The introduction of loss-absorbing bank capital across Asia has stalled, with little sign of any consensus emerging across the region’s many distinct markets.
Source: Reuters/Lee Jae-Won
A South Korean soldier patrols as vehicles returning from North Korea’s inter-Korean Kaesong Industrial Complex back to South Korea arrive at a checkpoint on the Grand Unification Bridge.
The introduction of loss-absorbing bank capital across Asia has been a long time coming. Most countries in the region began to adopt Basel III standards from January 1 this year, but Asian lenders are biding their time before pushing out bank capital that complies with new requirements on loss absorption, as well as non-viability rules.
Under the Basel III framework, all capital instruments that financial institutions issue on or after January 1 2013, which will count to Tier 1 or Tier 2 capital, must specify that they are to be either written off or converted to common equity if certain trigger events occur. The idea behind this is to force subordinated bondholders to wear losses before any public funds are used in a bailout.
Asian banks have expressed keen interest in selling new-style bank capital, but a host of issues are hampering the smooth progress of such plans.
A lack of consensus among the region’s many regulators is one issue. The question with regards to Basel III-compliant bonds has always been at what point does the non-viability rule come into play?
In Australia, banks use a capital-ratio trigger in local Tier 1 hybrids, which require the conversion of the bonds into shares if the bank’s common equity capital ratio falls to 5.125% or below – in line with Basel III requirements. ANZ’s first wholly Basel III-compliant Tier 1 issue, however, also included a non-viability trigger, which gave the country’s banking regulator the power to enforce that conversion if it believed the bank was no longer viable.
The Australian Prudential Regulatory Authority has yet to define the level at which the non-viability rule triggers. Other regulators in countries like Singapore, Malaysia and Thailand have taken a similar tack, leaving undefined the precise moment they would require Tier 1 or Tier 2 bonds to convert into shares or be written off.
Singaporean and Malaysian banks rely on their regulators to make a call on a non-viability event. The Monetary Authority of Singapore has not defined such a trigger point – possibly a deliberate move to give it more flexibility – and the first Basel III-compliant fundraisings have come with no explicit trigger. Still, the related uncertainty has contributed to severe downgrades in the ratings of Basel III bonds of Singapore banks.
The recent S$850m (US$671m) Basel III-compliant hybrid Tier 1 from Singapore’s United Overseas Bank had ratings Baa1 from Moody’s and BBB from Fitch. These were four and five notches, respectively, below UOB’s ratings, reflecting the uncertainty associated with the timing of loss absorption.
Bankers also point to the large number of small family-owned banks across Asia, which will find great difficulty in meeting Basel III requirements.
“If you look at Hong Kong, it has postponed the implementation as the regulator is trying to find a way to accommodate the many small banks,” said one Singapore-based banker. “If Basel III is adopted wholesale, a huge consolidation and restructuring of the banking market will have to take place.”
Balancing act
The strong capitalisation of Asian banks is another reason cited for the lack of supply of Basel III-compliant bank capital. However, with the US Federal Reserve looking to end its quantitative-easing policy, and with interest rates expected to rise from the middle of 2014, Asian banks may have only a short window to take advantage of the current low interest-rate environment.
“It will be a balancing act for these banks,” said Ivan Tan, credit analyst at S&P. “Basel III bank capital may cost more, but, although they may not need such capital urgently, the banks may pre-emptively raise funds this year or next.”
The cost of selling Basel III-compliant bank capital may not be as prohibitive as originally thought. Australia’s Westpac sold its first new-style A$850m Tier 2 two weeks ago at 230bp over the 90-day bank bill rate – leaving only a 13bp concession to the old-style outstanding Tier 2 due 2022.
UOB priced Singapore’s first Basel III-compliant hybrid at a yield of 4.9%, a premium of between 30bp and 50bp, depending on the comps used.
However, in both cases, investors showed resistance at those levels, indicating that they did not believe the premiums reflected the level of risks. Institutional investors gave the UOB deal a miss, while Westpac was unable to repeat the same kind of jumbo size increase that had become the standard with old-style transactions.
Bankers cautioned against using UOB’s deal as a benchmark for the rest of Asia.
“While it is a good result for the issuer, we have to bear in mind that the pricing also factored in regulatory risks,” said one debt syndicate banker. “Investors in the UOB bonds are pricing in a perceived rescue of the bank if non-viability is ever reached. They think that such a possibility will be remote in Singapore as they believe that the MAS will not allow major local banks to fail.
“The UOB template would never work in Europe or the US. If UOB had gone to those markets, it would have had to pay up.”
In some Asian countries, which have less-developed bond markets, regulators are stepping in to protect less-sophisticated bondholders.
In Thailand, the regulators are planning to draw up rules to bar the sale of such instruments to retail investors, while, in the Philippines, banks selling such notes will have to obtain signed consent notes from each investor.
In both countries, local banks complain that such moves only impede their ability to raise bank capital and meet new rules at the same time. As a result, the plans of Rizal Commercial Banking Corp to sell a US dollar-denominated new-style hybrid Tier 1 have stalled.
There is no easy and smooth transition to the Basel III regime for Asian banks seeking to raise loss-absorbing capital. Although banks will turn to regional peers for guidance, it is, ultimately, the individual and unique regulatory regimes in these countries that will shape the structure and pricing of their own Basel III-compliant bank capital.
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