Oversea-Chinese Banking Corporation (OCBC) has announced a bond swap, offering to exchange its S$1 billion ($645 million) of outstanding 5% upper tier-2 bonds due September 2011 for the same principal amount of new 5.6% lower tier-2 notes due 2019. While the exchange won't result in any fresh cash, it will increase the bank's lower tier-2 capital, which ought to be viewed favourably by investors in an environment where there is an increasing focus on capital adequacy ratios.
The new subordinated notes are callable after five years and, if not cancelled, the coupon will step up to 7.35% from 5.6% on the fifth anniversary. They are expected to qualify in full as tier-2 capital for the first six years, while the existing notes only qualify to 40% after being subject to a regulatory progressive reduction of 20% per year since September 2006. A swap is therefore quite an efficient way to boost the bank's capital. The bank said the exchange is being arranged by its own capital markets department.
Given the higher coupon, the fact that the new notes will rank senior to the old ones -- and thus move the bondholders up a notch in the bank's capital structure -- and because the offer is at par to face value, one can assume that most investors will accept the offer. Given the longer duration, between the maturity on the old notes and the call on the new ones, the exchange will also benefit holders who are seeking to reduce their future reinvestment risk. They should also be less volatile and, unlike the existing bonds, the new ones don't allow the coupon payments to be deferred.
The existing bonds were quoted at 100.8/101.5 yesterday, according to Bloomberg, after jumping from about 98.5 on Wednesday.
The exchange offer opens this morning and will close at noon Singapore time on March 23.
The fact that the new OCBC bonds will be lower tier-2, callable and feature a step-up coupon is interesting in light of the debate in the international bond markets in recent months about whether it will be possible to issue such bonds in the wake of Woori Financial Group's decision in January not to call a similar bond. While the issuer is completely in the right not to call, it has been a long-standing practice in the international bond markets that all callable bonds will indeed be called and, as a result, they are typically priced based on the call date as opposed the final maturity date.
Consequently, the decision by Woori not to call, which followed a similar move by Deutsche Bank in December, prompted a spike in the price of its bonds to account for the "new" maturity. Woori said the reason for keeping the bonds in the market was the relatively higher cost of refinancing them -- although some observers have noted that the reputational cost to the Korean bank from breaking with market practice may be just as costly in the longer run, and have argued that Woori should have had no problem raising additional funding in the domestic market to cover the call, especially in light of the current government guarantee.
There were also suggestions that Woori's decision might make it more difficult for other issuers to sell callable lower tier-2 bonds, which was already a tough sell amid the volatility and investor risk aversion. However, the fact that OCBC's bonds are Singapore dollar-denominated means they are subject to a slightly different dynamic. Indeed, OCBC, which is the third largest bank in Singapore with consolidated assets of S$181 billion, has a very strong domestic following and most of the bonds in question are likely to be held by onshore investors.
The bank is already very well capitalised with a tier-1 ratio of 14.9% as of the end of December and a total capital adequacy ratio of 15.1%, which should make investors comfortable to hold whatever debt the company issues. The minimum requirement with regard to the tier-1 capital ratio in Singapore is 6%, while the total CAR must be at least 10%.
Moody's also said in a note yesterday that there is a "very high probability of systemic support, if needed", given OCBC's high domestic market share (about 16% of total deposits) and its relative importance to Singapore's financial system.
Standard & Poor's and Moody's rate the bonds A and Aa2 respectively. This is one notch below their respective counterparty ratings on OCBC Bank to reflect the subordinated nature of the bonds.