Fitch Expects More Basel III Tier 2 Issues from Philippine Banks

Sun Jul 27, 2014 10:01pm EDT

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(The following statement was released by the rating agency) SINGAPORE, July 27 (Fitch) Philippine banks are likely to issue more Basel III-compliant Tier 2 instruments, which will be mostly targeted at the domestic market, Fitch Ratings says. The issuance will be largely driven by the need to refinance legacy instruments and support growth. There has been over PHP50bn (USD1.15bn) of Basel III Tier 2 instruments issued to date in the Philippine banking system. This followed the Bangko Sentral ng Pilipinas's (BSP) unveiling of new Basel III capital rules in January 2013. Government-owned Development Bank of the Philippines (DBP, BB+/Stable) was the first to issue Basel III-compliant securities in November 2013, with its PHP10bn Tier 2 instrument. Activity picked up following Basel III implementation in January 2014, with issuance to date limited to the local market amid more favourable pricing for the banks and healthy domestic demand from institutional investors and trust accounts. The issuance of these new types of instruments compares with the over PHP120bn in legacy Basel II-Tier 2 capital outstanding, which must be replaced eventually. Issuance of Basel III Tier 2 securities is also being driven by rapid balance sheet growth in a buoyant economy, where loan growth has averaged 15% recently. The banking system is considered well capitalised with healthy capital buffers above the BSP's Basel III requirements of 8.5% common equity Tier 1 capital adequacy ratio (CAR) and 10.0% total CAR, but these buffers may erode in a rapidly growing system. Fitch's approach to rating Basel III capital instruments is to notch down from an issuer's anchor rating based on incremental non-performance and loss severity risks. In the Philippines, the anchor rating is expected to be the Viability Rating or the equivalent point on the National Rating scale. As Basel III-Tier 2 instruments specify that losses are triggered only at the point of non-viability (PONV), the non-performance risk of these securities is judged to be broadly similar to that of senior debt, and therefore Fitch does not apply any incremental notching for non-performance risk for these instruments. The non-viability trigger in the Philippines is at the BSP's discretion, and includes scenarios such as the injection of public funds to prevent bank failure, or the closure of the bank. Upon non-viability, the loss-absorbing feature of these securities reduces their recovery prospects relative to senior debt. Basel III-Tier 2 securities issued in the Philippines to date incorporate partial, albeit permanent, write-down clauses. As a result, Fitch's base case notching for loss severity risk would be one notch below the bank's anchor rating. For instance, Metropolitan Bank & Trust Company's (Metrobank, BBB-/Stable) US Dollar Basel III-Tier 2 notes, proposed in late 2013, were assigned an expected rating of 'BB(EXP)'. This was one notch below the bank's 'BB+' anchor rating at the time. Metrobank ultimately issued in the domestic market following BSP approval for a peso instrument, raising PHP16bn in early 2014. The peso notes are not rated by Fitch. In the case of subsidiary banks, where Fitch considers it highly likely that the parent bank would provide pre-emptive support to prevent non-viability, the anchor rating applied would be the subsidiary's Issuer Default Rating, which is likely to incorporate some probability of parent support. A case in point is Philippines Savings Bank (PSBank; Not Rated), which issued PHP3bn in Basel III-Tier 2 securities in May 2014. PSBank is a 76%-owned subsidiary of Metrobank. 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. Contacts: Elaine Koh, CFA Director Financial Insitutions +65 6796 7239 Fitch Ratings Singapore Pte Ltd 6 Temasek Boulevard #35-05, Suntec Tower Four, Singapore 038986 Mikho Irawady Associate Director +65 6796 7230 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'. 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