Fitch Ratings says that issuance of Basel III-compliant Tier 2 instruments by Thai banks is likely to increase, driven by the banks' need to replenish their capital, improved regulatory clarity and investor acceptance.
While the Bank of Thailand has implemented the Basel III framework since January 2013, the issuance of Basel III-compliant instruments was initially limited to relatively small private placements.
The proposed issue of Thanachart Bank Public Company Limited's (TBANK; A+(tha)/Negative) Basel III Tier 2 instrument on 19 June will be the first widely-distributed transaction in the domestic market.
Fitch's approach to rating Basel III instruments is to notch down from an issuer's anchor rating based on non-performance risk as well as loss severity risk.
The Basel III Tier 2 instruments seen in Thailand thus far stipulate that losses would be triggered only at the point of non-viability.
As they do not include any going-concern loss absorption, under Fitch's criteria there would be no notching down from the anchor rating for non-performance risk.
The non-viability trigger is the injection of public funds to prevent the bank from failing.
After non-viability, the subordination of these instruments means there would be reduced recovery prospects relative to senior debt.
To reflect this loss severity risk, Fitch's base case would be to rate the instrument by one notch below the anchor rating and by two notches if very high losses are highly probable (for example in the case of a mandatory full and permanent write-down).
The privately-placed US$170 million Basel III Tier 2 issue by the United Overseas Bank (Thai) Public Company Limited (UOBT; A-/Stable) on 25 March 2013 included a provision for full and permanent write-down of the instrument at non-viability, which implies an instrument rating two notches below the anchor rating.
While the anchor rating would usually be the issuer's Viability Rating, in the case of subsidiary banks such as UOBT, Fitch considers that the parent bank would most likely provide pre-emptive support to prevent non-viability. Hence, the appropriate anchor would be the issuer's IDR.
TBANK's planned Basel III Tier 2 issue will incorporate a conversion to common equity at non-viability. That structure would suggest a one-notch differential from its anchor rating, which for TBANK is the entity's stand-alone 'A+(tha)' rating.
At the end-2013, there was THB270bn (US$8.3bn) in subordinated debt included as Tier 2 capital at Thai commercial banks, virtually all of which are legacy Basel II instruments.
Due to the phasing out of these legacy instruments as well as ongoing redemptions, Fitch estimates that this stock of Tier 2 capital would decline by THB81bn (US$2.4 bn) in 2014 and by a further THB53bn (US$1.6bn) in 2015.
This suggests that Thai banks will need to issue significant amounts of Basel III Tier 2 instruments to replenish their capital.
However, comfortable levels of Core Tier 1 equity ratios in the Thai system of around 11.63% as at end-March 2014 suggest limited immediate pressure to issue Basel III Tier 1 instruments for most of the banks.