US dollar-denominated subordinated debt from Asian banks is expected to increase this year as local lenders take advantage of the dollar bond rally, but restrictions in China and India mean that banks in these countries may not be able to raise funds offshore.
Asian banks have not been very active in raising capital through offshore bonds. Until now most of the issuance has been in their own domestic markets.
Since 2005 (the year of the first identified bond) there have only been 15 Tier II US dollar-denominated deals from banks in Asia, according to Dealogic data. A majority of those were from larger Indian lenders, with occasional issuance from banks in Hong Kong, Singapore, South Korea and Taiwan.
But the dearth of US dollar supply looks set to come to an end as favourable pricing means that even if banks have no need to issue the securities, they may come to the dollar markets to take advantage of primary market yields.
In Asia, in many cases the risk premium is smaller for Tier II bonds versus banks’ senior debt, than it is in Europe where borrowers pay an extra 30 basis points (bp) to 120bp on average. This is due to the fact that government support is higher for Asian banks and the risk of the trigger being set off is lower. This, combined with more stable rating trends and the home bias, means Asian investors would favour sub-debt over local banks.
“From a fundamental angle Asian investors feel more comfortable investing in the Asian banks but it all comes down to pricing. If it’s a bond issued by a fairly strong bank from Europe, they won’t have to pay up that much compared to a small Asian bank without government ownership issuing a similar new style capital,” said the Asia banks analyst.
The average spread multiple for US dollar-denominated bullet-maturity Tier II debt issued by banks in Europe is two times that of their senior debt, according to Morgan Stanley research.
For new-style lower Tier II debt, Asian banks would have to pay an average multiple of 1.3x the spread on their senior bonds. This would be higher in Japan (1.5x) than in Hong Kong and China (1.15x) and Korea (1.1x), for dollar-denominated bonds.
Supply is likely to come from Australia, Hong Kong, Korea, Malaysia and Singapore in callable Tier I and Tier II bonds this year, according to a Hong Kong-based debt banker.
Philippine banks are also expected to be active as regulatory treatment of legacy instruments is much harsher than elsewhere in the region. Any instruments issued before 2010 will be removed from the capital structure on January 1, 2014, so this will create a financing need which local lenders will be looking to fill throughout this year, he said.
The need to issue is bigger for Japanese banks as they have had more of a reliance on subordinated debt and hybrids in the past. As of March 2012 the total volume of Tier II hybrids issued by the three mega banks in Japan – Mitsubishi UFJ, Mizuho and Sumitomo Mitsui – was ¥7.4 trillion (US$81.5 billion) according to Standard & Poor’s (S&P) research.
No banks in Japan have issued Basel III-compliant hybrids in any market to date. Many of the Japanese banks are looking to issue Tier II subordinated debt, but the legal framework surrounding Basel III requirements has not yet been finalised in Japan. As such, domestic investors still have many concerns about the securities, according to Yuri Yoshida, director of financial institutions ratings at S&P.
“There is no market for Basel III-type hybrids in Japan. Nomura issued a Basel III-type Tier II bond in 2011 and it was sold only to retail investors as there was no real demand from institutional investors,” she said.
“A lot of the major banks are seeking to go overseas to issue Tier II hybrids. They are also expanding overseas so they need dollar funding. There is no immediate need to raise the Tier II since Basel III will phase in gradually but the banks may be keen to test the market.”
Any supply in the Asian dollar space will likely be met with good demand, according to bankers, as yield-seeking investors look to diversify from lower-rated corporate credits.
“If you look at the allocation data for the more recent bank capital deals they have been heavily allocated into Asia. We are talking about 60%-80% or even higher being allocated into Asia so there is a home bias in terms of demand,” said an Asia bank credit analyst.
Banks in China are equally keen to tap the dollar private bank market in Asia, but in order to do so they would need approval from the State Administration of Foreign Exchange (Safe) as well as the People’s Bank of China (PBoC), according to the financing solutions banker.
Because of this the offshore market is not as automatic a choice as for Chinese banks as in other Asian countries, and the scope for opportunistic issuance is limited. As such, if Chinese banks issue subordinated debt offshore, they are more likely to tap the dim sum bond market.
There is already a precedent for this. In November 2011, ICBC Asia issued the region’s first Basel III compliant subordinated bond, in the offshore renminbi, a 10-year non-call five bond worth Rmb1.5 billion (US$236 million), which priced at 6%.
However, the financing solutions banker that China’s lenders could only do a Tier II bond worth around Rmb2 billion (US$321 million) in the offshore renminbi market, which in the context of the capital needs of the Mainland banks is relatively small.
On January 16 this year, ICBC announced plans to issue Tier II capital instruments onshore, worth up to Rmb60 billion, by the end of 2014.
“It would be more interesting for them to look at the dollar markets [over the dim sum markets] where they could do mega transactions, but they need the approvals first and it’s not clear they would be forthcoming like they would for the rest of Asia.”
Indian banks are also subject to currency controls. They cannot borrow at more than 500bp above the relevant benchmark in their chosen country of issuance. As such, issuance of Tier I and Tier II capital would be problematic for a majority of Indian banks, as they would not be able to offer sufficient yield to attract international investors.