Each of its previous transactions have been viewed by the bank as a means of optimizing a strong balance sheet and funding an acquisition trail that now spans the length of Asia. Many observers, however, remain curious why the bank has opted for a tier 1 issue when it already has too much capital, tier 2 debt would be less expensive and would enhance rather than diminish its return on equity (currently 12.89%). Most have concluded that the move must pre-figure another and this time highly expensive acquisition that requires a large write-off against tier 1 equity.
At the end of 2000, DBS had a total capital adequacy ratio of 18.9%, of which 14.4% comprised tier 1 equity, compared to 20.1% at the mid-year point, of which 15.5% comprised tier 1 equity. The new deal will add about 1.3% of tier 1 subject to its current indicative size.
But DBS experts argue that the transaction has to be viewed within the context of the bank's overall strategy. "Yes the bank has a policy of rationalising its capital structure and yes it is expansion mode," says one. "They may be related processes, but they are separate. Just because the bank is launching this issue, it doesn't mean it's about to make a large acquisition. It's like two wheels of the same car, spinning independently, but pushing the vehicle forward in the same direction."
Others say that there are a number of ways in which the bank could put the proceeds to good use, including buying back common equity, which would improve the efficiency its capital base and give it more diversity. Indeed, the bank has always said that if it fails to find new acquisition targets, it will return excess capital back to shareholders through share buy-backs.
"A bank of this size cannot run its balance sheet on a one for one basis, so that every time it complete a debt markets transaction, proceeds are used to fund a new purchase," an observer states. "What it is doing is adopting a sensible policy of pre-funding itself and keeping its options open."
Pricing for the perpetual offering will be closely benchmarked against DBS's existing two subordinated debt issues. Both are dated upper tier 2 issues comprising: a 7.875% August 2009 transaction, currently trading at a bid/offer spread of 175bp/170bp over Treasuries and a 7.875% April 2010 trading at 177bp/167bp.
The key difference between upper tier 2 and tier 1 is the fact that the ability to absorb losses is not optional and interest deferral has to be non-cumulative. Upper tier 2 debt also has interest deferral language, but the interest still has to be paid at some point, whereas investors are never reimbursed for missed payments on tier 1 instruments. These are generally deferred when a bank has not paid dividends on ordinary shares.
Typically, hybrid tier 1 issues are rated one notch below tier 2 debt. In this instance, however, DBS has already won the argument with the rating agencies and managed to secure ratings of Aa3/A- in line with its existing subordinated debt. Bankers believe that this is because the agencies are willing to make less of a credit distinction for banks at the very top end of the ratings scale.
But DBS's main task will be to persuade investors not to demand a greater than necessary premium over and above its existing two deals. Usually, a tier 1 issue would price 100bp behind a tier 2 on the basis that the former is cumulative and the latter non-cumulative. In most jurisdictions, both tier 1 and tier 2 have to be perpetual, but in this instance, the new deal will have a perpetual step-up structure, while the two existing deals are both dated bullet structures.
In the bank's favour is the fact that there are no competing and, therefore, comparable existing transactions from the sector in Asia, that there remains a continuing supply/demand imbalance for dollar paper and a marked investor preference for higher rated securities at a time of heightened uncertainty about a global slowdown. Consensus opinion, therefore, suggests that DBS should be able to dispense with a new issue premium and clear the 10 year step-up deal around the 280bp to 290bp mark, a roughly 110bp differential to outstanding levels.
Outside observers have also credited the bank for incorporating a domestic currency tranche, which should further spur a market it has done much to develop in tandem with the Singaporean government
Hoping to catch a positive tailwind in the run up to the next FOMC meeting on March 20, the bank launched the deal two days after the announcement of its annual results on March 5. These revealed that net profits have risen 30% to $1.39 billion on the back of a 95% drop in bad loans.
