Hybrid capital, which is still virtually unknown in some markets such as Malaysia and the Philippines, is likely to take on a more dominant role as banks respond to pressures to be more efficient. Hybrid capital allows banks to raise capital that is treated as equity by the regulators but is non dilutive and allows investors to receive interest payments free from withholding tax as if it were bonds.
A different approach
As Asian regulators implement Basel II and International Accounting Standards, and as foreign banks play a bigger role in Asian markets, regional banks can no longer afford to take a “capital heavy” approach. They have to get to grips with the complexities of capital such as hybrid and subordinated capital, the opportunities for improving returns on equity and the need to have funds to finance acquisitions.
With many regulators in the region asking banks to hold capital higher than Bank for International Settlements (BIS) ratios, the focus has tended to be on safety rather than efficiency.
“Highly capitalised banks are expensive but, so far, Asian investors have not been knocking on the door to complain. A lot of them are family owned and so have not been under pressure to deliver returns. But this is all going to change and the issue of bank capital will become as important in Asia as it is in Europe,” says Samuel Zavatti, global head of financial institutions for ABN AMRO. Using its strong euro investor base, ABN, together with Deutsche, raised €300m for The Export Import Bank of Korea last October and €500m for Korea Development Bank in January using a five-year floating rate note structure.
In the first two months of 2005, issuance in euros as a percentage of total Asian international issues spiked to 13%, compared with 9% in 2004 and 5% in 2003 – showing the trend for Asian issuers to diversify away from the dollar.
“Basel II and IAS are going to have a profound influence on Asian capital markets and will speed up the process of looking at more innovative ways to raise debt and equity,” says Mr Zavatti. Basel II also brings the question of operational risk to the forefront and ABN has been advising Indonesia’s Bank Mandiri on risk management processes both before and after the bank’s IPO in 2003.
Capital pioneer
One of the pioneers in innovative bank capital has been the UK’s Barclays Capital which, sensing the opportunity in Asia, began to develop its operation in the region. The bank worked with Korea’s Financial Supervisory Service on bank capital regulations and did the first hybrid Tier 1 capital deal out of Korea in 2002 together with JPMorgan. The issuer was Hana Bank and the deal was a $200m perpetual non-call 10 transaction.
More recently, Barclays worked together with BNP Paribas on a deal for Shinhan, a $300m 30-year, non-call 10 transaction, only the third international hybrid deal done from the country. The first deal was done using a special purpose vehicle (SPV) because perpetual securities were not allowed under Korean regulations. But for the latest deal this was not necessary as they are now allowed, illustrating how fast things are moving in Asia.
“We would always start by trying to do things without an offshore SPV, which regulators prefer, too,” says Richard Grainger, director of financial institutions for Barclays Capital in Hong Kong.
“Usually an SPV is used for tax reasons, but they are generally much more complex, less transparent and often more expensive than the direct issuance route. In the Korean case, we originally had to use the SPV route because perpetual securities are not recognised under Korean law. Then the guidelines changed and we were able to do the Shinhan deal using a simpler, directly issued structure.
“A lot of Korean banks have issued hybrid Tier 1 in the domestic market which is cheaper,” he adds. “Issuers usually like the prestige of issuing internationally but sometimes from a cost point of view it doesn’t make sense.”
Early warning system
Philip Tsao, joint head of debt capital markets and risk management for UBS APAC region in Hong Kong, also makes the case for banks to diversify their funding by issuing internationally and, from the regulator’s perspective, the need to have an early warning system provided by bond prices.
“With domestic issuance, banks are likely to buy each other’s paper – building up contagion risk if one bank gets into trouble. But bonds sold internationally act as an early warning system. Professional investors are watching the cash flow carefully and a fall in bond prices can alert the regulator,” says Mr Tsao.
The regulatory environment in Asia has improved immensely but, even so, individual deals require considerable explaining to gain approval. Sometimes regulators establish state-of-the-art frameworks to conform to international standards, but are then wary about giving the go-ahead to new structures even though the guidelines allow for them.
