Allens Arthur Robinson

• Introduction
• BHP Billiton: Australia's biggest buy-back
• St.George SAINTS
• Tax treaty relief
• Small change
• Capital Markets publications
• Capital Markets services

• What are SAINTS?
• Not a reset preference security
• Buy-back agreement
• Dividend stoppers
• Conclusion
• Footnote

St.George Bank Limited has recently completed the offer of a new class of preference shares called Subordinated Adjustable Income Non-refundable Tier 1 Securities (SAINTS). St.George raised $350 million through the offer, which was considerably oversubscribed. In developing the SAINTS, it was necessary to take account of the proposed International Financial Reporting Standards (IFRS) and other issued capital of St.George.

What are SAINTS?

SAINTS are redeemable, convertible preference shares that entitle holders to a non-cumulative dividend in preference to any dividends on ordinary shares.

SAINTS have no necessary maturity. Holders do not have a right to require St.George to redeem, buy-back or cancel the SAINTS or convert SAINTS into ordinary shares – these events may only occur in certain circumstances at the sole option of St.George or on 20 November 2014.

The dividend rate is a floating rate calculated as 1.35 per cent per annum above the prevailing 90-day bank bill swap rate, reduced by the Australian corporate tax rate of 30 per cent.

If St.George does not redeem, buy-back, cancel or convert SAINTS by 20 November 2014, the margin of 1.35 per cent will be increased by a one-time step-up of one per cent per annum. The SAINTS are the first 10-year¹ hybrid offered to retail investors in Australia.

SAINTS are quoted on the Australian Stock Exchange.

Not a reset preference security

The SAINTS are not reset preference shares. The reset feature of hybrid securities issued in recent times is no longer viable if the security is to be classified as equity. This is particularly important to companies in the financial sector that need to maintain certain levels of APRA-designated Tier 1 capital.

Under the terms of the traditional reset hybrid, the holder or the issuer will have the right to redeem or convert the hybrid into ordinary securities upon the reset date, or upon the happening of certain trigger events.

St.George received accounting advice that the SAINTS should be classified as equity under both Australian Generally Accepted Accounting Principles and IFRS. This is because St.George has no obligation to deliver cash or another financial instrument to the holder – St.George has the right to never repay the SAINTS capital to holders, and dividends are purely discretionary.

Under the IFRS, proposed IAS32 will operate to classify an instrument as equity if there are no contractual obligations on the issuer in certain specified circumstances. For example:

• an instrument may be classified as equity if it is a non-derivative that may be settled in the issuer's own equity instruments but includes no contractual obligation for the issuer to deliver a variable number of its own equity. In the case of the SAINTS, St.George has the right, but not the obligation, to redeem for cash or a variable number of shares;
• if there is an event that is outside the control of either the issuer or the holder of an instrument, which upon occurrence, will require redemption of the instrument, the instrument should be classified as a liability. In the case of the SAINTS, St.George has the right to redeem/convert upon occurrence of a trigger event, but is not obliged to do so;
• in relation to the dividend rate step after the 10th anniversary of issue, St.George has the ability not to pay dividends as they are purely discretionary. Once again, the dividend rate step-up does not impact on the equity classification of SAINTS, as there is no obligation to pay dividends or redeem the SAINTS on the step-up date.

Because under the terms of the traditional reset hybrid security, the holder or the issuer will have the right to redeem or convert the hybrid into ordinary securities upon the reset date or upon the happening of certain trigger events, this results in the issuer being obliged to redeem/convert the hybrid. Under the new accounting standards, such hybrids would no longer be classified as equity.

The equity classification is important where the issuer wishes to have the financial instrument treated as Tier 1 Capital. In its release dated 5 April 2004, the Australian Prudential Regulation Authority (APRA) indicated that instruments approved as Tier 1 prior to 31 March 2004 will be grandfathered or subject to transitional arrangements. APRA has stated that instruments approved after 31 March 2004, and which come to be accounted for as debt under IFRS, may cease to be eligible for Tier 1 Capital post-IFRS. There is no current intention by APRA to grandfather new issues.

In connection with the SAINTS offer, APRA approved the issue to be included as part of St.George's Tier 1 Capital. However, APRA stated that it was unable to confirm classification of the SAINTS as equity under IFRS. This is because there is a possibility that the final IFRS may differ from the currently envisaged regime.

Buy-back agreement

In addition to its rights of redemption, cancellation and conversion, St.George may buy back SAINTS on 20 November 2014 or on any subsequent dividend payment date, or upon the occurrence of a tax or regulatory event, as defined in the terms of issue (the terms).

One unique feature of the SAINTS is the buy-back agreement, annexed to the terms. The buy-back agreement is designed as a mechanism for putting in place the terms of any buy-back of SAINTS that might occur if certain conditions are met and before the decision to buy back has been made. This has many advantages, including certainty of terms on which any unwind of the instrument may take place, and greater choice is available to St.George in terms of means to unwind the instrument. Great care needs to be taken with this feature of the SAINTS, otherwise the risk of unlawful self-acquisition may result and inadvertent suspension of rights on shares might occur.

Dividend stoppers

SAINTS rank equally with the St.George Preferred Resetting Yield Marketing Equity Securities (PRYMES) in respect of payment of dividends and equally with holders of PRYMES and Depositary Capital Securities (DCS) for any return of capital or payment of declared but unpaid dividends on a winding up.

The terms contain a dividend stopper that operates to prevent payment of dividends on lower ranking shares (ie ordinary shares) until an amount equivalent to one year's worth of unpaid dividends has been paid on the SAINTS.

The scope of the SAINTS' dividend stopper was considered in light of the other class of equal ranking preference shares issued by St.George, the PRYMES. In addition, the DCS (despite not being issued directly by St.George) were also relevant because the payment of dividends on those securities is guaranteed by St.George.

Therefore, unlike other recent hybrid securities, the SAINTS have three dividend stoppers. The operation of the three dividend stoppers is complementary in that none of them ever operates to freeze the payment of dividends as between SAINTS, PRYMES and DCS – this is because of the effect of the pro rata carve-outs that are contained in the dividend stoppers. There is one exception: if the SAINTS remedial payment of six months worth of dividends is not paid on SAINTS and PRYMES, no dividends are payable on SAINTS, PRYMES or ordinary shares (but payments of dividends on DCS are unaffected).

The above discussion highlights the importance of taking account of the effect of dividend stoppers where a company wishes to issue different classes of preference shares in the future, and the effect of current dividend stoppers on any new class of preference share. It is important to ensure that the dividend stoppers operate as they are intended, ie to effect a preference to the holders of the relevant class of shares but without adversely impacting on the preference of one class of preference shares vis a vis another.

Conclusion

The issue of SAINTS shows the importance of the IFRS on the structure of new hybrid securities. In addition, it highlights the need for issuers to take account of existing capital in structuring new equity and to be mindful that in issuing new equity, the terms of issue do not act as a fetter on future issues of new instruments. In respect of the SAINTS, the buy-back agreement feature was included to provide some flexibility in this regard.

Footnote

1. APRA Guidance Note 111.1 requires that for an instrument to qualify as Tier 1 capital, any step-up provisions (such as a step-up in the margin) cannot operate for the first 10 years of the instrument's life, and there can only be one step-up during the instrument's life.