Debt offering with a touch of wizardry
THE Bank of East Asia debt offering is a callable step-up structure, which has gained popularity among cautious investors recently.
Interest rate-linked investors can expect a lot more of this type of cash-raising from both corporates and banks given the expected strain on the local capital market in the debt-financing of the controversial new airport.
Last year the market saw corporates exploit the prevailing low interest rates with a surge of bond issues.
Appetites for this type of paper were blunted by the uncertain interest rate environment in the first quarter, but demand is now back, say issuers.
Only last month, Hang Seng Bank issued a $1.5 billion floating rate certificate of deposit.
Bank chief executive David Li Kwok-po ought to be given credit for seeing the advantages of such an innovative structure for the bank.
The callable step-up structure of the issue has placed him in an enviable win-win situation. It is difficult to see how he could lose unless prevailing interest rates actually drop in the next two years.
Step-up-structured offerings have been well-received in the past. But they have tended to be United States dollar-denominated and of short-term maturity of about two or three years maturity. In this respect, the Bank of East Asia issue differs.
Some capital market practitioners argue that the bank's offer may be a little bit too long-dated for it to be attractive to investors because many investors remain extremely cautious about the environment for interest rates over the long term.
The bank can call in the bonds after two years, arresting the step-up from 7.25 per cent coupon fixed rate to 10.1 per cent for the remainder of the life of the seven-year bond.
In this respect, from the investors' point of view, buying these bonds is like selling an interest rate option to Mr Li.
If interest rates rise higher than 10.1 per cent by the end of the second year, Mr Li will not call in the bonds and investors will be stuck with potentially out-of-the-money paper.
This kind of gamble on long-term interest rates may not be attractive, given that the coupon is only a 7.25 per cent return in the first two years and the issue is believed to be aggressively priced.
Investors who want exposure to Hong Kong dollar-denominated debt after 1997 may find the bond issue by Bank of China on the Macau Airport slightly more attractive.
Bank of China's issue consisted of two tranches; the floating rate pays 125 basis points above HIBOR for eight years while the fixed rate tranche pays 9.1 per cent for seven years.
Under the Bank of East Asia callable step-structure it is difficult to see how over the long term the investor wins. The bank will call in the event that it looks as if the investor is going to make money on the venture. It is unlikely to call it in if interest rates rise higher than the step-up, leaving the investor high and dry.
With the associated aggressive pricing, one practitioner equated taking up Mr Li's offer to paying in advance for a supper you may never eat.