“The whole issue of regulatory approval is a much bigger one here than in Europe and in some countries such as Indonesia we are still some way from getting hybrid Tier 1 off the ground,” says George Koo, also a director of financial institutions at Barclays Capital.
Regional development
Gary Hopkins, managing director, primary markets for BNP Paribas in Hong Kong, says: “The whole region is developing rapidly on the bank capital front. A lot of regulators have looked at and adopted international standards on allowable Tier 1 capital and dividend stoppers. In the past two or three years, the regulatory environment has improved quite a lot.”
Struggles and delays
But banks can still struggle to get deals away. A perpetual, step up 10, $550m upper Tier 2 deal for Taiwan’s Chinatrust Commercial Bank done by JPMorgan in March was delayed for six months in an attempt not to have a 20% withholding tax on coupon payments. This has still not been resolved and the deal had to be done through the bank’s Hong Kong branch office and the funds kept offshore. The deal was increased from $300m on the back of a $4bn order book. “It means Taiwan does not benefit from the funds,” says one banker.
The first upper Tier 2 deal for a Thai bank, Thai Military, has been postponed because of poor market conditions but bankers are expecting that Thai banks generally will start issuing as the situation improves. JPMorgan is a joint lead manager on the deal.
Focus on shareholder returns
“The big story in Asia is making a better return on capital,” says Marc Jones, managing director at JPMorgan in Hong Kong. “Management is much more focused on shareholder returns and hybrid capital is part of the equation. Hybrid capital is a useful tool for raising money for acquisitions without diluting your equity. Five years ago, bankers in Asia had much more of a trader’s mentality. They would see that the stock price was high and say, ‘let’s issue equity’. Now they are looking more closely at the value of it.”
Many Asian banks are well capitalised and the old attitude was why issue when there is no need.
Says Barclays’ Mr Grainger: “Banks should not only issue when they need. Capital issuance is not only about raising money it’s also about maximising capital efficiency and hybrid Tier 1 plays a large role in this.”
New fashions
Noel Kullavanijaya, head of financial institutions at Citigroup in Hong Kong, says: “Hybrid Tier 1 and structured products are coming back into fashion in Asia. Some countries such as Thailand and Korea made some use of these instruments just after the crisis. Now they are more widespread.”
According to Mark Adams, head of debt capital markets, Asia Pacific, for BNP Paribas: “Many Asian banks have healthy capital adequacy ratios but their capital is mostly pure equity with very little hybrid capital. Some countries are grappling with hybrid regulations. Malaysia has just come out with new regulations and we would expect to see some hybrid deals there shortly.”
Investment banks in Asia are beefing up their financial institutions group (FIG) in readiness for the new opportunities. SG Corporate and Investment Banking brought in Lincoln Chan from Standard & Poor’s last September to give it greater coverage in China.
“China is very eager for new products and know-how but at present non-performing loan problems are acting as a drag. They have to resolve this problem before they can concentrate on capital structures,” says Mr Chan.
As in Europe, FIG in Asia is about more than just capital raising. There is work to be done on balance sheet restructuring as well as M&A. Falling interest rates have created margin problems for banks and led to products such as Standard Chartered’s Whistlejacket, a tranched investment vehicle with an underlying portfolio of asset-backed and financial institutions securities. Banks can hold Whistlejacket’s capital notes on their balance sheet to give an enhanced return over their liabilities.
“It’s a form of asset and liability management,” says Vinay Agrawal, head of financial institutions for Standard Chartered in Hong Kong. “Banks have liquidity, margins are tight and this helps them solve the problem.”
In Asian M&A there have been a number of transformational deals such as Citigroup’s $2.7bn takeover of KorAm in which Citi acted as its own adviser, as well as HSBC’s purchase of a 20% stake in Bank of Communications.
Singaporean government-owned investment vehicle Temasek has also built up a portfolio of stakes in regional banks.
“Foreign investment in Asian banks forces them to play at a higher level and increases competition in the regional banking sector,” says Citigroup’s Mr Kullavanijaya.
