The price may be right even if Fitch says it's junk

Fitch has placed the securities of 26 banks "under criteria observation". Photo / File

A change of heart by international ratings agency Fitch Ratings could relegate some bank capital notes from investment grade to junk bond status.

That could make it more difficult for some New Zealand banks to sell such securities.

In the past, Fitch has rated tier 2 securities at one notch below a bank's long-term default rating but it is now considering whether that should increase to two notches.

As a result, Fitch has placed the securities of 26 banks, including the four biggest Australian banks that own New Zealand's four biggest banks, Cooperative Bank and SBS Bank on "under criteria observation," with a view to lowering their ratings by a notch.

Fitch said this reflects "continuing developments in bank resolution, notably developments in bank resolution plans, the build-up of bail-in debt buffers that protect more senior creditors and their implication for default risk and recovery prospects."

"Bank resolution" is regulator-speak for what they would do if a bank gets into financial strife.

Fitch's change of heart has real-world implications for banks planning to sell the affected securities.

Cooperative Bank announced the change to NZX because $15 million of its $32.4m of tier 2 capital is listed on NZX's debt market – hybrid securities such as these usually behave like debt but can be converted into equity if the bank runs into financial strife.

The NZX-listed securities are retail while the rest of Cooperative's tier 2 capital was sold to professional investors and institutions.

Fitch currently rates Cooperative's long-term default rating at 'BBB' and its tier 2 debt at 'BBB-', the lowest investment-grade rating.

A number of institutions have investment mandates which prevent them from investing in instruments without an investment-grade rating.

So, if Fitch decided to apply its new criteria to Cooperative's tier 2 securities, known as subordinated capital notes, their rating would fall to 'BB+' and they would become junk bonds.

SBS Bank, which also has a long-term default rating of 'BBB' from Fitch, is in a similar position with its $75.3m of subordinated redeemable shares which make up most of its tier 2 capital.

Cooperative's chief financial officer, Bevan Miller, told BusinessDesk the Fitch move would have no immediate impact on the NZX-listed debt.

"There are no ratings triggers in the existing listed instrument. The question will be when that instrument comes up for renewal" and that won't happen until July 28, 2021.

Miller noted there are a number of similar securities that were sold into the New Zealand market and that this "isn't a Co-op-specific issue."

But banks such as Cooperative may still be able to sell such securities if investors think the price is right.

As Miller said, some investors may no longer be able to buy them because of their investment mandates but "there are other pools of capital which don't necessarily have the same mandate constraints."

The NZX-listed notes were sold in 2016 with a 6 per cent coupon.

Interest rates have fallen a long way since then – the Reserve Bank's official cash rate was 2.25 per cent then and is now just 1 per cent while Cooperative's own five-year fixed mortgage rate for owner-occupier customers has gone from about 5.8 per cent down to 4.09 per cent.

That's why market pricing of the notes has reduced the effective coupon to 4 per cent, but that's still handsome compared with the rates Cooperative is offering on term deposits.

It isn't offering five-year deposits, but its four-year rate is 2.4 per cent for amounts between $2,000 and $9,999 and 2.5 per cent for $10,000 or more. For 18 months – and the notes mature in just under 17 months – Cooperative is offering exactly the same interest rates as for 48 months.