RPT-Fitch Comments on New Zealand's Basel III Tier 2 Structures
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May 22 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings says two distinct structures have emerged for Basel III-compliant Tier 2 instruments, issued by New Zealand banks. Both are structured with the aim of preventing the dilution of existing bank owners. Most banks have either institutional owners or are mutuals.
Both structures are likely to be rated one notch below the banks' anchor rating because full or part conversion to equity is the primary method of loss absorption and are unlikely to trigger before the bank becomes non-viable. Fitch expects equity conversion to be the primary method of loss absorption in most New Zealand Basel-III instruments due to tax impacts on instruments with write-off features. The existence of a legislated resolution regime in New Zealand means sovereign support for banks in general and, in particular, subordinated instruments are unlikely. As a result, the anchor rating for Basel III capital instruments will typically be the banks' Viability Rating. Notching from the Issuer Default Rating is possible when a bank is wholly-owned by another financial institution such as the Australian owned subsidiary banks.
Examples of the structures are provided in two recent transactions. The first is a NZD400m ASB Bank Limited (ASB; AA-/Stable/a) deal, issued directly to investors in April 2014. The loss absorption feature requires conversion to ordinary shares of ASB's parent - Commonwealth Bank of Australia (CBA, AA-/Stable/aa-), if either ASB or CBA were deemed non-viable by their respective regulators - the Reserve Bank of New Zealand (RBNZ) and the Australian Prudential Regulation Authority (APRA). The notes would be written-off in full if equity conversion was not possible, for example if conversion is prevented due to legal issues.
The second structure was used in Kiwibank Limited (Kiwibank; AA/Stable/bbb) NZD100m deal, launched in May 2014 and due to be issued in June 2014. In this structure, a special purpose vehicle (SPV) owned by Kiwibank's parent - Kiwi Group Holdings Limited, was set up to issue notes to the public, using the proceeds to invest in Kiwibank's Basel-III Tier 2 instruments. Under this structure only the Kiwibank instruments convert to ordinary equity in the bank on a non-viability trigger event. The capital notes issued by the SPV do not convert but become perpetual instruments and coupon payments become non-cumulative which link to dividends (if any) paid on Kiwibank's ordinary shares. This was Kiwibank's second deal. In December 2012 it issued New Zealand's first Basel III-compliant Tier 2 instrument which had partial and full write-off features for loss absorption.
Fitch expects the major New Zealand banks to use the ASB structure for future Basel-III Tier 2 issuance as it allows the instrument to receive regulatory capital recognition from both the New Zealand bank and its Australian parent. Further issuance of these instruments is likely, as the major banks seek to diversify their capital mix and/or bolster total capital ratios.
Smaller, domestically-owned financial institutions with unlisted parents are likely to use the second structure, although it would require them to establish holding company structures which could become costly. Fitch does not expect smaller domestically-owned financial institutions to be frequent issuers of Basel-III compliant instruments as their core capital ratios are generally strong and current growth projections do not appear to put these ratios under pressure.
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
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