Asia’s first Basel III dollar bonds, sold by Industrial & Commercial Bank of China Asia Ltd., are the region’s worst-performing new notes this month, showing investor concern tighter regulations could cause losses.
The subordinated debt, priced on Oct. 2, fell 1.1 cents on the dollar as of Oct. 7, more than any other Asian notes issued in October, prices compiled by Bloomberg show. The drop contrasts with a 0.1 percent gain for junior bonds in the region, according to Bank of America Merrill Lynch indexes.
The notes could be rendered worthless in the event that the China Banking Regulatory Commission or Hong Kong Monetary Authority deem the parent or borrower respectively at risk of becoming unviable. Lack of a definition for that label is the main challenge for investors in Basel III instruments, according to a survey by Fitch Ratings. China’s four biggest commercial lenders announced plans earlier this year to sell as much as 230 billion yuan ($37.6 billion) of junior bonds, whose holders get paid after senior noteholders in a bankruptcy.
“There are a lot of uncertainties with buying that deal and I don’t think you get sufficiently compensated for it,” said Tim Jagger, a Singapore-based fund manager at Aviva Investors Asia Pte., a division of the U.K. insurer. “At that sort of yield, I’d rather buy something I can touch and feel and understand a bit better.”
Global watchdogs led by the Basel Committee on Banking Supervision are seeking to bolster banks’ balance sheets after the financial crisis exposed inadequate buffers against losses. The latest guidelines require a clause allowing regulators to write-off capital, such as subordinated debt, if the issuer is in danger of becoming “non-viable.” China, which became a member of the Basel Committee in March 2009, is strongly committed to implementing the Basel III rules, the group said in a report on Sept. 27.
Under the terms of ICBC Asia’s so-called Tier 2 bonds, the CBRC and HKMA can invoke such a non-viability event. That would cancel the notes and the investors would lose their money, the debt’s marketing materials show. ICBC Asia is a unit of Industrial & Commercial Bank of China Ltd. (601398) China’s State Council, finance ministry, central bank and State Administration of Foreign Exchange can also trigger a non-viability event in certain circumstances.
Asian and other global regulators haven’t defined such events, Fitch wrote in its report dated Oct. 6. Some 65 percent of investors highlighted uncertainty about this trigger, making it the main concern for the new securities, Fitch said.
Tier 2 instruments, which absorb losses after Tier 1 assets such as common equity and retained earnings, must not be guaranteed by the issuer and must be subordinate to depositors and general creditors, according to Basel capital rules revised June 2011.
A regulator deeming an issuer at risk of non-viability is “not a zero-probability event,” according to Aviva Investors Asia’s Jagger. “Your loss in the event of a default is massive.”
ICBC Asia’s notes have fallen in secondary trading after the lender paid 64 basis points less than it did almost three years ago for subordinated debt also in dollars issued at 5.159 percent, data compiled by Bloomberg show. The $500 million of the new Basel III-compliant ten-year bonds, which were sold at 99.903 cents on the dollar, were quoted at 98.6 cents as of 10:42 a.m. in Hong Kong, Bloomberg prices show.
“The most difficult part of this deal was price discovery,” said Peter Leung, Hong Kong-based deputy chief executive at ICBC Asia. “It’s like pricing a piece of art, there’s nothing to really compare it to, so you just have to go on what you feel it is worth.”
A Tier 2 Basel III-compliant note sold last month by Standard Chartered Plc at 99.912 cents on the dollar had risen to 100.628 as of yesterday.
“It would have been nice if some cushion, pricing-wise, was factored into the bond,” Swee Ching Lim, a Singapore-based credit analyst at Western Asset Management Co., said about ICBC Asia’s issuance. “There seems to be a lot of uncertainty as to where a Basel III-compliant Asian Tier 2 bond should trade, given there are no public U.S. dollar-denominated precedents in this region.”
While signs of an economic pickup have emerged, China’s gross domestic product expanded 7.5 percent in the second quarter, the longest streak of sub-8 percent growth in at least two decades. Non-performing loans climbed for a seventh-straight quarter in the three months through June, the longest streak in at least nine years.
Years of rapid credit expansion will backfire on banks’ asset quality, profitability, and possibly liquidity, as the economy slows, Louise Lundberg, credit analyst at Standard & Poor’s, wrote in a report on Oct. 2.
The country’s credit-default swaps, which insure debt against non-payment, have risen 20 basis points this year, prices from data provider CMA show. Yields on 10-year sovereign bonds fell 4 basis points to 4 percent last month, as the premium companies must pay to sell similar-maturity securities rose as high as 167 basis points, a one-month high. The yuan was trading at 6.1203 per dollar as of 10:14 a.m. in Shanghai.
More than half of the 72 investors surveyed from the Asia-Pacific region are concerned that risk is not being adequately priced into Basel III bonds, Fitch wrote in its Oct. 6 report.
Private banks bought 45 percent of ICBC Asia’s securities, a person familiar with the matter said, asking not to be identified because the matter is private. The lender agreed to “pay a commission to certain private banks” based on client purchases, according to the bond’s marketing materials.
Metropolitan Bank & Trust (MBT) Co., the Philippines’ third-largest lender, was last month considering a Basel III dollar issue, a person familiar with the matter said at the time. Further offerings of the securities will likely follow, according to Herman van den Wall Bake, head of fixed income capital markets for Asia at Deutsche Bank AG.
“As bank capital amortizes I’m expecting more financial institutions to come to the market this year and next,” he said.
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