Banks in the United Arab Emirates will this year aim to repay capital placed with them at the height of the global financial crisis, with some turning to the bond market to avoid servicing expensive debt and risking a sudden “capital cliff” later on.
The country’s Finance Ministry placed 70 billion dirhams ($19.1 billion) with banks to shore up their balance sheets after the collapse of Lehman Brothers in September 2008 triggered a seizure of the world’s financial system.
But this support, converted into seven-year capital-boosting bonds in late 2009, was priced at a higher interest rate than the banks would pay if they borrowed money in today’s market.
For example, National Bank of Abu Dhabi, the UAE’s largest lender by market value, has a $750 million bond maturing in March 2017 that was trading Tuesday at a yield of 2.36 percent – less than half the price it will pay this year on the 3 billion dirhams of government bonds it still has outstanding.
“If you look at how much banks are paying on the bonds compared to where their senior debt is trading, it is a significant difference,” said Timucin Engin, associate director for financial services ratings at Standard & Poor’s.
And the price for banks will continue to rise; they are due to pay 5 percent on the bonds this year and 5.25 percent in the final three years to maturity, having paid 4.5 percent in 2012 and 4.0 percent for the first two years of the bonds.
This price differential between the government bonds, which contribute to a bank’s Tier 2 or supplementary capital, and market prices for new debt is leading many in the market to conclude that banks will aim to use the current low interest rate environment to replace the more expensive obligations.
“Abu Dhabi Commercial Bank may kick off the bond sale round, but most banks in Abu Dhabi that converted the government deposits will follow,” a senior UAE banker said.
ADCB, the UAE’s fourth-largest bank by market value, which received 6.6 billion dirhams in government cash, is expected to launch a bond offering shortly, having picked banks to arrange the deal, two sources told Reuters last week. Banks going to the bond market can either raise ordinary debt and use the cash to repay the state instruments, or sell a new subordinated offering.
The latter option would help retain the boost to a bank’s capital ratio, but the cost would be more expensive; three traders estimated NBAD would have to pay between 0.5 and 0.7 percent extra to issue five-year subordinated debt.
And UAE banks already have strong capital ratios, especially compared to their Western counterparts, so the need to replace the capital isn’t as great.
Regardless of how banks replace the bonds, the desire among UAE bankers to do it now is heightened by the fact that the capital worth of the instruments has already begun to diminish.
Under the terms of the government bonds, the weight attached to the capital decreases over time. This year, instead of receiving 100 percent of the benefit as before, banks can only count an 80 percent boost to their capital.
This will fall further, by 20 percentage points each year, until the bonds reach maturity at the end of 2016, when they will be worth just 20 percent.
“We will have to do something about it at some point, because no bank wants to fall off a capital cliff down the line,” Surya Subramanian, chief financial officer at Emirates NBD, which has 12.6 billion dirhams outstanding, told a Jan. 31 conference call for the media.