The margins paid by Australian banks has been increasing in the wholesale markets. A good example of this is the listed security - CBAHA. This is a floating rate security that matures in December 2015 which pays a margin of 1.05% above the 90 day bank bill rate. The security is one of the few pure debt instruments being traded on the ASX.
Since being issued it has struggled to maintain the 1.05% margin by consistently trading below the par value of 100. Until July 2011 it traded between a margin of 1.3% to 1.45%. Currently ($98.65) the margin is around 1.75%, which is quite a hefty increase over the original margin of 1.05%. The current margin is also reflected in the Credit Derivative market.
CBAHA pays a $1.56 dividend in 10 days, making the ex-dividend price around $97.00.
ANZ recently launched a Convertible Preference Share (CPS3) at a margin of 3.10% above the 180 day bank bill rate. This is the same margin as ANZ's previous CPS issue - ANZPA. Whilst CBAHA is senior debt, the ANZ CPS is sub-ordinated debt that ranks above common equity, but behind other claims including depositors. Given the deterioration in the margins of senior debt, it was surprising that ANZ achieved a margin of only 3.1%. The nature of converting preference shares is that on maturity you generally receive $101 worth of shares at the future share price. Since the bank is guaranteed to issue shares, rather than repay the loan, the securities are treated as equity for capital adequacy purposes. So if ANZ is $20 at maturity you get about 5 shares, if it is $25 at maturity you get 4 shares.
One of the features of CPS is that there is a maximum number of shares that you can receive. The lowest share price for conversion is around $10.21, so that the maximum number of shares you receive is 9.89 ANZ shares. If the ANZ share price is $5 on maturity, you don't receive 20 shares, you only get the 9.89 shares. In effect, you are granting ANZ a put option at a strike price of $10.21, maturing in September 2019. That has got to have some value. Fortunately APRA is changing the rules on maximum conversion rates so that instead of a put option at 50% of today's share price, it is being reduced to 20% of today's share price. So the strike price should be reduced from $10.21 to $4.04. Changing the rules may take some time, so until then the put strike price is still $10.21. ANZ did trade at $12.06 in January 2009, so the value of the put should not be undervalued.