Kookmin makes a date with domestic market

Asia''s largest domestic bank turns from the international to domestic markets to try and raise more cost efficient tier 1 capital.

Plans to issue roughly $850 million via a tier 1 hybrid transaction have been shelved, though not formally postponed and as Kookmin needs significant tier 1 capital, bankers believe a deal may yet re-surface once a domestic transaction is completed. The dollar denominated deal was mandated late last year to Kookmin shareholders' Goldman Sachs and ING, alongside Merrill Lynch and UBS Warburg. However earlier this week, it was supplanted by a domestic transaction, even though 144a documentation had been almost completed and the leads were waiting to include end of year financials, which would have become available at the end of February.

Prior to this, the market had been sounded out on a structure modeled on Hana Bank's market-opening $200 million deal of mid December. Using a similar perpetual non-call 10 structure, Kookmin had been hoping to achieve a spread of 300bp to 310bp over Treasuries, but had hit market resistance at 350bp over. At this level, the bank would have had to pay a coupon of 7.49% and also stomach the costs of swapping proceeds back to Won.

In the domestic markets, on the other hand, it hopes to achieve a coupon of 6%, which swaps back to about 210bp in US Treasury terms. The key question now is whether it will be able to get a feasible tax deductible structure past the regulator and more importantly, whether the domestic market can absorb the size of transaction being contemplated and what are considered extremely aggressive terms.

Hana Bank, for example, launched a Won400 billion ($300 million) upper tier 2 transaction in December at a blended spread of 7.49%. The 10 non call-five deal is said to be currently trading at about 7.02%. Seoul-based bankers conclude that a 100bp differential between the two banks is highly ambitious given that Hana only has a one notch lower rating than Kookmin on Standard & Poor's side.

It presently has a senior rating of Baa2/BBB, while Kookmin has an A3/BBB+ rating. Where tier 1 ratings are concerned, Hana drops into non-investment grade territory, with a BB+ rating from S&P and an implied Ba1 rating from Moody's. Kookmin, by comparison has a Baa2/BBB- tier 1 rating. Hana did, however, receive a BBB- rating from Fitch allowing its tier 1 deal to be sold to domestic insurance companies.
Bankers also point out that upper tier 2 capital is a much less risky proposition for investors and that in the international markets, hybrids typically trade up to 120bp wider than dated upper tier 2 capital instruments and up to 50bp wider than undated upper tier 2.

International investors were also only prepared to cede Kookmin's tier 1 deal a 40bp spread differential to Hana's. At Asia's close yesterday, for example, Hana's 8.748% December 2012 issue was being quoted at 388bp bid over Treasuries on a yield of 7.82%. Having been priced by lead managers Barclays and JPMorgan in December at 450bp over Treasuries, the deal has performed well in the month or so since launch.

But FIG purists are most askance at Kookmin's plans to use a dated structure for its domestic deal. The bank is said to be talking to the regulator about a 30 step-up 10 transaction. Yet bankers say that only one international jurisdiction - Canada - currently allows this and many argue that the rating agencies will take a very dim view of moves to water down the perpetual nature of what is supposed to be quasi-equity.

The chief difference between hybrids and upper tier 2 debt is that one type of instrument is cumulative and the other is not. This means that if coupons are deferred, they have to be re-paid at some point to holders of upper tier 2 debt, but not to holders of hybrids. From a regulator's point of view, hybrids are classified as core capital (tier 1) because they are essentially equity - they allow for loss absorption, write-offs and are perpetual with no fixed cost. They are consequently a slightly lesser form of capital than common equity, but much higher quality form of capital than either upper or lower tier 2 debt.

For banks that need to replenish core capital, or have breached their issuance limits for subordinated debt, hybrids are usually a far more advantageous and cost effective means of boosting capital than issuing straight equity. As a result, regulators typically limit issuance to no more than 15% of tier 1 capital. In terms of cost, hybrids are cheaper than common equity because coupons are tax deductible. They also do not dilute the existing shareholder base and therefore do not depress ROE.

At the end of 2002, Kookmin reported an overall CAR of 10.3% of which tier 1 stood at 6.6%. And as HSBC wrote in a recent report, "We view unfavourably the 0.49% drop in tier 1 capital from a year earlier of 7.09% given that the domestic operating environment clearly remains volatile."

Analysts also say that Kookmin needs a tier 1 boost because it plans to buy back the government's remaining 9.6% in the bank and has to assign a 20% higher risk weighting to its huge mortgage portfolio.

Nevertheless, most experts believe that should Kookmin come up with a workable structure, its deal is likely to be popular with investors. "Kookmin should have no problem selling something like this through its vast retail network," says one.

In the meantime, Cho Hung Bank has announced plans for a $250 million upper tier 2 transaction via Salomon Smith Barney. News of the deal has perplexed many observers since Cho Hung is in the process of being acquired by the Shinhan Financial Group, which will be the only entity needing to replenish its core capital after the write-off associated with the acquisition.

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