Malaysia leads the way in Basel III debt

Malaysia is poised to host Asia's first public issue of loss-absorbing
bank debt, so-called bail-in bonds, since the region began the
transition to Basel III standards earlier this year.

CIMB Bank
has received preliminary approval from the country's central bank for a
subordinated ringgit bond that will count towards its Tier 2 capital,
and may launch the deal in the next few weeks. There is also talk that
another local lender, Public Bank, will follow suit with a similar Basel
III compliant issue.

If the deals materialise in the coming
weeks, they promise to set a template as the first in Asia, excluding
Japan and Australia, since regulators from India to China introduced
Basel III rules in January.

Under the new, stricter capital
requirements, subordinated bonds require loss-absorption features if
they are to count towards a bank's capital ratios, ensuring that holders
are "bailed in" through writedowns or conversion to equity before any
public funds are used to bail out a bank.

Given their fairly
well capitalised levels, Malaysian bankers had not expected a Basel
III-compliant structure to hit the markets so soon. CIMB, however, is in
talks to buy Philippines-based Bank of Commerce for an estimated
US$296 million, which may have hastened its plans to raise bank capital.

"No
bank wants to be the first, since they will have to cough up a lot more
to compensate the investors for that write-off feature, and there is
really no proper benchmark or comp in the Asian markets," said one rival
banker.

Asia's first Basel III-compliant bond dates back to
November 2011, when Hong Kong-based ICBC Asia priced a Rmb1.5 billion
(US$236 million) Tier 2 Dim Sum bond that will write down to zero if the
bank becomes non-viable. That issue, however, came at a time of surging
enthusiasm for renminbi exposure, and investors also assumed - rightly
or wrongly - that there was little chance of ICBC Asia's state-owned
parent allowing the unit to fail.

More clarity has since emerged
on local interpretations of Basel III rules, but no Asian lender has yet
followed ICBC Asia's lead with a public sale.

A small Chinese
lender is also working on the first loss-absorbing Tier 2 bond in the
country's restricted domestic market, but a deal in Malaysia would
offer a more representative benchmark for the wider region.

Banks
across Asia have until now held back from replacing their old-style
Tier 2 debt, in part due to concerns over the cost of doing so.

Australia's
Suncorp in April sold the country's first retail Tier 2 to comply with
the new rules. The 10.5-year non-call 5.5 notes had a successful run
in the yield-driven retail investor market, allowing Suncorp to pay a
premium of just 85bp-90bp over old-style Tier 2 notes from the
Australian major banks.

In Malaysia, investors are looking for a
Basel III-compliant Tier 2 issue to pay a yield of six per cent-seven
per cent to offset the increased risk of losses. That would be
200bp-300bp above outstanding old-style Tier 2 paper. For instance,
Public Bank's Tier 2 notes due August 2022 and callable in 2017, were
trading on Tuesday at 4.00 per cent.

"The loss-sharing feature
means that, in effect, I'm buying a hybrid convertible," said one local
investor. "If there is little upside for me, I would think they will
have to pay much higher than hybrid Tier 1 notes. And that will also
depend on what options they provide for investors to exit."

CIMB,
however, will be hoping for a good response from investors, who have
been starved of new issues since March when the primary market ground
to a halt ahead of a general election.
Investor confidence has
returned with the incumbent government, but there has only been one
public deal since the elections on May 5 - a RM1.615 billion
multi-tranche project financing sukuk from Tenaga Nasional.

If it
does get a warm reception in the Malaysian market, CIMB may even set a
positive precedent for other banks in the country, and the region, to
follow.

As well as setting a benchmark for pricing, CIMB's issue
will provide more clarity on the structures that are acceptable - to
both regulators and investors.

Banks in the region had been
waiting for regulators to outline, among other things, what exactly
makes a bank no longer viable - the trigger point for subordinated bonds
to be written-off or converted into shares.

The Basel Committee
has guidelines for those so-called triggers, but banks and investors
would rather wait until they are endorsed by the local regulators that
will have the final say in each case.

Bank Negara Malaysia, the
country's central bank, has not set any threshold levels as a trigger
event for non-viability for Tier 2 issues, but Tier 1 investors will
suffer losses if a bank's common equity falls below 5.15 per cent. In
the case of both Tier 1 and Tier 2 issues, however, the final decision
on whether an issuer is viable will be made by Bank Negara on a
case-by-case basis.

Bank Negara requires all banks to have core
equity Tier 1 capital ratio of 4.5 per cent, a Tier 1 capital ratio of
6.0 per cent and a total capital ratio of 8.0 per cent by January 2015.

Banks in Malaysia are fairly well capitalised at the moment.
They
would be able to suffer a 300% rise in non-performing loans without
common equity Tier 1 falling below seven per cent, Moody's said in a
recent report.

That means CIMB and Public Bank will probably not
be soon followed by many local peers. They will, however, help the
whole region break the taboo around loss-absorbing bonds.-- Reuters