - owns the ASB.
Well if CBA ever do get into difficulty, their shares could fall sharply. Not the security an ASB bond issue might be expected to carry.
Chasing high rates ?
The higher the return, the higher the risk.
The bond is rated BBB rated, much lower than the ASB itself which is AA-.
And why did they offer 6.65% when other recent issues have been around 5.5% to 5.8% ?
Because the security is much lower - higher risk (this “law” never changes).
If they cannot repay you, the bonds will be traded for CBA shares.
What if an investor needs the money ?
Good bonds are liquid and can be bought or sold at any time - a nice feature .
If bank rates edge upwards towards 6%, could this lower quality bond trade below cost ? i.e. drop to $9,000 per $10,000 invested ?
It matures in 2024, so may not be so hot if an investor wants money out earlier.
In the past other odd ball bank bonds and preference shares have fallen as low as $7,000 per $10,000 invested.
Maybe this bond is OK for 1% to 2% of an investors money, but only if he/she knows how bonds work.
From a well qualified commentator;
“In the event of a CBA non-viability event, the investors money would get converted to CBA shares at 20% of the CBA price at the time the bonds are issued - March 2014. Their example uses AUD$74.60 as the now price so the investors money would be converted to CAB shares at an AUD$14.92 price.
The document then shows a sole illustration what the investor's loss would be if the actual share price at the time was only AUD$12. They show a NZ$5,000 deposit would be worth AUD$3,696 (which is around NZD$4,000 at 90 cents exchange rate).
This suggests that the downside risk is reasonably limited, if I can say -20% - yes minus20% - is reasonably limited.
But I have to question what the actual CBA share price would be in the event of a CBA non-viability event that triggered the exchange. Can I suggest that the share price is much more likely to be close to zero? That would mean the 308 CAB shares issued could well-nigh be worth zero. i.e. the investor stands to lose the whole of their capital.
I think the way this is illustrated could well be (is) quite misleading to some investors”.
But CBA and ASB won’t get into trouble as they are huge banks
Really ? NZ banks have loaned huge amounts to dairy farmers, and to Auckland home owners and property investors.
They most certainly could get into trouble if NZ gets foot-and-mouth disease.
Or if Fonterra manage to contaminate their milk products again.
Or if the Auckland property market – already over priced - has a sharp fall.
Supplied by Alan Clarke, financial & retirement adviser, & author. He also writes regular articles for the media & on line – see www.acfs.co.nz
His second book is due out in May 2014 & is entitled “The Great NZ Work, Money & Retirement Puzzle”.
Alan is an independent authorised financial adviser (AFA) FSP26532 & his disclosure statement is available on request and free of charge.