Korea Exchange Bank (KEB) became Asia's first issuer to tap the international dollar bond markets in over two months this week when it launched a $200m upper tier 2 capital issue. Volatile and widening secondary market spreads, nervousness over US interest rate increases and equity market falls have all conspired to keep potential issues from the region on hold since Singapore Power last entered the international markets in mid April.
Timing of KEB's deal, however, has been dictated by a need to meet 10% bank capital requirements under the Korean Financial Supervisory Commission's (FSC) 'Forward Looking Criteria'. Consequently, as soon as US and European markets showed signs of regaining some strength two weeks ago, lead manager Credit Suisse First Boston immediately reactivated a deal that many believed would never see the light of day.
In order to meet the quarterly June 30 deadline, the 10 non-call five offering had to be priced by Tuesday, a feat just managed right up against the wire. Rather than waiting for oversubscription, launch of the deal also, therefore, took place as soon as books were covered and was priced to sell.
Issued at 99.634 with a coupon of 13.75% and yield of 13.854%, the June 30 2010 transaction had a launch spread of 765bp over Treasuries, stepping up to 1,147.5bp after the year five call date. With fees totalling 1.5%, co-managers comprised ABN AMRO, Chase and Deutsche Bank and were allocated just under 5% in retention bonds.
For most observers, key to their view of the deal's success or failure was its pricing relative to existing benchmarks by Hanvit and Cho Hung Bank. Both banks issued a combination of lower and upper tier 2 dollar debt earlier this year to meet bank capital requirements. Since launch, both have also been exceptionally volatile in a reflection of nervousness in the international bond markets hitting lowest rated deals hardest.
In the space of three weeks during May, for example, trading prices of the two banks' subordinated debt slid from 104 to 92, with the yield on Hanvit's 12.75% 2010 upper tier 2 issue hitting a year to date high of 16%. As investor jitters about the US Federal Reserve's interest rate policy subsided towards the end of May, however, yields have come back in to the 13% level and spreads broken back through the 700bp mark.
The exact premium paid by KEB on its pricing in New York on Tuesday, has, however, been the source of some debate. While CSFB officials say that the B-/BB-/B1 rated issue came at roughly 55bp to 60bp over Hanvit's secondary levels, other bankers contend that the real level was about 10bp wider.
What is not in question is the fact that in addition to paying a roughly 20bp new issue premium, the bank also had to a pay a premium over both Hanvit and Cho Hung. Partly this has been seen as compensation for what is viewed as a slightly weaker credit and partly a reflection of the fact the investors had the upper hand in pricing negotiations.
"For the market it was a good deal, because it was priced where the market wanted it," comments one observer. "This is quite remarkable when you consider that this is Korea we're talking about - land of the infamously tough pricing negotiations.
"The bank needed the money and it had to pay for it," the banker adds. "In this respect it was a good deal and still cheaper and more palatable than other alternatives."
An even split
Lead officials report that about 35% of the bonds were placed in the US, 35% in Asia and 30% in Europe. The splits are particularly interesting since previous deals have been very heavily targeted towards the US.
As one banker explains, "At the beginning of the year, Korean subordinated debt as an asset class didn't really exist and market appetite for future deals was never going to be limitless. To make a deal like this a success, new sources of demand had to be found."
Following whirlwind roadshow presentations in the US and a series of conference calls in Asia and Europe, the lead was able to pull together about 28 investors, of whom about 12 came from Asia, 10 from Europe and eight from the US.
In terms of ticket size, the US led the way, with European demand centred around the UK and in Asia concentrated in Hong Kong and Singapore.
"What was interesting were the unexpected names which cropped up in the book," one banker comments. "Probably about 35% to 40% of the total were investors that hadn't participated in Asian subordinated debt before. They like the high coupons, but haven't had lines in place until now."
Particularly noticeable were private banking accounts, all of whom placed cash orders. "There was very little switch interest," the banker continues. "About 80% was cash."
The low number of switch orders has also been attributed to the fact that many funds have been sitting on up to 25% in cash over the past few months and are now keen to put some money back to work again.
Many competitors criticised CSFB for rushing a deal to market without full roadshows and then holding it hostage to investors' price demands. "Both previous Korean sub debt deals were deliberately pitched in Asia first to gain some pricing momentum against US investors," says one banker.
In reality, however, the lead had its hands tied by a combination of inopportune market conditions and a June 30 payment deadline. As soon an issuance window materialised, it took advantage of it.
In terms of stand-alone credit issues, on the other hand, timing was not quite so ideal. Problems at Hyundai Investment Trust Company, to which KEB is the largest creditor bank and rumours that the government will merge three weak state-owned banks into one, were felt to outweigh the credit advantages of KEB's ownership by Commerzbank.
The German bank, which is itself in discussions to merge with Dresdner Bank, owns 31.6% of KEB, compared with a 32.2% government stake, split between the Bank of Korea and Export-Import Bank of Korea (Kexim).
The confused status of Korea's latest round of bank mergers left investors' having to second guess the likely outcome. Most agree that plans to form a 'super' state-owned bank should be positive for the sub debt sector, since it affirms the government's determination not to let the banks fail.
Disagreement centres around how a potential merger might affect KEB. Indeed, having first indicated that Hanvit, Cho Hung and KEB would be merged, the government now appears to have dropped KEB in favour of Seoul Bank following pressure from Commerzbank.
Regarding Commerzbank's stake as a complicating factor in the merger process, some analysts hold a negative credit view. A number argue that KEB will stand alone as a solitary, weak bank up against a much larger wholly state-owned entity which the government may further cleanse of NPL's.
Other analysts, however, argue that just because the government owns less of KEB, it doesn't mean that it is less committed to it.
Says one, "In the event of an equity recapitalisation, the government would match every dollar that Commerzbank has to put in. But the key point is that the process would be led by the government not Commerzbank. It is still very obviously pulling all the strings."
Some analysts also argue that KEB should not trade at any premium to either Hanvit or Cho Hung, since Commerzbank's risk management expertise should ensure faster recovery of NPLs and a cleaner credit record going forwards.
Yet where senior counterparty credit ratings are concerned, KEB has lower ratings than either of its two domestic counterparts. Cho Hung, for example is rated Ba2/BB, with Hanvit one notch lower by Standard & Poor's at Ba2/BB- and KEB one notch lower again at Ba2/B+.
Cost effective funding
Arguments about the relative merits of all three banks aside, few would disagree that the bank has at least secured the most cost effective funds it could in the circumstances. Since its shares are trading below par value, it has not legally been able to consider an equity recapitalisation and would be unlikely to want anyway given the potential dilutive effect to existing shareholders.
"To do an equity issue would amount to giving away returns of up to 400% if you listen to some analysts' forecasts for the share price over the next five years," says one specialist.
KEB can leverage its lending against the capital it has now raised and as long as its return on equity is higher going forwards than the coupon paid on the bond issue then it will prove cost efficient over the course of what is effectively a five year maturity.
Within two days of trading the deal was still holding firm around re-offer, but has underperformed the sector as a whole, with the differential between KEB, Hanvit and Cho Hung widening to up to 80bp. At the end of Asian trading on Thursday, KEB was quoted at 758bp/744bp, compared to 683bp/654bp for Hanvit's 12.75% issue and 674bp/645bp for Cho Hung's 11.875% issue.