Local interpretations of stringent bank capital requirements are making it easier for Asian lenders to attract investors to issues of Basel III-compliant subordinated bonds.
Regulators across Asia seem to be second guessing a core component of Basel III capital requirements as they roll out standards to make it easier for banks to raise debt that counts as capital.
A matter of contention is the so-called non-viability trigger, the point at which regulators decide a bank is no longer able to function. To count towards regulatory capital ratios under Basel III, subordinated bonds must be written down to zero or converted to equity when the trigger is hit. The so-called “bail-in” clause is designed to keep the bank afloat without the use of taxpayer money – at least in theory.
Local interpretations of that rule, however, differ wildly across Asia. For instance, banking authorities in Japan, South Korea, Taiwan and India appear to be making it easier for banks to issue subordinated bonds than their counterparts elsewhere. The result is a hodgepodge of regulations across the region.
“The definition of point of non-viability is absolutely different in each country (in the region) and it absolutely changes the risk profile of each bond,” said Brian Weintraub, Deutsche Bank vice-president at the financial institutions group, during a Fitch Ratings-organised conference on bank capital in Singapore earlier this month.
The Basel framework requires banks to have a capital buffer that can include subordinated Tier 2 bonds, hybrid Additional Tier 1 securities and common equity.
With a few exceptions, most Asian banks have enough capital to meet the new requirements. Much of the capital, however, comes from common equity, the safest, yet most expensive, form of capital. Boosting the amount of hybrid debt in the capital mix will allow banks to cut their average costs of capital and increase their returns on equity.
“It makes sense for banks to streamline their capital, to have Additional Tier 1 and Tier 2 bonds as part of their capital structure,” said Sean McNelis, HSBC’s head of financing solutions, Asia Pacific.
Investors have been willing to buy subordinated bonds, instead of common equity, as long as the rules governing them are clear. Regulators across Asia have started to clarify those rules, including details on what make a bank non-viable, allowing a string of Basel III-compliant transactions to emerge.
“Across all of Asia, since Basel III has come in, there have been roughly 60 issues (in local and international markets) that have priced for a total of US$36bn,” said Deutsche Bank’s Weintraub.
That is far short of the amount of bank capital raised in other markets. US banks issued US$6bn of AT1 in the week of April 26 alone.
Easing the rules
Bank capital guidelines in Japan and South Korea appear to give larger roles to the governments in protecting banks against losses. Japan’s rules imply the government would rescue banks rather than force losses on bondholders, analysts said. On the hand, losses on Korean subordinated bonds would be likely only if a bank did not survive a government bailout.
“In South Korea, like in Japan, regulators would come in at the point of non-viability (reducing the chance of a bail-in), and that is well-liked by investors,” said Rosemary Fu, senior vice-president at Pictet Asset Management, at the Fitch conference.
South Korea’s government has a track record of supporting its major lenders and, perhaps not surprisingly, it has one of the more investor-friendly Basel III regimes in Asia.
The guidelines, for instance, call for regulatory intervention long before capital ratios fall to the point of non-viability. These alerts, coupled with low – and clearly defined – triggers for non-viability, could be considered an investor-friendly feature.
A Korean bank will become non-viable if its T1 capital ratio falls to 1.5%, or if common equity T1 falls to 1.2%, or at the regulator’s discretion. These levels are relatively low, meaning banks are less likely to trigger them.
Japanese law allows banks to receive capital injections from the government before they reach the stage of being declared non-viable. Analysts say that position played a big role in driving demand for Basel III offerings in March from Sumitomo Mitsui Financial Group and Mizuho Financial Group.
In Taiwan, regulators have concluded that banks can remain “viable” as long as their capital adequacy ratios do not fall to 2% or below, according to bank analysts. This means subordinated bondholders are unlikely to experience losses unless a bank is already near bankruptcy.
“Major regulatory discretion includes a less easily triggered government receivership as the point of non-viability, which tends to occur at a very low level of capital, or 2% capital adequacy ratio,” Fitch said in a report last year.
Stuck on T2
With the exception of Singapore, Taiwan is in the unusual position of leading the Asian market with among the first Basel III-compliant AT1 capital bonds, partly because its regulations are so investor friendly. Taiwanese banks also wanted to take advantage of prevailing low interest rates.
CTBC Bank sold a two-tranche NT$20bn (US$667m) perpetual non-cumulative Basel III-compliant AT1 bond in late June, while Taishin International Bank sold two AT1 perpetuals totalling NT$5bn in April and May.
Most AT1 issuance, so far, has been in the US and Europe, largely because Basel III rules require such capital to be in the form of undated perpetual bonds, with deferrable coupon payments.
However, regulators in many Asian countries do not allow retail investors to buy perpetual bonds. China and South Korea have no regulatory frameworks for such bonds at all, and changes have not moved beyond the discussion level.
“There is a movement more towards having an efficient mix of capital, but not as much you would see from some European peers,” said Deutsche Bank’s Weintraub. “For instance, in some of the jurisdictions we are dealing with, the overwhelming focus from a regulatory and issuer perspective has been getting Basel III Tier 2 in place – they haven’t even begun to discuss Tier 1.”
As regulators and issuers understand the costs of issuing perpetual debt with coupon deferrals and full write-downs of value, they may well change their minds about how closely they want to follow the stricter global guidelines.
Meanwhile, Taiwanese banks have not issued offshore loss-absorbing bonds yet, but bankers said they are working on a few potential deals and the low trigger will help convince investors to buy bonds from these issuers.
A delay in clarifying rules for new-style capital bonds continues to stymie issuance in India, according to bankers at financial institutions in the country.
So far, less than a dozen banks have issued Basel III-compliant T2 bonds in the rupee market, while Yes Bank is the only Indian lender to issue an AT1 rupee-denominated security. Still, that deal was executed in an unusual, quid-pro-quo arrangement where Yes Bank bought subordinated debt from its only investor, a non-banking finance company.
Banking authorities are deliberating on a draft regulation that will expand India’s deposit insurance agency into a newly named Financial Resolution Authority with responsibilities similar to those of the Federal Deposit Insurance Corp in the US.
A bank will only enter the FRA’s resolution stage after it has gone through a well-defined corrective-action framework that kicks in when certain regulatory triggers are hit. The process can help a struggling lender avoid a further deterioration of its capital – as was the case with a freeze on new lending at United Bank of India earlier this year.
Among its duties, the authority would have power to decide whether a bank is viable or not. The change could potentially delay the loss-absorption trigger on AT1 and T2 instruments.
Indian regulators, however, have moved back and forth on their interpretations of the Basel standards a few times, and investors remain wary of further changes.
The Reserve Bank of India last year appeared to allow temporary write-downs of subordinated bonds, paving the way for investors to recoup losses if a bank recovered. Earlier this year, the regulator reversed that decision and ruled out temporary write-downs, a move that scared investors away from potential Indian subordinated debt.
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