Citic Ka Wah mandates perpetual dollar bond

One of Hong Kong''s most dynamic financial credits has set its sights on an undated upper tier 2 debt issue.

In what should mark the final piece of funding needed for the acquisition of Hong Kong Chinese Bank (HKCB), a $200 million to $300 million deal is being lined up for launch in mid to late April under the lead management of HSBC, ICBC and UBS Warburg.

In the space of one year, Citic Ka Wah (CKW) has become one of the most interesting credits in the Greater China universe and over the past month, one of the best performing. From being just one among many small Hong Kong banks fighting for survival in a crowded market, CKW is now perceived to be the driving force behind its parent Citic Beijing's ambitious attempt to create a leading financial services group spanning Hong Kong and China.

The new debt issue follows a debut lower tier 2 debt issue of June 2001, the precursor to a HK$4.2 billion ($540 million) acquisition of HKCB finalised in January this year at 1.26 times book value. More recently, CKW also completed a HK$726 million ($93 million) rights issue to replenish tier 1 capital and for the Financial Year Ended December 31, reported a total Capital Adequacy Ratio of 20.8%, of which tier 1 represented 14.8%.

The goodwill write-off for HKCB, however, will see CKW's CAR drop to about 14.2% of which tier 1 will represent 9.6%. This sets the bank some way below the 18.3% average of the Hong Kong banking sector, which has been traditionally overcapitalised because of the few investment opportunities available. As well as boosting overall capital levels, the new deal will also help improve the bank's capital mix and help its ROE (Return on Equity), which stood at 10.19% at year-end.

But the new transaction is not without its challenges and only reason it is being attempted in the first place is because CKW is full on lower tier 2 debt. Upper and lower tier 2 debt rank pari passu in a bank's capital structure, but upper tier 2 debt is always more expensive because of its interest deferral language.

FIG experts also believe that CKW will be the lowest rated bank to ever tap the perpetual upper tier 2 sector. From Asia, there have been a number of upper tier 2 deals from the Singaporean and Korean banks in the past few years, but all have been dated issues and hence remove the risk that investors will be left with a true perpetual on their hands.

Some investors, for example, remain extremely wary of the perpetual structure after a particularly unpleasant experience with a number of Japanese banks in the mid to late 1990s. Most perpetuals are structured such that punitive step-ups encourage issuers to call their bonds after say 10-years. In the case of the Japanese banks, however, their collective credit ratings fell so fast that the front end spreads on each of the deals ended up being far wider than the back end and none of the bonds were called.

In CKW's case, the rating it receives will be key. Currently the bank has a Baa3/BBB- subordinated debt rating and a Baa2/BBB senior debt rating. Standard & Poor's usual policy is to drop a bank by one notch below its senior debt rating for lower tier 2 debt and two notches for upper tier 2 debt.

Moody's meanwhile, takes a more liberal approach and usually rates upper and lower tier 2 debt at the same levels for banks with a bank financial strength rating in the C category or above. CKW currently has a D+ financial strength rating.

On this basis, CKW will drop into non-investment grade territory from both agencies, although a review of the bank's credit profile incorporating HKCB, may prompt an upward revision keeping the bank in the low BBB category.

Either way, FIG experts believe that the deal should be well received since it is coming at a time when investors are looking for yield opportunities and upper tier 2 debt typically prices about 50bp to 60bp over lower tier 2. Added to this, a transaction from a Citic group entity will provide investors with an ever-attractive China kicker.

CKW's outstanding $300 million 7.625% 10 non-call five offering of June 2001 did not perform well for most of last year. Having been issued at 290bp over Treasuries, it hit one 400bp peak in October and then a second 330bp peak in early February this year. Since then, however, the bond has come in 45bp and closed trading in Asia yesterday (Tuesday) at 285bp bid.

At this level it stands at a 95bp premium to Bank of East Asia's Baa2-rated February 2011 issue, bid at 195bp over and a 50bp premium to Dah Sing's Baa2-rated March 2011 issue, bid at 235bp over.

Credit analysts believe that despite the recent spread contraction, the rally may still have some legs to it as CKW is trading wide of a 45bp launch premium to Bank of East Asia and a 25bp launch premium to Dah Sing. At a bid yield of 7.6%, it is also still trading very close to some of the lesser rated China infrastructure plays such as Ba3/BB+ rated GH Water, which has a June 2008 issue bid at 7.68% and BB+ rated Road King, which has a July 2007 bond bid at 7.7%.

Since the HKCB acquisition, CKW has become Hong Kong's fourth largest listed bank and its seventh largest overall behind HSBC, Bank of China, Hang Seng, Standard Chartered, Bank of East Asia and DBS (Dao Heng). Yet despite a combined asset base of HK$79.6 billion ($10.2 billion), the bank still has some way to go to match the likes of Bank of East Asia, which has an asset base of HK$181.8 billion ($23.3 billion).

But it has been Citic's vision of a financial services holding company, which has excited the investment community and prompted the recent spread rally. Having not made much headway with its telecommunications plans, the Mainland behemoth has now turned its attention to WTO and the opening up of the financial services sector.

The unlisted parent, Citic Beijing currently owns 55.08% of CKW and 29% of Citic Pacific, its Hong Kong listed investment arm. Under the proposed re-organisation, a new entity, Citic International Financial Holdings, will replace CKW on the Hong Kong Stock Exchange and bring the commercial bank (CKW) asset management arm (Ka Wah Asset Management) and investment bank (Citic Capital Markets) under one umbrella.

However, while CKW and Ka Wah asset management will be 100% owned entities, Citic Capital Markets is a 50/50 joint venture established last month with Citic Beijing. Simultaneously CKW has also signed an MOU to establish a strategic relationship with the parent's Mainland commercial banking arm, Citic Industrial Bank.

In the operational review for its 2001 annual results published in February, CKW set out its stall quite clearly. "With Citic's support and the bank's in-depth knowledge of the Hong Kong and Mainland markets, the bank is well positioned to accelerate the development of its Mainland businesses and to capitalize on the vast opportunities that arise as a result of China's entry to the World Trade Organisation," it stated. "The bank will position itself as the provider of a full range of financial services and strive to become a premier financial group in Hong Kong, the Mainland and the region."

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