The Aa2/A+ rated credit has mandated its house banks Goldman Sachs and Morgan Stanley Dean Witter to lead a $500 million perpetual offering which is thought likely to have a 10-year step up structure. It is also believed that the bank might combine the issue with what would be its third $500 million issue of upper tier 2 debt. Roadshows for the deal are rumoured to have been provisionally scheduled for early March, after the announcement of the group's annual results on March 5 and ahead of the next FOMC meeting on March 20.
DBS has been Asia's most active issuer of subordinated debt, with a first $750 million deal launched in August 1999 and a second $500 million transaction in April 2000. Both issues were viewed as a means of optimizing the bank's balance sheet by improving return on equity (ROE) and funding its acquisition trail across Asia. Proceeds from the first deal, for example, are said to have been used to replenish capital depleted as the result of the bank's purchase of the Bank of the Philippines Islands and proceeds from the second to subscribe to a rights offering that helped recapitalize Thai Danu Bank.
Why raise tier 1 when tier 2 would be more efficient?
This time round, bank capital experts believe that an issue of tier 1 capital heralds a much larger and more expensive acquisition, with rumours resurfacing about a bid for Australia's Westpac, or alternatively Equitable PCI in the Philippines. This reasoning stems partly from the fact that the bank has too much, rather than too little capital and partly from the fact that it would make little sense to raise more expensive tier 1 equity at a time when the bank still has room to issue further tier 2 debt.
As one expert puts it: "The most interesting aspect is not the fact that DBS is doing a deal, but why. It indicates that the bank foresees having to make a huge tier 1 write-off, which proceeds from this deal will replenish. Since DBS already has a high ratio of tier 1 equity, the potential acquisition target would either need to be large or expensive. In the latter scenario, any purchase at a premium to book value would necessitate a goodwill write-off against tier 1 equity."
Indeed, DBS continues to affirm an expansionist strategy, stating that if it fails to find new acquisition targets it will return excess capital back to shareholders through share buy-backs. Currently, its available cash is set to expand only further, particularly since a new law introduced in June 2000 requires all Singaporean banks to dispose of their non-financial assets and unwind cross shareholdings with non-bank companies. Over the coming three years, analysts estimate that the bank is set to receive between $2 billion and $3 billion through the sale of what is largely a commercial property portfolio.
The most recent available figures show that DBS had a total capital adequacy ratio of 20.1% as of June 2000, of which 15.5% comprised tier 1 equity. This put it second to OCBC on 25% of which 20.9% comprised tier 1 equity. DBS's previous subordinated debt issues have, however, enabled it to improve ROE to the extent that the bank now enjoys the highest return of any bank in Singapore. As of June, for example, it recorded a 13.1% level on an annualized basis, against 11.5% for OCBC, 12.4% for UOB, 11.7% for OUB and 10.1% for Keppel TatLee.
Singaporean banks and Hong Kong banks both maintain extremely high capital adequacy ratios by global standards. The main difference between the two lies in the fact that the latter have much more efficient capital mixes because they employ more tier 2 than the former and consequently enjoy higher ROEs.
As a means of improving shareholder value, the Monetary Authority of Singapore (MAS) announced last autumn that it would allow banks to lower tier 1 from 10% to 8% of a total capital adequacy ratio that remained static at the 12% level. Prior to this in December 1998, the MAS allowed tier 2 debt for the first time, enabling banks to hold up to 2% of the 12% total as tier 2 debt.
What is a hybrid?
The hybrid structure now under consideration was allowed by the US Federal Reserve in 1996 and by Basel two years later. Since then, hybrids have become extremely popular instruments for investment grade credits in first the US and more recently in Europe. Typically, they are viewed by issuers as a more tax-efficient form of equity and by investors as a means of gaining higher yield without sacrificing credit quality.
In essence, they provide a tax deductible form of capital raising that is priced and traded like debt, but treated as equity. To qualify as tier 1 capital, instruments have to be non-cumulative, able to absorb losses on an on-going basis, remain permanently on the books and rank junior to subordinated and senior creditors.
What principally distinguishes tier 1 capital from tier 2 is the fact that the ability to absorb losses is not optional and interest deferral has to be non-cumulative. Upper tier 2 debt also interest deferral language, but the interest still has to be paid at some point, whereas investors are never reimbursed for missed interest payments on tier 1 instruments. Coupon payments are generally deferred when a bank has not paid dividends on ordinary shares.
One other complicating feature demanded by the regulators is that hybrid instruments should demonstrate a degree of permanence in order to qualify as equity and therefore tend to be perpetual in nature. However, since bond investors need the appearance of maturity in order to hold the securities in their fixed income portfolios, most deals have punitive step-up coupons to ensure that deals are called.
