March 28, 2014 / 8:56 AM / 4 years ago

First test for Korea sub debt

* Woori to issue loss-absorbing subordinated bonds

* Rising loan delinquency, government stake sale worry investors

* High demand for Korea and capital bonds should still support deal

By Frances Yoon

HONG KONG, March 28 (IFR) - South Korea’s first offering of loss-absorbing bank capital is set to test investors’ appetite for a financial sector facing rising bad debts, although it has a history of state support.

Woori Bank has hired seven bookrunners for its first Basel III-compliant Tier 2 bond and is expected to launch the 144A/Reg S US dollar offering in April.

Woori will provide an unusual test for Korea’s first Basel III offering. It has a ratio of bad loans above the industry average, the government is looking to sell its majority stake and it has a history of angering subordinated bondholders.

Still, Korea’s Basel III regime is seen as more investor friendly than elsewhere in Asia and the government has a track record of supporting its major lenders.

Bankers expect strong appetite for Korean risk and for subordinated debt to drive demand for the offering.

“People want yield, people love Korea. So, it makes sense to go down to a Woori Tier 2 and get some yield for Korea risk rather than chasing the seniors that are trading in the 60bp-70bp area,” said one banker.

Bankers and analysts expect a Woori Tier 2 to be more popular than a Chinese Tier 2 because Korea is perceived to be less risky from a macroeconomic viewpoint.

Woori’s Tier 2 paper, therefore, will likely price at a wider spread than the Tier 2 bonds of Singapore’s UOB, which were trading to yield 3.8%, but tighter than the Tier 2 issue of ICBC (Asia) at 4.7%.

RISING NPL

A successful capital raising is important for Woori, as credit losses are eating into the bank’s capital ratios. In the fourth quarter, Woori reported a 26% rise in write-downs of bad loans.

“Woori has the highest non-performing loan ratio among the Korean commercial banks we cover at 2.99%, which is significantly higher than the industry average of 1.77% as of December 2013,” said Sophia Lee, senior analyst at Moody‘s.

Although credit costs fell in the fourth quarter, the bank still had to set aside W150bn (US$140m) for loans to certain companies, such as bankrupt Ssangyong Engineering & Construction and loss-making STX, a trade and ship maintenance holding company, according to analyst reports.

“Although the bank will make efforts to lower non-performing loans through write-downs and sales, the non-performing loans ratio will remain at 2% level in the near term, which will still be worse than its peers and higher than the industry average,” said Lee.

The market takes these concerns into account as the bank’s senior 2018s trade 30bp wider than those of peer Shinhan Bank. Shinhan’s A1/A/A rating puts it one notch higher than Woori’s A1/A-/A-.

MISSED CALL

Woori Bank also has a troubled history with US dollar investors. Although new-style bonds are likely to come in a 10-year bullet format like its outstanding old-style 2021s, investors still remember losing money in 2009 when Woori surprised the markets in skipping the call option on a US$400m March 2014 Tier 2 issue.

“People got slaughtered on that previous bond. It dropped 10 points in a day,” recalled a credit analyst who focuses on financial institutions. “It’s hard to go to your boss and say you want to buy this again. I’ve heard US investors say ‘I’ll never touch it again’.”

Still, Woori is expected to capitalise on robust US demand for Basel III-compliant Tier 2 bonds. US investors drove order books for the first such bonds from Sumitomo Mitsui Financial Group and Mizuho Financial Group north of US$7.5bn in the past fortnight, when those issues priced. US bids eventually accounted for about 70% of both offerings.

Japanese law allows banks to receive capital injections before they reach the stage of being declared non-viable, and that played a big part in driving that demand.

South Korea’s Basel III guidelines also call for regulatory intervention long before capital ratios fall to the point of non-viability, in the form of management-improvement requests. Together with specific low triggers for non-viability, these alerts could be considered an investor-friendly feature.

Korean banking laws see the occurrence of a non-viability event if a bank’s Tier 1 capital ratio falls to 1.5%, or if common equity Tier 1 falls to 1.2%, or at the regulator’s discretion.

That approach and the track record mean many analysts believe the Korean Government will step in to prevent the country’s major banks from becoming non-viable, having taken a majority stake in Woori’s parent company in the wake of the 1997 Asian financial crisis.

Moody’s and Standard & Poor’s rate Woori two to four notches above its standalone credit rating due to the high likelihood that it will receive government support.

Woori’s sub debt plans also coincide with strong demand for Korean bonds in general.

Credit spreads on dollar bonds from South Korea have tightened as much as 50bp since the beginning of this year, while spreads on Korean bank debt, including Woori, narrowed about 25bp just in the last month as investors sought a safer alternative to Chinese credit amid rising macroeconomic and bond default risks.

Woori’s bonds have tightened even though its holding company, Woori Financial Holdings, is in the process of selling its securities trading arm and regional affiliate banks. The Korean Government was also looking to sell its 57% stake in Woori Financial Holdings, officials said last June. (Reporting By Frances Yoon; Editing by Steve Garton)

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