Asian banks have different business models than many European and US banks, not to mention the Asia is enjoying stronger economic growth than the rest of the world. More importantly, Asian authorities are tend to be more bond investor friendly. These positive factors are underscored by the swift recovery in Asia's AT1 bond markets, including China, South Korea, Hong Kong, Singapore and India. BEA Union Investment believes investors should not keep Asian bonds off their radar lest AT1 wipe-out will happen in Asia.
AT1 is also known as contingent convertibles, or "coco" bond. Once the bank's capital ratio falls below a pre-set level, the loss-absorbing mechanism will be triggered, prompting the bonds to be converted into shares or being written down, either partially or in full. In a bull market, investors went after the yields without worrying so much about the fine prints or fundamentals. Not until when a crisis hits, the structures of the notes are once again under microscopic scrutiny, leading to better pricing differentiation in accordance to the credit health of a bond. For instance, a bond that comes with a write-down-only clause, should trade at a bigger risk premium than those that can be partially written down.
Commercial banking, not investment banking, is lifeline for many Asian banks
Market participants will also return to the fundamental. Understanding the difference between the business nature of Asian banks and banks of developed markets is important. Asian banks' fundamentals are relatively resilient. One of the reasons being commercial banking - taking deposit and extending loan, forms the core part of their businesses. Also worth noting is that Asian banks generally have smaller scale investment banking operations. This is a stark contrast against that of developed markets, where equities and private lending played a key part.
The Swiss authorities wrote down Credit Suisse's coco bonds to zero shocked the market because it gave investors the impression that the regulator is falling short of protecting the interest of bond investors. But the notes were structured in a way that there is no guarantee that equity shareholders must absorb the losses before coco bond holders when the bank is no longer viable. Also bear in mind that each AT1 is structured differently. In some cases, interpretation of the terms could be left with regulators once they stepped in.
Asian authorities are likely more bond investor friendly
Should similar situations arise in Asia, we believe the authorities, and also the issuing banks, will be inclined to protect the interest of bond investors. We came to this conclusion after two separate episodes. Last November, South Korea's Heungkuk Life, a mid-sized insurer, first decided not to exercise the call option of its US$500 million bonds. But the decision sparked fears for country's economic health and sent financial markets into a spin. To contain market jitters, the Korean authorities intervened, and subsequently resulting in Heungkuk Life retracted its decision and ended up buying back its 30-year bonds. Also in the same month, Hong Kong's Wing Lung Bank decided to call back its $500 million bonds. Given the notes' narrow spread and low interest rates, the move was not particularly economically favourable in the interest of the lender. This also demonstrated Asian banks value bondholders.
The universe in Asian bonds is extremely diverse, spanning different countries, sectors, risk profiles, duration and note structures. At the end of the day, it boils down to the individual bond selection to generate capital gain as well as income. It surely seems to be a daunting task for retail investors to navigate the nuances and dynamics of each country and issuer. It will be better off leaving the asset allocation in the hands of professionals to help truly diversify the portfolios in such volatile times.