Jonathan Rogers, IFR Asia Senior Credit Analyst
The response to a 10-year US dollar Reg S deal brought last week by South Korea’s KEB was as telling an indictment of the new-style Basel III-compliant bank paper as you could wish to see. That’s because Korea Exchange Bank issued in the old, Basel II-compliant format, catching the window to do so before Korea introduces Basel III compliance in December.
And boy did the punters love it. The US$200m issue was overwhelmed with orders, pulling in 12 times book cover and screaming in over 20bp the day after pricing. It was a bit like a crowd of consumers rushing to buy the old-style Nokia BL-5CB and shunning the new Apple iPhone 5.
And just as the Nokia phones of yesteryear were reliable and stayed charged for days, so the buyers of the KEB deal opted to own a bond that will not get written down to zero in the event of that bank entering the twilight zone called non-viability – the equivalent of your iPhone running out of battery and being rendered useless.
The deal’s success contrasted starkly with the resounding thumbs down given to Asia’s first US dollar Basel III-compliant benchmark – a deal from China’s ICBC at the beginning of the month. In an almost mirror image performance of KEB’s deal, the ICBC bonds widened almost 20bp in the aftermarket having been quickly dumped by the swathe of private banks that bought the bulk of the paper.
The breaking of the Basel III duck was so unconvincing that you can only imagine the anxiety that will afflict the bankers who are charged with bringing the next Basel III-compliant bank deal. One thing seems certain: the next one is likely to be priced as cheap as chips to ensure it crosses the line without getting dumped in secondary.
It seems the gnomes of Basel have, in attempting to ensure that the government bailouts of banks are a thing of the past, added significantly to the industry’s cost of capital. But we had all better get used to the Basel III-compliant product because, as countries begin to adhere to the new regime, that’s all there can be.
WHICH BRINGS ME to the concept of risk-modeling. I have no idea if the investors who bought the ICBC bonds had in place a risk model which will allow them to predict with a degree of presumed accuracy the likelihood of a bank being declared non-viable. If any of them have such a model I would love to see what quantitative elements it contains – because I could do with a laugh.
Non-viability would, presumably, occur against the backdrop of a banking crisis and few of those have ever been predicted with any accuracy (except perhaps by a flailing-armed pundit who makes the call so long before the event that if you’d followed his advice the opportunity cost would have been massive). And in any case, non-viability will have an arbitrary element to it even during a banking crisis that no model can accurately capture.
In the event of KEB going bust, you can at least model what your recovery value would be, and if the bonds have gone to a distressed level you can trade them profitably by modeling a workout scenario. You can’t do that if a non-viability, bail-in bond becomes distressed, because the next step is that it could be worthless.
THE TRUTH IS that buying into certain structures involves a pure punt on the likelihood of an event happening. It’s the same with the perpetual product and making a judgment about whether the paper is likely to be called. Punters who see a large step-up on a perp note are likely to expect the paper to be called because the issuer won’t want to wear the cost of the step if it isn’t. But that might not happen at all if interest rates go stratospheric.
Perps were a casualty of the May tapering debacle, with Thailand’s PTTEP having warmed investors up for issuance in that format prior to the meltdown only to have to eat humble pie and return earlier this month with a plain vanilla deal. It didn’t help that so many of the perps issued this year performed like dogs in the secondary market.
But just as it was thought fit to test risk-on again with the ICBC Tier 2 trade, so it is now the turn of the perp to attempt a comeback as Aluminum Corp of China is lining up a perp handled by ANZ, HSBC and Natixis.
A degree of realism seems to have been attached to the proposed deal, with the deal structured to include a hefty 500bp step, something that surely will mean investors look to value it to the call. If the leads aren’t too ambitious with pricing they can probably have a shot at reopening what has become one of the most hyped – and most elusive in terms of deal success – arenas of the region’s primary market. And even though valuing a perp is hardly an exact science, it’s preferable to the roll of the dice involved in booking Basel III-compliant paper.
