Wealthy Asians snub bank capital bonds

Fri Sep 20, 2013 4:01am EDT

* Private banks reduce leverage for bank hybrids

* Fears of fallout in case write-downs are triggered

* Clients turn to corporate perpetuals instead

By Christopher Langner

SINGAPORE, Sept 20 (IFR) - Tougher lending policies are threatening to drive Asia's private-banking clients away from bank capital and towards corporate hybrids.

Private bankers said they are reducing the margin loans, or leverage, they make available to buyers of loss-absorbing capital instruments that expose investors to the risk of permanent principal losses.

"They are seeing that some of these bonds will trade to zero if the loss-absorbing features are triggered," said one fixed-income specialist at a private bank. "If my collateral may be completely gone, I will give zero leverage, as well."

To count towards a bank's capital adequacy ratio under Basel III rules, securities must write down to zero or convert to equity in case the bank's capital falls below a certain threshold. Corporate issuers, however, have no such requirements, and new leverage policies may lead to a resurgence of corporate hybrids in Asia.

Wealthy Asian individuals have been among the most enthusiastic buyers of bank capital in recent years, but there are signs that the new loss-absorbing requirements and tougher margin limits are eroding that investor base.

Reduced appetite for bank capital bonds may make it more expensive for financial institutions to meet capital adequacy rules, adding to the pressure on earnings in the sector.

On August 29, Societe Generale was able to sell only 9% of its US$1.25bn Tier 1 bond in Asia, despite offering a relatively high coupon of 8.25%.

That was in sharp contrast to UBS selling 70% of a US$2bn Tier 2 capital bond to private banking clients, many of them in Asia, in February 2012.

The UBS bonds featured a total write-down if the bank's common equity Tier 1 capital falls below 5% or it is considered non-viable. At the time, Asian private banking accounts paid little attention to that risk, focusing instead on the 7.25% coupon and the well-known Swiss name.

The deal sparked a trend and Asian private banks became the first stop on any bank capital deal for most of 2012. In fact, bankers said, of the Basel III-compliant bonds European banks printed last year, two-thirds to three-quarters were allocated to Asian accounts, mostly private banks.

HYBRIDS IN DEMAND

Societe Generale's reduced Asian allocation is also a big contrast to other recent hybrids that come without the risk of write-downs.

On September 9, Japan's Fukoku Mutual Life Insurance sold a US$500m 6.5% perpetual bond callable after 10 years. As much as 60% of those bonds ended up in Asian hands, while 45% of the lot went to private banks.

After the Reg S-only issue, a 144A/Reg S 60-year non-call 10 hybrid from Sumitomo Life Insurance followed the next day, also pricing at 6.5% and heavily bought by private banks.

Both bonds had investment-grade ratings of Baa1 from Moody's and leverage was said to be readily available from private banks. Neither had write-down clauses.

The depth of Asian demand for those hybrids has led to predictions that corporate hybrids may soon reappear elsewhere in Asia. The obvious candidates to reopen the market are the blue chips of the region.

"If the corporate hybrid is structured appropriately, there will be plenty of demand for it, and not only from private banking," said a high-yield portfolio manager.

BIG-BOY LETTERS

Even where leverage is still available for bank-capital securities, private banks are taking additional steps to make sure clients know what they are buying.

One private banker said his shop had capped leverage on bank capital bonds to 30% recently, partly because of fears of potential downgrades of such paper. Another said many private banking clients had declined to take up the margin loans on offer.

The reason, he explained, was that end-investors were being told very clearly of the risks involved in buying bank-capital bonds.

"Private bankers have started to worry about potential lawsuits," said the first banker.

Several wealthy Asian investors sued their financial advisers in the aftermath of the 2008 global financial crisis for giving them bad advice on potential losses from some of their investments.

As a result, some private banking clients are being asked to sign forms indicating they understand the risks involved in these bonds, commonly referred to in the financial world as "big-boy letters".

"The chances that the capital bonds of some of the best banks in Asia are written-off are small, but, if that happens, everyone wants to be safe," he said.

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