Looking local
Source: REUTERS
Customers select vegetables at a supermarket in Changzhou, Jiangsu province.
Asia’s banks are in something of an ironic situation. They are among the world’s best-capitalised, but, under the Basel Committee’s latest bank capital regulations, they are among the most active issuers of bank capital.
There is a simple reason for this: growth. With the exception of the stagnant Japan, Asia’s largest economies are all expanding at rapid clips. As local companies rely more heavily on bank funding than they do elsewhere, regional banks have been rapidly growing their balance sheets to keep up with this demand. As their balance sheets grow, so does their need for Tier 1 and Tier 2 bank capital.
“In Europe and North America the risk-weighted asset growth of most banks is flat to around 2%, whereas here it’s 10% to 15% or higher,” said a senior debt origination banker who had helped several Asian lenders raise capital.
“Banks need to grow their levels of Additional Tier 1 and Tier 2 capital in line with this in order to optimise their capital structure under Basel III, as well as, of course, refinancing outstanding Basel II instruments whose applicability is amortising under the new rules.”
Basel III states that only equity or hybrid equity can count towards T1 capital ratios. Banks are leery of using pure equity alone, as issuing new stock dilutes existing shareholders and equity funding is expensive. Typically, AT1 instruments are cheaper to issue, and are structured as preference shares or perpetual bonds with call dates after five or 10 years.
All AT1 and T2 instruments must also be subject to writedowns under the Basel III rules, a requirement designed to ensure that bondholders absorb losses before taxpayers are asked to fund bailouts.
Having committed to the Basel III regime in 2013, China is Asia’s biggest source of bank capital issuance to date. Bank of China, Industrial and Commercial Bank of China and Agricultural Bank of China have spearheaded US$110bn of subordinated offerings in the local and international markets. Many more will follow, with China Construction Bank and China Minsheng Bank among the next wave.
China’s capital hunger
Banks in India, South Korea and, selectively, Thailand also need to top up their capital ratios. Additionally, insurance companies are beginning to seek deals to supplement their capital ratios. All told, it means a rapid increase in the number of capital raisers.
“There is likely to be a greater number of issuers this year, but of smaller sizes,” said Mark Follett, head of high-grade debt capital markets for Asia ex-Japan at JP Morgan.
There is still a lot to do. In an earlier IFR Asia report, HSBC predicted that, if the top four banks in each Asia Pacific country raised capital equivalent to 1.5% of their risk-weighted assets, they would likely require US$140bn of AT1 and a further US$200bn of T2 capital over the next three to five years. Issuance in 2015 should reach volumes similar to those of last year.
However, deals this year may not be as large. Instead, Chinese and regional lenders are likely to focus increasingly on domestic markets as they seek to fill their bank capital coffers.
The deals conducted in the latter half of 2014 underscored the amounts of capital China’s banks need to find.
Bank of China’s Rmb40bn (US$6.5bn) perpetual non-call five AT1 issue, placed in the offshore market on October 15, was the world’s biggest in the format. In November, ABC raised Rmb40bn for its T1 needs through a domestic private placement of preferred shares, while, in December, ICBC issued US$5.7bn of offshore AT1 across three currencies.
T2 deals have been coming thick and fast since ICBC issued Rmb20bn in the local market in August 2014, the first from one of China’s top-five banks under the Basel III rules. Bank of Communications then followed with a US$1.2bn, 10-year non-call five Reg S deal in September, China’s first Basel III T2 in the offshore markets.
Others will follow. CCB and China Minsheng are potential candidates, but, eventually, virtually every provincial and city bank is likely to come.
“AT1 and T2 are efficient means for the Chinese banks to raise regulatory capital. We expect certain banks to access the AT1 offshore markets for the first time in 2015, while fundraising in US dollars, euros and CNH is also likely to be a theme,” said the senior banker.
“AT1 and T2 are efficient means for the Chinese banks to raise regulatory capital. We expect certain banks to access the AT1 offshore markets for the first time in 2015, while fundraising in US dollars, euros and CNH is also likely to be a theme.”
The country’s smaller banks could end up matching the US$110bn raised in 2014 through a large number of smaller local AT1 and T2 deals.
“Offshore T1 is not a natural instrument for a number of banks more geared to local markets,” said Dominique Jooris, head of credit capital markets in Asia ex-Japan for Goldman Sachs. “If you have 10% of your assets in US dollars, it makes sense to have 10% of your capital in US dollars, too, but it’s less logical for small locally focused banks, such as most of those in China.”
