Back in August last year, the Bank of Thailand introduced changes to legislation that were designed to make it easier for the country's financial institutions to raise capital. By allowing them to sell instruments of upper tier 2 capital, essentially unsecured subordinated debt, the central bank was offering institutions a way to meet their capital requirements, something necessitated by the difficulty in raising equity through the stock market.
One would presume that, armed with this new tool, commercial banks and other institutions would be lining up with deals, but as yet, that hasn't happened. Only the Industrial Finance Corporation of Thailand (IFCT) - the part government-owned agency to help finance financial institutions - has dipped its toes in the new market, with a Bt1.8 billion ($41.4 million) transaction.
HSBC, which was responsible for selling the bonds to institutional investors, acted as joint lead manager with Thai Farmers Bank, who handled the retail accounts. The 10-year subordinated debenture bonds, launched in November 2000, were structured with a call-up option after five years. For the first five years, the coupon is 125 basis points under the minimum lending rate (MLR), and from that point until maturity the bonds will pay MLR minus 50. The notes were unrated, simply because the IFCT is one of the few institutions that doesn't require one.
A couple of months on and we have not seen any other bank publicly state that they will be following the IFCT's lead, although that hasn't stopped the market speculating. Mark Boyne, treasurer of HSBC in Bangkok, attributes the lack of activity, in part, to potential issuers wanting to see the reaction to the IFCT deal, and the lengthy process of getting a rating.
"Firstly, they wanted to see how the IFCT deal was received; in fact, it was oversubscribed and demand led to the initial offering being increased from Bt1.5 billion to Bt1.8 billion," says Boyne. "Secondly, deals offered by almost all the other institutions will require a local rating, which means it takes longer to bring deals to the market. Also, they will be looking at other ways of raising the necessary capital."
Taking all of this into account, financial institutions mulling over the use of upper tier 2 capital instruments should by now have decided whether they merit real consideration. But the key factor in their decision surrounds the value these deals have in meeting capital requirements versus the fact that the cost of borrowing in this way is higher.
"I think the prospects for this market are quite high so long as the investors are comfortable with the creditworthiness of the issuer and that the bonds are issued at the right interest rate," Boyne says. "That is something borrowers will have to come to terms with as the costs will be higher than they may pay elsewhere. For instance, one of the stronger local banks might have to pay MLR minus 1.25% on an upper tier 2 debt instrument compared to MLR minus 2.5%-3% for a senior bond."
If borrowers are prepared to accept the extra costs, however, Boyne believes they will not have a problem in finding willing investors. "On the plus side, there is a lot of liquidity in the market and retail investors are not happy with the returns they are getting from bank deposits and similar assets," he explains. "Whereas a few years ago the interest rates were around 7% or 8%, they currently stand at 1% or 2%, and buyers are looking for higher yielding instruments, particularly floating rate."
And, according to Boyne, it isn't just the retail buyers with spare cash in their pockets. "I think the appetite is there as there are several different types of buyers for these deals," he opines. "Aside from retail investors, insurance companies are mandated to produce returns of more than 6%. In this climate of low interest rates, that's difficult to achieve so they will be looking at other ways to hit targets. Also, there is a small but growing number of mutual and providence funds and they will be looking for somewhere to invest their funds."
Although upper tier 2 instruments might not necessarily become an essential way for financial institutions to raise capital, Andrew Stotz, an analyst at SociTtT GTnTrale, believes more banks will use this tool in 2001 and beyond. "It's not so significant because the amount of the IFCT bond was Bt1.8 billion, compared to Bt458.8 billion of corporate bonds outstanding, and Bt1500bn of total bonds outstanding," he says.
"But the top three banks - Bangkok Bank (BBL), Thai Farmers Bank and Siam Commercial Bank - are likely to use it. It should also be remembered that their capital needs are much more focused on equity and tier 1 capital. Of the smaller banks, the Bank of Asia and Bank of Ayudhaya could be next in line for raising capital."
So just how much issuance will be seen through upper tier 2 capital in the year ahead? Set against the overall Thai bond sector, the volumes will be relatively small due to the embryonic state of the market. "IFCT's deal was Bt1.8 billion and it is likely that the banks will initially start off with small issues to explain how this works to investors, yet still ensuring that they are oversubscribed," Stotz says. "So we may see somewhere between Bt2 billion and Bt 4 billion being raised this way by each big bank in 2001."
Stotz agrees with Boyne that the market is certainly liquid (and sophisticated) enough to take these new instruments on board, citing what is happening to bank deposits as a positive indicator. "Actual deposits by volume at banks keep rising, despite deposit rates falling," he says. "Three month deposit rates are the best indicator of what the majority of deposits are used for. These rates have fallen from 5.42% (Q1 1999) to the current level of 3.5%, so the funds should be flowing out elsewhere. This is good news for the development of the bond markets."
"In terms of the investors themselves, the IFCT issue was split 50/50 between retail and institutional investors," he continues. "I would say that both of these would invest in the upper tier 2 product, but will have to trust the banks and understand the instrument, hence, only the bigger banks will initially do issues."
The progress may be slow initially, but market whispers suggest that of the possible borrowers mentioned, the Thai Farmers Bank is a likely candidate, arranging its own deal following its participation in the IFCT transaction. Bank Ayudhaya is another name that keeps cropping up, and another bank to look out for may be the Thai Military Bank.