Gremlins at the bank capital gates

Teething issues blight many debut bank capital deals, including Bank of China's recent $6.5b offering, but such problems are unlikely to last.

Teething issues are bound to crop up in debut bank capital deals and even the biggest issuers can fall foul of gremlins, including Bank of China’s recent preference share transaction.

Although viewed as a landmark deal, BOC’s mammoth $6.5 billion Additional Tier 1 offering raised mid-October experienced some technical issues a few days after it was launched.

The error began from the start in terms of how it was set up, said a Singapore-based fixed income trader who is trading BOC’s notes to FinanceAsia. While the structuring of the dollar-denominated AT1 bond is straightforward, the snag is that the instrument is linked to renminbi-denominated preference shares.

The reason for the official denomination in renminbi is due to China’s State Council’s regulation, under which capital market instruments have to be denominated in the Chinese currency and governed by Chinese law to be considered Additional Tier 1 capital.

The complication arose when the Bloomberg system initially quoted the instruments in dollar notional value, thereby leading to numbers not rounding up properly, explained the trader. What Bloomberg has done now is to quote these notes in renminbi, meaning that they’re trading nominally in the Chinese currency instead.

“It was a little messy,” said a debt banker away from BOC’s preference share deal. “It would have been easier to do it in renminbi from the start, rather than have this switch a few days later, which affected the trading sizes and the actual allotments.”

Debt capital bankers with upcoming Chinese preference share notes in the pipeline can learn from BOC’s little technical mishap. In fact, sources close to the upcoming ICBC AT1 deal, which is due to launch sometime in the next few days, said they have addressed this issue.

ICBC International is the sole global coordinator of the deal. Bank of America Merrill Lynch, Goldman Sachs and UBS are the joint bookrunners of ICBC’s proposed preference share transaction.

The issuer — which received regulatory and board approval to issue as much as Rmb35 billion ($5.7 billion) of AT1s — could be considering a dollar-, euro- or offshore renminbi-denominated issuance.

BOC trading well

Despite the initial hiccups, BOC’s AT1 deal is trading well in secondary markets, with its cash price trading up by one to 2.5 points from par as of November 14, according to Bloomberg bond price data.

“It did mean that we had to go back and rebook each ticket which was a pain, but that hasn’t hindered liquidity or changed anything,” said the Singapore-based fixed income trader.

In addition, all fund settlements are denominated in dollars and the conversion is set at a fixed rate of Rmb6.1448 against the dollar, said bankers familiar with the matter. So regardless of where the USD/CNY rate goes, investors do not run a currency risk.

“You only own dollar risk and obviously Bank of China risk,” the trader added.

Moody’s expects Asia ex-Japan banks to continue issuing Basel III securities in large volumes, noting that they have already issued more than $32 billion, including $26 billion issued in the first six months of 2014, said Gene Fang, senior credit officer at Moody’s in a July report.

The reason behind the wave of bank issuance is the need for Basel III compliance. Asia’s banks are boosting their balance sheets based on new guidelines set by the Basel Committee on Banking Supervision in July 2011.

In the aftermath of the financial crisis the global regulator recommended much more stringent capital rules for banks to protect against losses

Investors to exercise caution

Clearly, setting the perfect benchmark for bank capital issuances is not an easy task, and more often than not, first timers tend to get scrutinised heavily by the market.

With the flurry of bank capital deals that are likely to come in the coming months from varying jurisdictions, this makes it crucial for investors to learn how to differentiate between the array of bank capital notes that are expected to come to market.

“The problem is that new issuances can become more and more complicated,” said Tim Jagger, fixed income portfolio manager at Aviva Investors at FinanceAsia’s Southeast Asia Borrowers and Investors Forum held in Singapore on October 30. “[Each] bank capital [instrument] is different. In terms of commoditising credit, the bond market is going to be very difficult.”

Such fears arise due to the different resolution frameworks that can be seen in Asia.

Unlike Basel II tier-2 notes — also known as old-style bank capital — the new-style bonds come with a “non-viability absorption” clause and the terms can vary from country to country.

This clause is where investors could lose all their money if regulators decide that a bank cannot survive and can happen in two ways: there can be a write-down of the notes’ principal or a conversion of that paper into equity.

In the region, the most investor-friendly of the various non-viability clauses come from Japan and Korea. Their governments are allowed to make pre-emptive capital injections into the respective financial institutions before creditors absorb the losses, bankers said. Such resolution frameworks aim to minimise any disruption to the financial system.

This is completely different from ICBC Asia’s non-viability language, where an injection of funds by the Hong Kong Monetary Authority would make the financial institution non-viable. In such a scenario, the bond will be written down to zero.

Also, ICBC Asia’s bonds are subject to regulations under the Bank Capital Rules of Hong Kong and China’s Capital Rules for Commercial Banks.

“There needs to be more streamlining so that there’s only one regulator that will call it non-viable, be it the PBoC [People’s Bank of China], HKMA or CRBC [China Banking Regulatory Commission],” said Devan Selvanathan, head of global debt platform for Asia-Pacific at Natixis at the forum. “Until this comes through you are going to have a multi-tiered marketplace for hybrids, which perhaps is not so conducive for the market.”

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