OCBC sells largest Basel III bond in Asia ex-Japan

The Singaporean bank raised a $1 billion 10.5-year Basel III-compliant bond to help fund its expansion and replenish old-style debt.

Oversea-Chinese Banking Corporation sold a $1 billion 10.5-year Basel III-compliant Tier 2 bond on Tuesday, illustrating the Singapore bank’s ongoing push to boost its capital in order to fund its growth and replenish maturing old-style subordinated debt.

OCBC's new bond  – callable in year 5.5 – is the largest Basel III-compliant dollar deal and the first-ever bank capital transaction in the 144A market in Asia ex-Japan, according to Dealogic.

The note forms part of OCBC's strategic funding plans, analysts said.

“We are seeing that banks in Singapore are pursuing relatively rapid growth strategies,” Eugene Tarzimanov, senior credit officer at Moody’s, told FinanceAsia. “So they will also need to boost their capital reserves that are somewhat diluted by growth.”

On April 1, OCBC announced a HKD38.4 billion ($4.99 billion) offer to buy Hong Kong’s Wing Hang Bank in an effort to grow its presence in north Asia. The deal, which still needs regulatory approval, is potentially the biggest acquisition of a Hong Kong-based financial institution since 2001 when rival Singaporean bank DBS acquired Dao Heng Bank.

Part of the new issuance could also be used to replenish OCBC’s maturing subordinated debt. The Singaporean bank just redeemed a Basel II Tier 2 paper – also known as old-style notes – with S$712 million ($566 million) outstanding, said credit analysts.

“Singaporean banks are going to issue more Basel III securities this year and one of the drivers is that they need to replace their legacy Basel II instruments that are maturing or will be callable,” Tarzimanov said.

Singaporean banks had S$22.2 billion of outstanding old-style securities at the end of 2013, of which S$5.9 billion is callable or will mature in 2014, Moody’s estimated in a report dated March 19. The rest will be callable or mature by 2019.

OCBC’s 144A/Reg S bond comes a month after United Overseas Bank, another Singapore-based bank, issued $800 million in comparable notes -- the first-ever dollar-denominated Basel III-compliant transaction to emerge from Southeast Asia.

Investor-friendly structure

Although OCBC’s notes are subordinated obligations – a security that ranks below other securities with regard to claims on asset or earnings in the case of a default – they come with fairly investor-friendly terms.

Interest payments are fixed for the first 5.5 years, thereafter the paper resets at the prevailing five-year US dollar swap rate plus a credit spread if not called. This is a positive for investors in a rising interest rate environment as duration risk – the measure of the sensitivity of the fixed income instrument’s price to a change in interest rates – is reduced, syndicate bankers said.

Also, OCBC’s notes are subject to sequential and partial write-off as defined by the Monetary Authority of Singapore’s point of non-viability (PONV) language. A PONV trigger event is an occurrence where investors could lose all their money if regulators decide the bank cannot survive.

Sequential means that the bank’s Additional Tier 1 paper, followed by hybrid Tier 1 bonds, gets written off before the Tier 2 notes, and that these instruments will only be written down partially – to whichever level is necessary to make the financial institution viable again.

Negative ratings

However, one major risk remains. OCBC’s ratings have been placed on negative watch by one global rating agency owing to its planned acquisition of Wing Hang Bank. For example, Moody’s placed the Singaporean bank’s Aa1 rating on review for a downgrade on April 3, citing the execution risk associated with its plans to finance the acquisition and recapitalise. 

As a result, OCBC's Basel II Tier 2 notes maturing in 2022 and callable in 2017 traded about 16bp to 17bp wider than comparable DBS and UOB issuance prior to the new bond's pricing, according to a note published by CreditSights, an independent credit research provider.

While this is an indication that bond holders might not have been compensated enough for the additional risk, there are still advantages to holding OCBC’s new notes.

Compared with the Basel III Tier 2 10-year notes issued by ANZ, Mizuho and Sumitomo, Singaporean bank bonds offer yields that are only slightly lower, notably for structures that are shorter-dated and have callable features, and are more highly rated on average.

“As such, compared to the Basel III Tier 2 issuance to-date of the Aussie and Japanese banks, we see the Singaporean banks as attractive,” Matthew Phan, credit analyst at CreditSights, said in the note.

OCBC’s notes -- which had an order book of $4.3 billion from 260 accounts -- priced flat to fair value and 20bp tighter than its initial price guidance of US Treasuries plus 265bp, according to a term sheet seen by FinanceAsia.

The nearest comparables were UOB’s notes maturing in 2024, which traded at 227bp prior to the deal's announcement, market sources said. UOB's and OCBC's outstanding 2022 paper traded 17bp apart, meaning that the fair value for the new bonds was around 244bp over US Treasuries.

OCBC’s transaction traded 5bp tighter at US Treasuries plus 240bp in secondary markets shortly after being priced, sources familiar with the matter said.

Bank of America Merrill Lynch, HSBC, JPMorgan and OCBC are joint bookrunners of OCBC’s transaction, which is also part of its existing $10 billion medium-term notes programme.

OCBC needs to recapitalise

OCBC’s ambition to grow by acquisition is expected to keep providing business for investment banks.

The Singapore lender has already secured a bridge loan of about HK$38.5 billion ($4.9 billion) from Bank of America Merrill Lynch, HSBC and JP Morgan for the Wing Hang Bank acquisition. It is also expected by analysts to tap equity markets at some point so it can shore up its Tier 1 capital ratio and bring it back on par with its peers.

Assuming OCBC acquires 100% of Wing Hang Bank without raising any equity, its Tier 1 capital ratio will fall to around 11% from 14.5%.

“They need to boost their capital through equity issuance. But if there is turbulence in the market, the bank might have to delay or scale down its plans to raise equity, leaving the institution with a lower capital buffer,” Moody’s Tarzimanov said. “This is why we have placed [its] ratings on the review for downgrade.”

OCBC's Tier 1 capital ratio is expected to fall as it is paying about S$2.8 billion of goodwill as a result of acquiring Wing Hang Bank above book value – at 1.77 times book value – and also because the combined entity would also have risk weighted assets of S$172 billion compared with OCBC's S$150 billion of risk-weighted assets as at end-December.

At the moment, OCBC has secured acceptances from Wing Hang’s major shareholders, including members of the Fung family and Bank of New York Mellon, which collectively hold about 51% of Wing Hang shares but it is unclear if minority shareholders will accept the offer, and the ultimate size of the deal will depend on what percentage agree.

The proposed acquisition of OCBC will increase the bank's exposure to Hong Kong and China but, overall, that is less of a concern for Moody's. “Wing Hang is a fairly conservatively run bank, with a pretty clean balance sheet and an A2 rating,” Gene Fang, vice president and senior analyst at Moody’s, said. “It is relatively less exposed to shadow banking and trust lending in China.”

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