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Korean banks face uphill battle to raise regulatory capital

[HONG KONG] South Korean banks face an uphill battle to raise regulatory capital after international supervisory authorities questioned the structure of their Additional Tier 1 securities.

The concerns of the Basel Committee on Banking Supervision (BCBS), expressed in late February, relate to the nominal 30-year maturity on capital securities in Korea.

As local laws do not allow undated bonds, Korea's Financial Supervisory Service (FSS) counts securities as perpetual if they have a maturity of at least 30 years and the issuer has the option to extend it.

That approach clashes with the Basel committee's June 2011 guidelines, which state that instruments need to be "perpetual, meaning there is no maturity date", to be counted as AT1 capital.

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"(The Basel representatives) pointed to what is stipulated in the guidelines and we explained that the theory of a perpetual bond does not exist in Korea, but the rollover makes it the same as if it were perpetual," an official at the FSS, Korea's financial regulator, told IFR. "They didn't make an official decision as to whether this is a problem or not."

The scrutiny underlines the differences in local interpretations of Basel rules and has thrown a spanner in the works for Korean banks looking to raise capital to meet Basel III standards.

Woori Bank, which mandated arrangers for an AT1 issue in March, has been forced to delay the offering, according to sources close to the deal.

The bank issued a US$500 million non-call AT1 bond due 2045 in the offshore markets last June, which remains Korea's only US dollar AT1 issue under the Basel III standards.

Delaying AT1 offerings poses a risk for issuers like A1/A-/A- rated Woori, which has lower capital ratios than its peers and will be required to build additional buffers after being designated one of Korea's five domestic systemically important banks, or D-SIBs, in December.

It also needs to replenish outstanding Tier 1 capital that is being phased out, the bulk of which is callable in 2016 and 2017.

Woori's T1 and common equity ratios were 10.5 per cent and 8.5 per cent, respectively, at the end of last year, according to its website, close to Korean D-SIB minimums of 9.5 per cent and 8 per cent by 2019.

However, its ratios were lower than higher-rated Shinhan Bank, which had respective T1 and CET1 ratios of 12.4 per cent and 11.9 per cent in the fourth quarter.

"It could be a problem if Woori doesn't raise this debt," said a source. "Not only do they have to satisfy certain ratios by 2019, but they also need to be prepared for being a D-SIB."

"They have limited options because they are still government-owned, which means they have little room to raise equity."

Woori surprised the markets in February 2009, when it skipped a call option on a US$400 million March 2014 Tier 2 issue.

Meanwhile, appetite for AT1s in the local market has also cooled. Liquidity concerns earlier this year at Deutsche Bank dampened Korean demand for loss-absorbing debt, while new restrictions on banks' ability to pay coupons have made it harder for lenders to issue the bonds.

Since last December, Korean banks are only able to earmark a fraction of their annual profits for coupon payments. The new regulation makes AT1 securities more risky investments for investors, who will miss out on payments if the bank fails to make a profit.

"This change is designed to avoid a scenario where a bank with large retained earnings continues to make distributions on loss-absorbing capital, such as equities and AT1 securities, even though its capital adequacy continues to weaken," said a Fitch Ratings report.

Korean lenders have issued about US$1.5 billion-equivalent of AT1 capital onshore and offshore since 2009, with no additional supply so far this year, according to Thomson Reuters data.

The FSS official said the regulator is exploring solutions with other government departments to resolve the issue so that AT1 issues can resume. "It's better to delete the 30-year part on the FSS rules and include the concept similar to a perpetual under the FSC (Financial Services Commission) enforcement decree," said the official. "We may ask the justice ministry to provide a legal interpretation that will allow Korean banks to issue perpetual bonds legally without changing the law," he said. "We will continue to persuade Basel authorities that these bonds are effectively perpetual. I think we will be able to overcome this soon." Woori Bank declined to comment.

A spokesperson at the Bank for International Settlements also declined to comment on ongoing discussions.

AT1 securities give lenders an alternative way to raise their regulatory capital to meet requirements that banks have enough capital to use as a buffer in times of stress, instead of using taxpayer money in a bailout.

Woori, the country's second-largest lender, is 51 per cent owned by the state, which has made four unsuccessful attempts to sell its controlling stake since it injected more than US$12 billion to bail out the bank and its former affiliates over 15 years ago.

Woori appointed Bank of America Merrill Lynch, Citigroup, Commerzbank, Credit Agricole, HSBC and Nomura as bookrunners last month.


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