Banks in Asia are beefing up their hybrid businesses as the product gains popularity among corporates in Asia and in anticipation of a rise in bank capital issuance after Basel III takes effect from 2013.
The fee pool for Asian hybrids — said by two debt specialist to be in the region of $50 million for the past two years — has become more lucrative. And as a result, more banks have shifted hybrid specialists to Asia, an indication of where they see opportunity.
“When I first came to Asia 12 years ago, it was quite innovative for a house to have someone focused on capital products for financial institutions,” said Mark Follett, managing director and head of high-grade debt capital markets Asia ex-Japan at J.P. Morgan. “But people gradually built up teams in 2001 through 2002 to focus on structured capital.
“The same thing has happened with corporate hybrids. When we did the first hybrid transaction in 2010, few houses had people who were familiar with the product. Nowadays when we do deals, the structuring person sits in Asia,” he added.
A handful of banks relocated their hybrid bankers to Asia last year. Six months ago, Mark Lindon, who previously ran the UK and Ireland financial institutions group at Deutsche Bank in London, moved to Singapore as head of capital solutions group Asia focusing on corporate and bank capital hybrids. Lee-Shin Koh, a director at Citi, moved from Sydney to Hong Kong in July last year to cover corporate and bank hybrid capital for Asia-Pacific. Lee previously covered hybrids for Asia-Pacific out of Australia.
Corporate hybrids, bonds that have equity-like features, have gained popularity in Asia since Cheung Kong Infrastructure issued the first Asian hybrid after more than a decade back in 2010. According to Dealogic data, US dollar corporate hybrid bond issuance chalked up $3.35 billion from three deals in 2010 and $2.3 billion from five deals in 2011. There was no dollar hybrid issuance in 2009.
Thanks to the recent stock market rout, companies are reluctant to issue equity and are looking more closely at hybrids. Such instruments can be accounted as equity — and improve banking ratios as well as help avoid companies breach loan covenants.
“When share prices are depressed, companies are less willing to issue equity,” said Follett. “The advantage of issuing a hybrid is that a company has the ability to raise non-dilutive equity which it can later replace with equity when markets improve,” he added.
However, hybrids are not immune to stock routs. Most perpetuals have embedded features that make them unattractive to hold in a volatile market. For instance, investors are deeply subordinated and the bonds do not have a fixed maturity, so investors could get stuck holding them forever if companies do not call the bonds.
Recent deals include Citic Pacific’s perpetual trade at a cash price of 95/96 and China Resources Power’s perpetual trades at around 95.5. So far this year, only one issuer — Philippine port operator ICTSI — has tapped the dollar hybrid market, and it was able to do so as it was one of the few bonds to trade well last year.
“Perpetual bonds thrive in a neutral credit environment,” said Follett. “It is not a defensive product. Because of embedded features allowing issuers to miss interest payments and subordination, it is an instrument that will underperform in volatile conditions,” he added.
Private banking demand for the product is strong, and this throws up opportunities for highly rated companies with strong name recognition. “A private banking investor would often rather take a subordinated position in a strong company than a senior position in a weaker credit,” said Follett.
The sell-off in the dollar has also thrown up opportunities in local currency bond markets — particularly the Singapore dollar market, where more perpetuals are expected. Last year, Cheung Kong Holdings issued a senior perpetual in the Singapore dollar market while Global Logistic Properties in January issued a S$250 million tap, paying an initial distribution of 5.5%. If GLP had tapped the dollar market, it is estimated that it would have had to pay at least 7%.
“We saw a perfect storm in credit markets last year and that led to a selloff in dollar hybrids. There is very strong interest from issuers for dollar hybrids but they are faced with a difficult set of comparables. So, there is a pricing arbitrage to take some of these issuers to other markets,” said Follett.
The methodology that rating agencies use for hybrid issuance continues to evolve and in the future, according to Follett, there will be “new structures that address changes in rating agency methodology”.
