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Asian financial institutions will continue to raise capital this year in order to meet the upcoming Basel III deadline in 2019, fortifying their balance sheets as they go.
When it comes to their currency options, they are spoilt for choice these days. Debt capital market bankers expect new local currency-denominated Basel III-compliant issuance in this neck of the woods to continue outpacing new debt denominated in dollars and euros given that it’s much cheaper to raise it domestically.
Although regulators have been nagging domestic financial institutions to diversify beyond their borders, cost of funding will outweigh such considerations in the minds of the banks.
“These instruments will primarily go into the local currency market because they can price them more cheaply,” Pramod Shenoi, head of capital solutions for DCM financial institutions group at Standard Chartered, told FinanceAsia. “For the Chinese banks, it makes complete sense to try to issue as much locally as possible.”
In Asia ex-Japan, banks raised a total of $29.4 billion of additional tier-1 (AT1) capital and $71.5 billion of tier-2 across all currencies last year, according to Dealogic data. Out of that total, nearly 80% of the deals were executed in the local currency market (LCY).
Regulators around the region proposed a tighter bank-capital regime to comply with an international agreement drawn up by the Basel Committee on Banking Supervision, an international group of standard setters.
The measures, adopted after the 2008 global financial crisis, are meant to make banks less vulnerable in future emergencies. They call for banks to maintain a buffer of loss-absorbing capital of at least 7% of risk-weighted assets.
As a result, there will be a greater focus on raising capital until the end of the decade as Asia-Pacific banks respond to global regulatory pressures, according credit analysts. The amount of required capital is clearly the most for Chinese and Indian banks.
Chinese banks rated by Moody’s have an estimated Rmb650 billion ($105 billion) worth of Basel II — or old-style — tier-2 debt maturing by 2021, which will likely be refinanced via domestic markets, Stephen Long, Asia managing director for Moody’s financial institutions group, told FinanceAsia.
Mainland China’s top-five banks have obtained approvals from regulators to issue a combined Rmb270 billion worth of Basel III-compliant bonds from 2014 to 2016. The banks are Agricultural Bank of China, Bank of China, Bank of Communications, China Construction Bank and ICBC.
So far Bank of China and ICBC have issued AT1 notes, with the former selling a $6.5 billion offering in October and the latter a triple-tranche multi-currency $5.7 billion deal in December.
China’s three other large state-owned banks are likely to follow this year. Each transaction is expected to be about $5 billion or more, meaning the total size of the first batch of AT1s may easily top $20 billion to $25 billion, DCM bankers said.
Also in a Moody’s report released last September, rated public sector banks in India will need to raise Rs1.5 trillion ($24 billion) to Rs2.2 trillion in tier-1 capital between financial year 2015 — ending March 31 — and full implementation of Basel III in 2019, assuming a moderate recovery in GDP and gradual decline in new nonperforming loans formation. Most of this will be executed domestically, bankers said.
“Tier-1 and tier-2 issuance are going to continue to be a theme across the Asia-Pacific region, now that the regulatory framework is clear and the investor base has been established,” Sean McNelis, head of the financing solutions group for Asia-Pacific at HSBC, said. “We expect to see a similar year to 2014 with Chinese banks continuing to issue in order to optimise their capital structure under Basel III.”
Cheap thrill
There are a few simple reasons as to why it’s costlier to raise capital offshore. In some jurisdictions, withholding taxes are imposed on the instruments whereas in some other markets, the cost of swapping is extortionate.
For example, Agricultural Bank of China was able to reap substantial savings via the issuance of the nation’s first preference share offering. In November, it priced a Rmb40 billion ($6.5 billion) AT1 note at 6%, the lower end of the initial price guidance range.
This is significantly cheaper than Industrial and Commercial Bank of China’s recent offshore renminbi preference share offering. Even though ICBC was able to price a Rmb12 billion ($2 billion) AT1 note at 6% in December, it had to pay an additional 20% in withholding tax as it was executed offshore.
This cost saving is also pertinent to financial institutions from other Asian countries, which is why there hasn’t been any foreign currency-denominated bank capital raised by banks in India, Malaysia or the Philippines (for now at least) — three jurisdictions that benefit from deep domestic debt markets.
In the case of India, state-owned financial institution Bank of Baroda raised an Rs10 billion ($162 million) AT1 note at a coupon of 9.48% in the week of January 12. By comparison, the borrower would have paid about 12.5% in Indian rupee terms if it had raised the capital in international markets and swapped the proceeds back into local currency, StanChart’s Shenoi said.
But, putting all eggs into one basket is clearly a risk. Local regulators around Asia have been pushing domestic banks to diversify their bank capital issuance across both onshore and offshore markets to help mitigate systemic risks, according to debt arrangers in conversation with regulators.
For example, if a bank were to raise Basel III-compliant capital solely onshore it would mean Basel III non-viability triggers — where investors could lose all their money if regulators decide a bank cannot survive — would hurt domestic investors, accentuating the domestic fallout, explained a Hong Kong-based DCM banker.
“If you are regulator, you would want to see the banking risk of your subordinated debt being distributed, not just out of the banking system, but out of the whole system,” said the DCM banker, who declined to be named. “That means selling to people in America, Europe and elsewhere in Asia has benefits from a diversification point of view.”
While viewed as a risk by some, credit analysts do not perceive this to be a serious issue for Asian sovereigns. The need to raise funding offshore boils down, at the end of the day, to the specific needs of the bank and whether it has fast-growing foreign currency-denominated assets.
“If dollar loan books are growing at a faster pace than domestic, having some dollar-denominated capital does help mitigate the currency movement effect on your capital ratios,” Moody’s Long said. “But from a credit point of view, [not diversifying offshore] is not a big risk to the financial system.”
