Philippine banks get creative to meet Basel III rules

By Kit Yin Boey, Reuters

Posted at Feb 14 2014 06:33 PM | Updated as of Feb 15 2014 02:33 AM

SINGAPORE - Metropolitan Bank & Trust Co this week finally secured approval from Bangko Sentral ng Pilipinas to issue peso-denominated Basel III-compliant Tier 2 notes.

Metrobank will become only the second Philippine bank to raise subordinated debt compliant with Basel III as Bangko Sentral ng Pilipinas has put several hurdles in the way of issuing these capital-eligible bonds.

These obstacles have forced other Philippine banks to be creative to meet Basel III rules, as they had to act quickly to meet a deadline for meeting the new standards.

The Philippines implemented Basel III in a single step on January 1 2014, instead of taking the phased-in approach preferred by other countries. Lending by Philippine banks is also growing rapidly, at a rate of 15% or more annually.

Foreign banks have typically turned to debt markets to raise Basel III bank capital. However, a cautious Bangko Sentral ng Pilipinas introduced a ruling, known as Circular 786, that requires local investors to sign letters to confirm they understand the risks involved in buying Basel III-compliant debt. The circular also restricts the right of investors to sue the regulator.

This hurdle has forced banks to delay plans to issue Basel III bonds. Metrobank, for instance, had plans to issue a Tier 2 bond beginning last April when it obtained internal approval to sell an offering of up to $500m.

The Development Bank of the Philippines is so far the only one to have overcome the rules. Last year the bank sold a Ps10bn 4.875% 10-year non-call five issue that qualifies as Tier 2 capital under Basel III.


Instead of seeking the subordinated debt avenue, Philippine lenders are raising capital ratios by other means.

BDO Unibank amended all its outstanding preferred shares to include a loss-absorbency mechanism that will convert the preferred to common shares if the regulator determines that the bank is not viable. Approved by shareholders in late January, this plan effectively qualifies the preferred shares as Tier 1 capital and complies with the new rules.

Philippine National Bank and Bank of the Philippine Islands turned to the equity markets in the last two weeks to strengthen their core capital with a rights issuance that gave them a solid capital buffer.

The traditional wisdom that debt markets are the cheaper route to raise bank capital may not apply in the Philippines. Some Philippine banks do not pay dividends, which means the costs of issuing equity for them may be lower than issuing debt.

Their return on equity will still drop if they issue more stock, however. In the BPI Ps25bn stock rights issue, the return on equity could have dropped about 60bp because of the dilution created by the new shares, according to analysts.

Still, a BPI spokeswoman said it would have been more costly to go to the debt markets.

"Our shareholders have been more supportive and you can see that in the over-subscription," she added. "We are pretty comfortable now with compliance with Basel III capital and have no need to tap for such funds in the near future."

Asian companies may not be considering the earnings they give up when they issue shares, however, which is why they tend to believe issuing equity is cheaper, said a banker involved in one of the equity raisings.

However, he added that, "ultimately, it is not about which funding is cheaper, the fact is that the banks have significantly raised the core Tier 1 capital in one fell swoop, such that they will not need to go to the equity markets for bank capital for a long while more."

Under the new Basel III standards, Philippine banks need to have a minimum Tier 1 ratio of 6%, versus the 4.5% indicated in the old framework. Capital conservation buffers need to be at 2.5%, implying a minimum Tier 1 ratio of 8.5%.

BPI's share issue bumped up its Tier 1 capital adequacy ratio to about 18.6%, while PNB's Ps11.6bn stock rights issue will boost its Tier 1 capital adequacy ratio to 19.7%, making both among the best-capitalised banks in Asia-Pacific, according to Moody's.

That is good news for creditors, which face less repayment risk and a stronger equity base.

"The banks' equity raisings are credit positive," said Moody's assistant vice-president Simon Chen. "The quality of the banks' capital positions has improved, as they have replaced debt with core equity."

While equity funding notably increases core capital, raising Tier 2 capital via the debt markets will remain a challenge.