Bank of East Asia raises $500 million via hybrid tier-1 deal

The offering, made up of perpetual callable notes with a step-up coupon and preference shares, marks the first bank capital deal in Asia in 12 months.

Hong Kong-listed Bank of East Asia (BEA) last night raised $500 million from the sale of hybrid tier-1 capital securities, marking the first ever sale of such securities by a Hong Kong bank.

It was also the first bank capital deal in Asia in more than 12 months and the size of the order book as well as the resilience of the orders even as global equity markets have tumbled and credit spreads widened over the past four days, showed that there is clearly pent-up demand in the region for these types of transactions.

According to sources, the total order book amounted to more than $5.3 billion, or just over 10 times the value of the bonds on offer. About 230 investors submitted orders and despite the turbulence in the market during the bookbuilding, and a tightening of the price guidance on the final day, the deal lost no orders of magnitude or consequence.

Indeed, the coupon, which is payable semi-annually, was fixed at 8.5%, which is equal to the low end of the final guidance range of 8.5% to 8.75%. The initial guidance, which was communicated to investors at the start of the Asian trading day on Wednesday, was 8.75% to 9%. The bonds were issued at par so the coupon and the yield are the same. The final coupon translates into a spread over US Treasuries of 507.6bp and a spread over mid-swaps of 490.7bp.

The deal is made up of subordinated step-up 50-year (although bankers refer to them as perpetual) notes that are callable after 10 years, and non-cumulative step-up preference shares, which are stapled together. Initially, only the notes will pay interest, while the preference shares will start to pay dividends (of the same amount as the notes) following the occurrence of certain events, including a deferral of interest payments on the notes, an event of default under the terms of the notes, or if BEA's capital adequacy ratio falls below that required by the Hong Kong regulators (currently 8%). At that time, the notes and the preference shares will be separated from one another with the notes being returned to the issuer and the preference shares staying with the investors.

If the notes are not called after 10 years, the fixed coupon will be replaced by a floating rate at Libor plus 736.05bp, which will be payable quarterly. Based on the current three-month Libor of 3.65%, the coupon would step up by about 250bp to 11%.

Given the success of this deal, bankers and analysts say they expect more banks will follow suit with similar subordinated instruments as they seek to meet new requirements on core capital that are expected to come into play in the wake of the recent financial crisis. One analyst, who asked not to be named, said BEA's use of a mandatory interest payment deferral tied to profits, which makes the notes even more equity-like, should be attractive to other potential issuers as well.

"This has to be the way forward, because there are a lot of changes to Basel II and higher capital requirements on banks," the analyst said. "I think there is going to be a lot less focus on tier-2 type instruments and more on tier-1. We have started to see banks in Korea do rights issues to improve their core captial, and similarly, Bank of East Asia is going to use this to buff up its capital base and potentially, I guess, to expand into China."

However, investors do take on a lot of core capital risk when buying such deeply subordinated instruments -- in the pecking order they rank just above equity -- and the buyers need to be very comfortable not only with the credit-worthiness of the issuer, but also with the fact that it will continue to generate enough profit after tax and after interest payments on more senior debt to pay the coupons, or the dividends on the preference shares. Under the terms of the deal, there can be no interest payouts to the holders of the stapled securities if the bank doesn't have a 12-month profit that is greater than the interest payments.

Standard & Poor's has rated the notes BBB-, which is three notches below BEA's foreign currency credit rating of A-. The difference, it said, reflects the subordination of the issue; the interest payment deferral option (once deferred, this coupon payment or dividend is lost to the investor forever) and the "heightened risk due to [the] mandatory nature of the deferral trigger", and the fact that BEA was close to reporting a full-year loss in 2008.

Moody's Investors Service has assigned a Baa1 rating with a negative outlook to the notes, which is two notches below BEA's A2 rating.

Bank of East Asia, which is controlled by Hong Kong tycoon David Li, said in a statement to the Hong Kong stock exchange that the "current environment presents an opportunity for the bank to steer towards a more optimal capital mix in a relatively cost efficient manner". It also noted that since the preference shares are non-cumulative and generally non-voting, the issue "will not create any material dilutive effect, nor affect the voting right of, the shareholders of the bank".

However, with a capital adequacy ratio of 13% at the end of June, BEA had seemingly no pressing need to raise core capital.

Stapled securities have traditionally been quite common in Europe and Australia, but are not often seen in Asia, even in countries where bank capital deals have been more frequent, such as Malaysia, Korea and Singapore. However, there have not been that many bank capital deals in the region in recent years, as Asian banks have remained relatively healthy during the latest financial crisis and their balance sheets were in much less need of "repair" than those of their peers in Europe and the US and as noted earlier, some banks in the region have also turned to rights issues to improve their core capital ratios, notably DBS in Singapore, Malayan Banking (Maybank) in Malaysia, Bank Danamon in Indonesia and Shinhan Bank and Kookmin Bank (through its listed holding company KB Financial Group) in Korea.

Indeed, Asia hasn't seen a single bank capital deal since Hong Kong's Wing Hang Bank sold $225 million worth of perpetual upper tier- 2 bonds in September last year. In terms of a benchmark hybrid tier 1- deal, this is the first in Asia since State Bank of India raised $225 million from a perpetual note in June 2007.

The stapled securities were offered under the Regulation S banner, which means onshore US investors weren't eligible to buy. Hence the roadshow, led by joint bookrunners Deutsche Bank and UBS, went to only Hong Kong, Singapore and London.

European investors have a lot of these instruments to choose from in their home market however, so it was perhaps no great surprise that 80% of the BEA deal was bought by Asian investors, while the remaining 20% went to European accounts. In terms of types of investors, private banks took 69%, fund managers 17% and banks 9%, while 5% ended up with other investors.

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