Experts believe that a DBS hybrid would need to price at least 150 bases points (bp) behind the current trading levels of the bank's upper tier 2 debt. Usually, investors would require a differential of about 100bp, since the only difference between upper tier 2 and tier 1 is that one is cumulative and other non-cumulative. In most jurisdictions, both instruments have to be perpetual in nature. Singapore, however, is one of a handful of jurisdictions worldwide which allow dated upper tier 2 securities.
As of Asia's close (Tuesday), the bank's 7.875% 2009 was quoted at 168bp bid over Treasuries and its 7.875% 2010 at 170bp bid. This would consequently price a 2010 step up tier 1 issue above 300bp.
Bankers also argue that a further pricing premium might be needed if DBS were to slip into BBB territory. The bank has a subordinated debt rating of Aa3/A- and a tier 1 issue would almost certainly be rated one notch lower.
Yet few doubt that the deal would be anything other than a roaring success. In an environment where falling interest rates have prompted a desire for yield and threats of a global credit crunch a desire for security, few transactions would offer a better combination of the two than a deal from the premier bank of a triple-A rated country.
OCBC reconsiders subordinated debt
Singapore's second largest bank is also believed to be reconsidering a sizeable subordinated debt offering following the appointment of a new CFO, Chris Matten, who arrived in January from Australia, where he had been head of Group Capital Management at National Australia Bank.
The bank had been on the verge of doing a $1 billion transaction last autumn via JP Morgan and Merrill Lynch, but pulled back at the eleventh hour and seemed to have puts its plans on ice. Matten, however, is regarded as something of a capital guru by DCM bankers and is said to be keen to bring a new deal, although it is likely to be smaller in size.
Whether the original lead managers remain in place also remains open to question, with ratings advisor Goldman Sachs said by some to have moved back into favour.
Maybank revives plans for sub debt issue
A transaction from OCBC will, nevertheless, almost certainly follow one from Maybank (Malayan Banking Berhad), which is actively canvassing banks for pricing on a $300 million to $350 million offering to launch at the end of the first quarter. Since the bank is said to have been inundated with proposals from Asia's entire DCM fraternity, it has not bothered to send out formal invitations for what is likely to involve two bookrunners slots.
Since selection is also likely to be determined mainly on price, it will have almost certainly prompted the kind of aggressive spread levels that investors will be unlikely to deliver. Rated Baa2/BB+ on a subordinated basis, the bank has an existing benchmark in the form of a 7.125% sub debt issue due September 2005. Having consistently traded around the 270bp to 280bp level over Treasuries, the issue has tightened in over the past week to a current bid/offer level of 245bp/235bp.
In large measure, the tightening follows the successful pricing of a $550 million lower tier 2 deal by Hong Kong's Bank of East Asia (BEA) late last month. With a Baa2/BBB rating, the 10 non call five deal was launched with a semi-annual coupon of 7.5% to yield 281.5bp over Treasuries. Since then, it too has tightened in to a 240bp/234bp level, while its nearest comparable benchmark, a 7.75% 2007 issue for Baa1/BBB Dao Heng Bank, has moved from 260bp bid to 230bp bid.
In relative terms, however, Maybank has outperformed the two Hong Kong banks and some experts believe the tightening may have been overplayed. The bank has, for example, a speculative grade rating from Standard & Poor's, yet is now trading through investors' benchmark triple-B US sub debt index, which is averaging a 250bp level over Treasuries.
Many also argue, that Maybank will have to come at a premium to BEA because it will not be able to anchor demand and generate tight pricing by appealing to Hong Kong's large private banking network. BEA, by contrast, saw 58% of paper placed in Asia, of which 75% went to Hong Kong, where retail accounted for 45%. Most were said to have been attracted to the credit, not so much because it was offering subordinated debt, but the fact that they wanted to weight up their exposure to the Territory without sacrificing credit quality.
Yet, Maybank's standing as a defensive play within Asia's broad spectrum of subordinated debt issues should in itself ensure strong investor support. The bank first considered raising tier 2 debt in early autumn last year, but pulled back in favour of a loan arranged by Sumitomo and Standard Chartered.
As of June 2000, the bank reported a comfortable capital adequacy ratio of 15.2%, of which tier 1 equity comprised 10.9%. These ratios have suffered, however, as a result of the mergers imposed on the Malaysian banking system to create 10 anchor banks. Maybank's all cash offer for Phileo Allied and Pacific Bank in August, for instance, is estimated to have reduced its total capital adequacy ratio to 10.2%, below the 12.8% industry average.
Yet as HSBC analyst Charles Ooi commented at the time: "We believe that a lower ratio will not undermine Maybank's capital soundness given its lower NPL ratio and significantly higher loan loss reserve coverage ratios relative to the industry average."
The mergers also benefitted the bank in improving its ROE, which HSBC estimated is likely to be enhanced from 14.9% this year to 16.6% next.