Malaysia leads the way in Basel III debt
* Banks line up first loss-absorbing bonds
* Deals will test appetite for new style subordinated debt
* Other lenders in Asia may follow template
By Kit Yin Boey
May 23 (IFR) - Malaysia is poised to host Asia's first public issue of loss-absorbing bank debt, so-called bail-in bonds, since the region began the transition to Basel III standards earlier this year.
CIMB Bank has received preliminary approval from the country's central bank for a subordinated ringgit bond that will count towards its Tier 2 capital, and may launch the deal in the next few weeks. There is also talk that another local lender, Public Bank, will follow suit with a similar Basel III compliant issue.
If the deals materialise in the coming weeks, they promise to set a template as the first in Asia, excluding Japan and Australia, since regulators from India to China introduced Basel III rules in January.
Under the new, stricter capital requirements, subordinated bonds require loss-absorption features if they are to count towards a bank's capital ratios, ensuring that holders are "bailed in" through writedowns or conversion to equity before any public funds are used to bail out a bank.
Given their fairly well capitalised levels, Malaysian bankers had not expected a Basel III-compliant structure to hit the markets so soon. CIMB, however, is in talks to buy Philippines-based Bank of Commerce for an estimated US$296m, which may have hastened its plans to raise bank capital.
"No bank wants to be the first, since they will have to cough up a lot more to compensate the investors for that write-off feature, and there is really no proper benchmark or comp in the Asian markets," said one rival banker.
Asia's first Basel III-compliant bond dates back to November 2011, when Hong Kong-based ICBC Asia priced a Rmb1.5bn (US$236m) Tier 2 Dim Sum bond that will write down to zero if the bank becomes non-viable. That issue, however, came at a time of surging enthusiasm for renminbi exposure, and investors also assumed - rightly or wrongly - that there was little chance of ICBC Asia's state-owned parent allowing the unit to fail.
More clarity has since emerged on local interpretations of Basel III rules, but no Asian lender has yet followed ICBC Asia's lead with a public sale.
A small Chinese lender is also working on the first loss-absorbing Tier 2 bond in the country's restricted domestic market, but a deal in Malaysia would offer a more representative benchmark for the wider region.
Banks across Asia have until now held back from replacing their old-style Tier 2 debt, in part due to concerns over the cost of doing so.
Australia's Suncorp in April sold the country's first retail Tier 2 to comply with the new rules. The 10.5-year non-call 5.5 notes had a successful run in the yield-driven retail investor market, allowing Suncorp to pay a premium of just 85bp-90bp over old-style Tier 2 notes from the Australian major banks.
In Malaysia, investors are looking for a Basel III-compliant Tier 2 issue to pay a yield of 6%-7% to offset the increased risk of losses. That would be 200bp-300bp above outstanding old-style Tier 2 paper. For instance, Public Bank's Tier 2 notes due August 2022 and callable in 2017, were trading on Tuesday at 4.00%.
"The loss-sharing feature means that, in effect, I'm buying a hybrid convertible," said one local investor. "If there is little upside for me, I would think they will have to pay much higher than hybrid Tier 1 notes. And that will also depend on what options they provide for investors to exit."
CIMB, however, will be hoping for a good response from investors, who have been starved of new issues since March when the primary market ground to a halt ahead of a general election. Investor confidence has returned with the incumbent government, but there has only been one public deal since the elections on May 5 - a M$1.615bn multi-tranche project financing sukuk from Tenaga Nasional.
If it does get a warm reception in the Malaysian market, CIMB may even set a positive precedent for other banks in the country, and the region, to follow.
As well as setting a benchmark for pricing, CIMB's issue will provide more clarity on the structures that are acceptable - to both regulators and investors.
Banks in the region had been waiting for regulators to outline, among other things, what exactly makes a bank no longer viable - the trigger point for subordinated bonds to be written-off or converted into shares.
The Basel Committee has guidelines for those so-called triggers, but banks and investors would rather wait until they are endorsed by the local regulators that will have the final say in each case.
Bank Negara Malaysia, the country's central bank, has not set any threshold levels as a trigger event for non-viability for Tier 2 issues, but Tier 1 investors will suffer losses if a bank's common equity falls below 5.15%. In the case of both Tier 1 and Tier 2 issues, however, the final decision on whether an issuer is viable will be made by Bank Negara on a case-by-case basis.
Bank Negara requires all banks to have core equity Tier 1 capital ratio of 4.5%, a Tier 1 capital ratio of 6.0% and a total capital ratio of 8.0% by January 2015.
Banks in Malaysia are fairly well capitalised at the moment. They would be able to suffer a 300% rise in non-performing loans without common equity Tier 1 falling below 7%, Moody's said in a recent report.
That means CIMB and Public Bank will probably not be soon followed by many local peers. They will, however, help the whole region break the taboo around loss-absorbing bonds. (Reporting By Kit Yin Boey; editing by Christopher Langner and Steve Garton)
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