Sumitomo Mitsui Financial Group, Japan’s second largest lender, is marketing a dollar-denominated 10-year Basel III note in an effort to replenish capital lost under the regulation’s grandfathering arrangements.
The Tier 2 subordinated bond, which is likely to be priced on Wednesday, is being issued a week after Japan’s third largest bank Mizuho Financial Group’s Basel III-compliant note, highlighting a need for Japanese banks to raise capital in the coming months.
Desmond Lee, bank credit analyst at Morgan Stanley, wrote in a report on March 14 that there is at least $12 billion of legacy capital lost each year under Basel III’s grandfathering arrangement. This is second after Chinese banks.
Grandfathering is the phasing-out process of ineligible capital instruments.
Lee also expects about $28 billion worth of legacy bank capital – both in US dollar and local currency-denominated – redemptions in the next few years. “This suggests higher Basel III supply pressures in the near term,” he wrote. “The redemption schedule of legacy bank capital for the big four Japanese banks are very front-end loaded.”
Big redemptions
Mizuho and Sumitomo happen to be the two Japanese banks with the highest bond redemptions in the next two years with $11 billion and $9 billion respectively, highlights Lee. The other financial institutions have less than $5 billion of bond redemptions over the same period each.
Mizuho’s $1.5 billion 10-year Basel III Tier 2 note – the first ever new-style bank capital bond from a Japanese financial institution – was priced on March 20 at Treasuries plus 185bp. The paper tightened from an initial price guidance of Treasuries plus 200bp to 212.5bp and has a yield of 4.631%, according to a term sheet seen by FinanceAsia.
Sumitomo’s new-style notes – which have an initial price guidance of Treasuries plus high-100bp – are likely to come at a tighter pricing compared to Mizuho’s as the former is deemed the far superior credit to the latter bank. This is the case in spite of both financial institutions benefiting from potential government support and facing similar challenges in their operating environment, according to analysts.
For example, David Marshall, senior analyst for Asia Pacific banks at CreditSights, an independent credit research provider, told FinanceAsia that Sumitomo has a stronger track record than Mizuho in terms of underlying profitability, interest margins and fee income, potentially leading to tighter pricing versus Mizuho.
“If the yield comes in at the same level as Mizuho’s issue, then we would prefer Sumitomo’s bonds,” said Marshall. “If Sumitomo’s issue comes 20bp less than Mizuho’s, that would be fair for these two entities.”
Sumitomo earned a net profit of $6.9 billion, up 28% in the first three quarters of this fiscal year ending March 31, whereas Mizuho's net profit rose nearly 44% to about $5.5 billion. The profits for these two banks were the highest since the 2008 global financial crisis.
Sumitomo’s bonds are expected to be rated Baa2/BBB+/BBB by Moody’s, Standard & Poor’s and Fitch respectively, while Mizuho’s notes were rated BBB+/BBB by S&P and Fitch respectively.
Creditor-friendly structures
Historically, Japanese banks have enjoyed very strong support from the government, despite having a low level of government ownership in the banking system.
Japan’s bank resolution framework aims to minimise any disruption to the financial system through early intervention and pre-emptive recapitalisation of solvent financial institutions. This is seen as the lowest cost resolution method and, as a result, is viewed positively by investors.
Morgan Stanley’s Lee highlights that pre-emptive capital injections will not be regarded as a point of non-viability (PONV) trigger event – an occurrence where investors could lose all their money if regulators decide the bank cannot survive – on Basel III-compliant Tier 2 securities by the Japanese Financial Services Agency (FSA).
“The definition of PONV in Japan appears to be relatively creditor-friendly, as it seems to be limited to negative net worth or bankruptcy situations,” he wrote. “We think PONV is very difficult to trigger for systemically important Japanese banks, as they would receive pre-emptive capital injections and avoid reaching negative net worth.”
A PONV event is deemed to have occurred when the prime minister of Japan invokes Article 126 Section 2 of the Deposit Insurance law – where banks, brokerages and insurers will be eligible for public capital injections and loans from the Deposit Insurance Corporation of Japan – and will happen only if a bank is deemed to be insolvent, say analysts.
Moody’s highlighted that the Japanese government has allocated Y29 trillion ($283.5 billion) for capital injections in the event they become necessary. This is equivalent to about 70% of Japanese banks’ shareholder equity.
Goldman Sachs, Barclays, SMBC Nikko and Citi are the bookrunners of Sumitomo’s deal. Bank of America Merrill Lynch, Goldman Sachs, JP Morgan and Mizuho were the bookrunners of Mizuho’s transaction.