One potential change that could impact China’s bank capital market in the longer term is the format in which banks conduct AT1 instruments. The China Banking Regulatory Commission insists such deals must be structured as renminbi-denominated preference shares. That has forced bank arrangers to incorporate complex structuring to sell such deals internationally, as these are typically made available in US dollars.
“This is a big reason only major banks can do international AT1 deals,” said another debt origination banker. He believes the CBRC has to allow banks to issue T1 deals in a debt format consistent with the Basel Committee’s guidelines.
“I think it will ultimately happen,” he said. “I’d be surprised if the banks are still issuing under today’s format in five years’ time.”
Other issuers
Lenders from other countries will also raise Basel III-compliant funds, albeit in smaller volumes than China’s banks.
India’s state-affiliated banks are likely issuers. Many are relatively thinly capitalised, but their balances sheets are growing. They are also have BBB– to BB senior credit ratings from the international agencies. So, international AT1 deals would be rated in the Single B area, making them expensive. As a result, India’s banks have, to date, opted to raise bank capital in the rupee market. Bankers think this is unlikely to change in the short term, although they may consider offshore deals over time.
Among other likely candidates are leading Korean banks, such as Shinhan Financial, Kookmin, Woori and Hana, along with select lenders in Thailand.
Bankers broadly predict that 50% of bank capital raisings will be conducted domestically, as local currency markets typically offer cheaper funding. This is particularly the case in Indian rupees, Malaysian ringgit and Singapore dollars. One banker noted that DBS, UOB and OCBC conducted Singapore dollar Basel III deals that were roughly 50bp–100bp cheaper than could have been managed in US dollars, taking advantage of their reputation among local investors.
Some bankers think regional lenders may seek Basel III funding outside their local currencies for the sake of diversification. ANZ’s Rmb2bn 10-year non-call five T2 Dim Sum bond on January 15 is one such example. It was priced to yield 4.9%, at a higher spread than that available in US or Australian dollars, but gave the bank access to a new array of investors.
“The offshore renminbi market has proven to be accepting of T2 and AT1 structures from both Greater China and highly rated offshore issuers. It clearly represents a funding alternative for higher-rated banks considering debt capital issuances,” said Sean McNelis, head of financing solutions group for Asia Pacific at HSBC.
The local fundraising focus of Asia’s banks means US interest rate increases are unlikely to affect them much. Anyway, absolute funding costs do not greatly figure into banks that need US dollar Basel III funding.
“Spread levels, were they 50bp tighter or 200bp wider, would not make much of a difference in the decision process of banks that need to raise capital and are considering using non-equity instruments as surrogates to common equity,” said Jooris.
In fact the largest potential rate impact on Basel III instruments could be China’s falling interest rates. The country’s bank shares tend to offer high dividend yields of 6% to 7%, while AT1 instrument returns have dropped to around 6%. The risk is that bank capital instruments become unappealing as global investors find higher returns elsewhere and China’s local buyers switch to surging equity markets.
Insurance capital
Asia’s insurance companies offer another avenue of potential capital instrument issuance.
Insurance companies elsewhere are already conducting such deals. European insurance companies follow the European Union’s Solvency II Directive, which allows them to issue hybrid instruments. Australia created its own version of the rules through the Life and General Insurance Capital Standards in 2013. This framework allowed QBE Insurance to conduct a US$700m 30-year non-call 10 T2 deal in November, Australia’s first such offering from an insurance company in the offshore markets.
Some Asian insurers are also interested. Korean Re and China Taiping Insurance of Hong Kong launched the first subordinated insurance hybrid bonds from Asia ex-Japan in October. More of them, from Singapore, Korea, Japan and particularly China, are likely to follow.
In late 2014, the China Insurance Regulatory Commission came out with its China Risk Oriented Solvency System (C-ROSS) draft proposals – the PRC’s version of Solvency II. Once fully implemented, these rules could change how local insurance companies consider their capital structures.
“The C-ROSS framework establishes a clear template for insurers in China to issue hybrid capital. Any issuance can also be optimised to achieve equity credit from the rating agencies, said McNelis.
Many Asian insurance companies are likely to start with international deals.
“Offshore investors are, generally, more familiar with insurance hybrid instruments, which could benefit pricing,” said Follett. “It also makes sense from a risk-diversification standpoint. If local banks hold insurance paper and vice-versa, then all the risk remains in the domestic market.”
Last year may have witnessed the biggest bank capital deals from Asia, but the region’s pipeline of subordinated issuance from lenders and, increasingly, insurance companies has a long way to go.
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