Fitch Assesses South Korea's First Basel III Tier 2 Instrument

Mon Apr 28, 2014 8:55pm EDT

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(The following statement was released by the rating agency) SEOUL/HONG KONG, April 28 (Fitch) Fitch Ratings assesses the risk in securities such as Woori Bank's (Woori; A-/Stable/bbb) Basel III-compliant Tier 2 subordinated notes - the first issuance by a South Korean bank of that kind - to be equivalent to two notches below the commercial banks' anchor rating, which is the Viability Rating (VR). The subordinated notes have a full and permanent write-off feature to absorb losses upon trigger events. The same instrument issued by other Korean commercial banks would have similar notching. Fitch expects issuances of Basel III securities by Korean banks to increase noticeably in the next 18 months because the banks will need to support their asset growth and offset the amortisation of the legacy regulatory capital securities. Fitch also expects the structure of the Woori transaction to be broadly followed by other Tier 2 deals. The rating of the Basel III Tier 2 securities two notches below the anchor rating reflects Fitch's view on loss severity due to the instrument's poor recovery prospects relative to senior unsecured instruments, which stem from the instrument's deep subordination. The subordinated notes will be written-off completely and permanently if and when the bank becomes insolvent as defined in Article 2 of Korea's Act on Structural Improvement of the Financial Industry or receives a management improvement order as per Article 36 of the Regulations on Supervision of Banking Business. Apart from the regulatory authorities having discretion in declaring a bank as non-viable, Korea has also specified that a management improvement order will be activated if a commercial bank's total capital adequacy ratio falls below 2% (or Tier 1 ratio below 1.5% or common-equity Tier 1 ratio below 1.2%). An insolvency test will be triggered if a commercial bank's total capital adequacy ratio falls below 4% (or Tier 1 ratio below 3% or common-equity Tier 1 ratio below 2.3%). The typical anchor for Basel III securities is an issuer's intrinsic strength as Fitch would generally not factor in extraordinary support from the Korean authorities for this type of instrument. Fitch believes that for securities with Basel III loss absorption feature, there is no certainty that they will be bailed-out through a pre-emptive deployment of public funds without the activation of a management improvement order by the Financial Supervisory Commission. In order for Basel III subordinated securities to be bailed-out reliably, a pre-emptive common-equity capital injection by the authorities is vital. However, Fitch believes that for the Korean government to inject common equity to support a commercial bank as a going concern, it will need to deploy public funds as defined in Article 2, Special Act on the Management of Public Funds, which is highly likely to require approval from the National Assembly. As such, it is uncertain that such public funds will be available or made available in a timely manner to protect the holders of Basel III loss absorption securities. This uncertainty compares with the use of the Bank Recapitalisation Fund, which was set up in 2009 during the global financial crisis to support some banks, but only for their Basel II subordinated debt and hybrid Tier 1 capital. Lastly, in Fitch's view, the Korean government (via Korea Deposit Insurance Corporation) is a reluctant holder of a controlling stake (57%) in Woori, with privatisation the ultimate objective of the government. As such, while it is possible that the government will inject common equity to support Woori, should the latter need such support, Fitch does not consider the possibility sufficiently reliable to notch from the support-driven IDR. More details on how Fitch assesses risks in bank subordinated and hybrid securities are in "Assessing and Rating Bank Subordinated and Hybrid Securities Criteria", dated 31 January 2014, which can be found at www.fitchratings.com Contact: Heakyu Chang Director +82 2 3278 8363 Fitch Ratings Limited 9F Kyobo Securities Building 26-4 Youido-Dong, Youngdeungpo-Gu Seoul 150-737 Jonathan Cornish Managing Director +852 2263 9901 Mihwa Park Associate Director +65 6796 7238 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. Additional information is available on www.fitchratings.com ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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