bendigo bank

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chapter 14—capital structure decision making and cost of capital evaluation for bendigo bank ltd
chapter 14—the cost of capital and taxation issues in project evaluation
capital structure decision making and cost of capital evaluation for bendigo bank ltd
author’s note: this case study is a hypothetical scenario of a buy-back transaction and associated capital structure change undertaken by bendigo bank ltd. although it does use a real company situation and financial data, it is not to be construed as representing actual strategic decision making by the company or its board of directors.
bendigo bank ltd is an australian company listed on the australian securities exchange (asx). the company began operations in 1858 as the bendigo building society, and acted as a co-operative enterprise providing saving and lending facilities for the community of bendigo, a major city located in central victoria. since its inception, the bendigo building society expanded its operations and focus to provide banking services to individuals and businesses in much of rural victoria. as a result of this expansion, the bendigo building society developed a quite extensive branch network, with individual banking premises or agency offices in many country towns throughout victoria, as well as offices in southern new south wales and also in metropolitan melbourne. the society went on to flourish from its small beginnings, to the extent that it has created a dominant niche market in country victoria and southern new south wales. the co-operative was granted a banking licence on 1 july 1995, and has been listed on the asx since this time. bendigo bank ltd’s corporate policy has been to ‘achieve steady growth while providing attractive rates for investment and conservative interest rates for borrowers’.
since becoming a fully fledged listed bank, bendigo bank has expanded its product range from traditional savings accounts and the provision of housing and personal loans to all forms of banking services, including credit cards, business lending, leasing and insurance products. the company also provides phone and online banking services to customers and has built up a widespread automatic teller machine (atm) network in association with other building society and credit union bodies. this has allowed bendigo bank to compete more aggressively with the other major banking companies, although, in terms of size, customer base and market share, it remains a relatively small operation compared to the ‘big four’ banks.
the board of directors of bendigo bank are very wary of the recent regulatory review of the structure of the banking industry in australia and current speculation regarding merger activities between major banking and insurance companies in australia. announcements of the commonwealth bank takeover proposal for the colonial group, national australia bank’s acquisition of the fund management business mlc ltd from lend lease corporation and rumours of other possible deals
chapter 14—capital structure decision making and cost of capital evaluation for bendigo bank ltd
involving amp ltd, st george bank and bankwest, have heightened the board of directors’ concerns about the possibility of bendigo bank being a takeover target as part of industry restructuring activities. bendigo bank is particularly attractive as an acquisition interest on account of its niche market and established infrastructure and clientele in regional areas of australia.
one potential way of reducing the likelihood of bendigo bank becoming a takeover target is to undertake a buy-back of a proportion of its ordinary share capital. this would be aimed at reducing the total pool of equity capital available for any predators to access, lowering the general liquidity of the company’s equity to make substantial individual share ownership less attractive and decreasing the magnitude of proportional share ownership of any one investor in the company.
the buy-back proposal involves a repurchase of 10 per cent of the company’s current issued share capital at a price of $5.80 per share, funded either by:
• an issue of non-redeemable, non-converting preference shares with a $5.80 issue price and paying a 7.5 per cent annual dividend; or
• an issue of unsecured notes with a $5.80 face value and an 11.00 per cent coupon rate, which will mature on 31 march 2010.
flotation and issue costs associated with these alternatives are expected to be 4 per cent of the gross proceeds from a preference-share issue and 2 per cent of the gross proceeds from an unsecured note issue.
the company’s ordinary shares are currently trading at $5.54 on the asx, with high and low closing prices over the past year of $6.40 and $4.88, respectively. the full year dividend in financial year 1999 was $0.23 per share, representing a dividend yield of 4.15 per cent based on current market value. the company also has listed subordinated perpetual convertible notes, with an 8.00 per cent annual interest rate and $4.00 issue price, which are currently trading at $5.15. these perpetual convertible notes were issued in october 1997 and can be converted to ordinary shares at a conversion factor of 1 note to 1 share. bendigo bank also has listed unsecured notes on issue, comprising a 10.50 per cent coupon rate and a face value of $4.00. these notes were issued on 31 march 1995 and mature on 31 march 2005, and have a current market price of $4.60.
other relevant market and asx information relating to bendigo bank is as follows:
• bendigo bank’s beta coefficient based on daily share price and index comparison over the past two years is 0.88.
• the company has an effective corporate tax rate of 36 per cent, and it pays fully franked dividends to its ordinary shareholders only.
chapter 14—capital structure decision making and cost of capital evaluation for bendigo bank ltd
• the current return on 10-year government bonds is 6.54 per cent.
• the expected return on the all ordinaries accumulation index is 12.72 per cent, incorporating adjustment of dividend imputation benefits.
• assume that the date of your evaluation is 31 march 2000. this is simply for ease of calculation of preference and unsecured note yields.
the following extracts from the financial statements of bendigo bank provide additional information relating to the company’s current capital structure and sources of finance:
chapter 14—capital structure decision making and cost of capital evaluation for bendigo bank ltd
bendigo bank ltd
balance sheet for the financial year ended 30 june 1999
current and liquid assets 98 504
due to other institutions 62 191
provisions 24 688
due from other institutions 85 777
investment securities 529 717
deposits 3 775 873
loans and receivables 3 298 802
unsecured notes 44 965
other assets 191 439
perpetual convertible notes 38 000
other liabilities
15 433
total liabilities 3 961 150
shareholders’ equity
issued share capital 199 979
reserves 16 931
retained profits 26 179
total shareholders’ equity
243 089
$4 204 239
4 204 239
extract from bendigo bank ltd share registry as at 31 march 2000
type of security
number of securities on issue
paid-up ordinary shares
78 282 206
10.50% unsecured notes ($4.00 face value)
11 241 250
8.00% perpetual convertible notes ($4.00 face value)
9 500 000
chapter 14—capital structure decision making and cost of capital evaluation for bendigo bank ltd
1. consider the nature of the operations and activities of the banking industry in general, and the capital structure and sources of finance for bendigo bank specifically. how do the capital structures and financing requirements of banks differ significantly from most other companies and industries, and what influence does this have on the importance of their financing and cost-of-capital decision making?
2. in relation to the hypothetical share buy-back currently assumed to be under consideration by bendigo bank, outline the factors the board of directors should consider in determining whether to issue preference shares or unsecured notes to finance this share repurchase. calculate bendigo bank’s current after-tax, market-value-based weighted average cost of capital (wacc), and the quantitative effect of the above two financing proposals on the company’s wacc. make a recommendation to the board of directors as to the optimal financial alternative to use.
3. one obstacle potentially negating the anticipated benefits of a buy-back of ordinary equity is the outstanding issue of perpetual convertible notes, which can be converted into ordinary shares of the company at any time by convertible note holders. what is the likelihood of these convertible notes being converted into ordinary shares in the near future and what factors are convertible note holders likely to consider in determining whether or not conversion is warranted? what are the likely effects on the company’s capital structure and cost of capital from the conversion of a substantial proportion of these notes?
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