* Banks sell Basel III bonds to optimise capital structure
* NBK issues tightly priced AT1 bond
* Gulf countries yet to implement new rules
Middle Eastern banks are taking advantage of cheap borrowing costs to optimise their capital structure even though countries in the region have yet to fully implement Basel III rules.
National Bank of Kuwait priced a US$700m 5.75% perpetual non-call six-year inaugural Additional Tier 1 bond, becoming the latest bank in the region to sell this type of instrument.
That banks from the region are accumulating capital is surprising at first glance given the strength of their ratios. NBK has a Core Tier 1 ratio of 13.3% under Basel III, while the average Tier 1 ratio for GCC peers ex-UAE stood at 15.7% as at December 31.
But just like some of the strongest Western European banks that don't need capital, AT1 offers other advantages.
"One of the key rationales is capital optimisation and proactive capital management," said Kapil Damani, capital solutions, debt capital markets at BNP Paribas.
Under Basel III, banks need to hold a minimum 4.5% of risk-weighted assets (RWA) in the form of common equity. They can have an additional 1.5% of RWAs in AT1.
"It, therefore, makes sense to have that extra layer in the cheapest form of non-dilutive capital in comparison with common shares," said Damani.
Other banks rumoured to be considering similar transactions include National Bank of Abu Dhabi and Oman's Bank Dhofar.
They would add to a list including Dubai Islamic Bank and National Bank of Fujairah, which have already printed bonds this year structured to comply with Basel III norms, the latter in the local dirham market. Kuwait's Burgan Bank and Abu Dhabi's Al Hilal have also raised Basel III debt in the past year.
Banks are also future-proofing their balance sheets. In Kuwait, Basel III will be implemented by December 2016, while in the UAE there is no formal framework at all.
By issuing Tier 1, banks can boost their S&P risk-adjusted capital ratios too. The RAC ratio provides a basis for analysing capital adequacy, independent from banks' own risk assessments.
MORE COMPLIANT
The biggest difference between the more recent deals and earlier hybrid Tier 1 issuance from the likes of Abu Dhabi Islamic Bank and Dubai Islamic Bank is the inclusion of loss absorption and point of non viability (PONV) language.
While early deals did not address that issue, recent bonds in the UAE have included contractual provisions, but only when they have been necessary for the instruments to qualify as regulatory capital.
To some extent, non-viability might be a moot point for banks that are either state owned or private sector national champions, such as NBK, in a region where there are no taxpayers needing to be potentially protected through bailing in noteholders.
Buyers of the debt can also take comfort from relatively investor-friendly formats.
"Both Kuwaiti and UAE AT1 structures helpfully provide a statement of intent around maintaining hierarchy within the capital structure at PONV," added Damani.
And in contrast with other jurisdictions, in Kuwait there are no hard triggers - loss absorption is limited to the point of non-viability.
Moreover, with respect to the NBK issue, payment cancellation risk is mitigated by a dividend stopper - a contractual term that prevents payments on ordinary shares if coupons on the AT1 debt are suspended. This feature is not permitted in Europe.
Together with the scarcity of paper from one of the region's leading banks, these features enabled NBK to price its AT1 deal just 30bp back of where Sweden-based Nordea's 5.25% perpetual non-call six is trading.