Citic Ka Wah perps up investors

The Hong Kong bank offers yield-starved investors the attractive combination of spread and rating.

Breaking new ground for the Hong Kong credit markets, the bank successfully priced Asia ex-Japan's first upper tier 2 debt issue with a perpetual structure yesterday (Thursday).

The $250 million offering, which secured a Baa3/BB+ rating, was priced at 99.726% on a coupon of 9.125% to yield 8.967% or 385bp over Treasuries. Callable annually after 10-years, the bond steps up at the same date by either 100bp or 1.5 times the launch spread, calculated as 501bp over Libor. Three bookrunners comprising HSBC, ICBC and UBS Warburg, were also joined by quite a full syndicate for a small deal, with China Construction Bank, Ka Wah Capital and Merrill Lynch as co-leads and Deutsche Bank and Standard Chartered as co-managers.

At a time when even a CCC-rated credit like the Republic of Indonesia is being quoted close to 300bp over Treasuries, Citic Ka Wah (CKW) not only offers investors a significant pick-up over comparable Hong Kong credits, but much of the wider Asian universe as well. And as one participant highlights, "Given a choice at similar pricing levels, investors would much rather buy a subordinated bond from an investment grade credit than a senior bond from a junk one."

At 385bp over Treasuries, however, pricing was deemed to be fair by bank capital experts. The only slight criticism concerned the structure, with some bankers arguing that the leads should have pushed the Hong Kong Monetary Authority (HKMA) to adopt dated rather than perpetual structures for upper tier 2 debt as this would have ultimately proved cheaper for the issuer.

But as others point out, Hong Kong tends to follow English legal precedent and in this instance the Bank of England does not allow dated transactions. The principal reason for this is that upper tier 2 ranks one step closer to equity than lower tier 2 and therefore has to appear to give a greater degree of permanence on the balance sheet.

Key to the pricing was what level the new deal should come relative to CKW's outstanding lower tier 2 deal. This $300 million 7.625% 10 non call five deal falls due in 2006 and is currently bid at 265bp over Treasuries. Working on an assumption that a new lower tier 2 deal should price at 300bp to 310bp over Treasuries, the leads then decided to begin marketing the upper tier 2 deal 90bp wider to take into account the additional notch of subordination and the perpetual rather than dated structure of the trade. The deal subsequently priced 15bp tighter at 75bp back, a considerable achievement, given that it only just scraped an investment grade rating.

Bankers say that upper tier 2 deals typically trade anywhere from 50bp to 100bp wide of lower tier 2 subject to structure and the underlying rating. UK banks with higher double-A ratings such as Abbey National, for example, show a roughly 45bp spread differential between dated lower tier 2 and undated upper tier 2.

Regionally, the only comparable is DBS Bank, which has an outstanding upper tier 2 transaction and a tier 1 hybrid. At Asia's close yesterday, the Singaporean bank's upper tier 2 May 2011 issue was quoted at 141bp over, while its tier 1 perpetual callable in March 2011 was trading 62bp wider at 203bp. Both are quoted over 10-year Treasuries.

The main difference between tier 1 and upper tier 2 capital is that interest deferral is non-cumulative in the former instance. This means that investors are not re-imbursed for missed coupon payments. However, because the HKMA has not yet finalised its guidelines governing upper tier 2 debt, experts say it is not yet clear whether it will use the dividends test or capital adequacy test to govern when a bank can miss a coupon payment.

In dealing with the rating agencies, the leads appear to have positioned the credit extremely well since Moody's normal policy is to rate the subordinated debt of banks with a bank financial strength rating below the C category at a one notch differential to senior debt. In this case, the same rating has been applied even though CKW has a BFS rating of D+ and crucially, it means the deal attracted an investment grade rating enabling pricing to be kept tight.

One other major benchmark is Bank of East Asia's outstanding Baa2/BBB rated 7.5% 2006 lower tier 2 deal, which was bid yesterday at 6.14% to yield 170bp over Treasuries. At the time of launch last June, CKW priced at a 45bp premium to BoEA, but this widened out considerably after September 11, and has consistently ranged around an 85bp to 95bp premium throughout 2002. Yesterday, it stood at the wider end of the range on a 95bp premium

For CKW's new deal, observers report a final order book around the $650 million level, with a total of 70 investors. By geography the book split 72% Asia, 28% Europe. Of the Asian book, China accounted for 45%, Hong Kong 29% and Singapore 26%. By investor type, asset managers came in at 28%, banks 34%, corporates 8% insurance companies 7% and private banks 23%.

One of the most interesting highlights was the strong interest from Chinese bank investors, which do not have take a hit on their own capital from investing in the bonds of another bank. Their participation also underlines the likelihood of strong secondary market support for the deal and the direction in which the credit is heading.

While CKW ranks as Hong Kong's fourth largest listed bank and its seventh largest overall, it is the China connection and parentage that stand out. Its unlisted parent Citic Beijing owns 55.08% and is presently finalising the creation of a holding company structure Citic International Financial Holdings, which will contain the commercial bank (CKW), NPL management (Ka Wah Investment Management) and investment banking (Citic Capital Markets, in which CKW holds a 25% stake).

CKW Treasurer Moses Yeung says that the transformation should be completed around the first quarter of 2003. "Our aim is three-fold," he explains. "We want to create a flexible structure that can deliver the full range of financial services to a broad mix of customers. We want each individual component of the holding company to fully develop its area of speciality and overall we want to deliver better returns to shareholders."

Management have also said that they see the greatest growth potential coming from Hong Kong rather than China and aim to take market share from smaller, less nimble and less aggressive competitors. Long-term, however, investors are likely to concentrate on China, which currently accounts for 23% of CKW's exposure and in particular how Citic Industrial Bank, the Mainland banking arm will fit into the equation as China progressively liberalises the banking sector.

As a result of the new deal, CKW will lift its capital adequacy ratio from 16.4% at the end of March to just over 18%. At the end of 2001, the bank reported a 20.8% level, but this has dropped because of the goodwill write-off associated with CKWÆs acquisition of HKCB finalized in January this year at 1.26 times book value. Upper tier 2 debt was also decided upon, because the bank is full on lower tier 2. Both types of debt rank pari passu in a bankÆs capital structure, but upper tier 2 is always more expensive because it gives the issuer the option to defer coupon payments.