Banks lean on subordinated bonds

Korean banks have more than doubled sales of subordinated bonds to preempt an increase in borrowing costs when Basel III rules take effect in December.

Woori Finance Holdings, KB Financial Group and Hana Financial Group were among issuers of a combined 2.96 trillion won ($2.75 billion) last quarter, up from 1.35 trillion won in the previous three months, according to Bloomberg-compiled data.

KB unit Kookmin Bank sold 400 billion won of notes at 3.82 percent. Industrial & Commercial Bank of China Asia issued Basel III-compliant securities on Oct. 2 and the yield has increased to 4.71 percent.

Korean banks, which increased borrowing after the global financial crisis, face 49.3 trillion won of maturing debt in 2014 and have sold about 17 trillion won of debentures this year. Net income at the lenders slid 56 percent in the second quarter to 1 trillion won, as record household debt and sinking consumer confidence threaten a pickup in economic growth.

“Korean lenders want to have enough of a capital buffer ahead of the new rule implementation,” said Lee Byung-gun, an analyst at Dongbu Securities. “They need to pay back debt sold after the global financial crisis.”

Taper Concerns

Under Basel III, newly issued subordinated debt should have conditions which would allow it to be converted into equity in the event of a banking crisis. In ICBC’s case, the notes could be rendered worthless in the event Chinese regulators rule the parent or borrower is at risk of becoming unviable.

Woori Finance sold subordinated securities “preemptively” as it expects borrowing costs to rise, according to an e-mailed response to questions. The lender issued 150 billion won of 3.85 percent notes last month which are due in September 2020, Bloomberg data show.

Average yields on three-year corporate notes rated AA- have fallen from an almost one-year high on June 24 of 3.48 percent to 3.27 percent on Oct. 11, Korea Financial Investment Association data show.

Heightened concerns earlier this year that the U.S. Federal Reserve may begin tapering off its bond-purchase program also prompted banks in Korea to sell more debt ahead of an expected rise in borrowing costs, according to Min Dong-won, a credit analyst at Hyundai Securities.

Stricter Controls

“Korean banks needed to sell subordinated debt to meet obligations coming due next year, plus they have to be prepared for Basel III rules which will begin in December,” Min said. “They also wanted to sell debt in case yields rose further in September, which was when the market expected the central bank would cut back on its quantitative easing program, although that didn’t eventually happen.”

Banking regulators worldwide are imposing stricter capital adequacy controls under new standards developed by the Basel Committee on Banking Supervision in response to the global financial crisis that led to the bankruptcy of Lehman Brothers in 2008.

Basel III requires banks to hold capital equivalent to at least 7 percent of their risk-weighted assets while also meeting an indebtedness limit and liquidity requirements. Banks under Basel III are permitted to hold 1.5 percent of their risk-weighted assets in non-core Tier 1, and 2 percent in Tier 2 capital, principally subordinated bonds. Under Basel II, non- core Tier 1 capital included hybrid instruments, securities that won’t be permissible under Basel III.

The hybrid nature of the debt will make such issuance more costly for banks, according to Hyundai Securities’ Min.

‘Good Investment’

The subordinated bonds are a “good investment for long-term investors like insurers that need stable yields with limited risk,” Dongbu Securities’ Lee said. “The supply-demand conditions are just ripe for banks’ subordinated debt this year.”

Korea will begin applying the Basel III rules for banks and bank holding companies from December this year, the Financial Services Commission said in May.

Woori Bank, a unit of Woori Finance, Korea’s largest financial group by assets, sold an additional 500 billion won of 3.89 percent subordinated debt yesterday, the Seoul-based lender said in a regulatory filing.

The 3.85 percent notes it sold last month compares with 2.98 percent it paid in March for 200 billion won of senior unsecured debt due 2018, Bloomberg-compiled data show.

Credit Risk

Ten-year AA+ rated subordinated bonds due June 2023 sold by Woori were yielding 3.86 percent on Oct. 10, 59 basis points more than three-year AA- corporate notes. Three-year sovereign notes yield 2.87 percent and 10-year sovereign notes 3.51 percent, Korea Securities Dealers Association data show.

As Korea’s economic growth picks up, the cost of insuring its government’s bonds from non-payment using credit-default swaps is falling. Swaps were at 66 basis points as of Oct. 10, the lowest since Sept. 19, down from 117.1 basis points on June 24, the highest since August 2012.

The won has strengthened 7.4 percent against the U.S. dollar since June 30, the most of 11 major Asian currencies. Subordinated bank bonds can also be a haven for individual investors who have lost money on riskier corporate debt, according to Kim Sang-man, a credit analyst at Hana Daetoo Securities.

Five affiliates of Tongyang Group, a Korean conglomerate which runs businesses from cement to securities, filed for bankruptcy protection in September.

The affiliates including Tongyang International and Tongyang Cement and Energy had sold a combined 1.7 trillion won of corporate debt and commercial paper to almost 50,000 retail and institutional investors, the Financial Supervisory Service said in an Oct. 7 e-mailed statement.

Bloomberg