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Woori Bank Viacheslav Shilin, MBA

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Woori Bank Viacheslav Shilin, MBA Deutsche Bank Markets Research Asia Company Date South Korea 22 September 2016 Woori Bank Viacheslav Shilin, MBA Corporate Credit Research Analyst Financials (+65 ) 6423 5726 [email protected] New AT1 bonds: initiate with Buy. We see FV at ~4% YTC Woori Bank issued its second Basel-III compliant AT1 bond. The issue size is USD500m, ratings are Ba3/BB+ by Moody’s and S&P, and the coupon is 4.5% with the first call date in Sep-21. According to Bloomberg, the total demand for this bond amounted USD850m with most of it (60%) coming from Asia, then Europe and US taking up 20% each. This compares slightly weaker than the demand for Woori’s original AT1 bond in June 2015 when the total book amounted to USD1bn, while the distribution of investor interest was similar: 60% Asia, 25% US and 15% Europe. One noticeable difference in the primary allocations though is that Insurers took 24% in the latest deal while their share was only 5% in 2015. Bulk of the bonds in both cases went into the hands of institutional asset managers. We believe that the main reasons for Woori to issue this AT1 are twofold: (1) incorporation of Capital Conservation Buffers and D-SIB capital surcharges kicked-in in South Korea this year. This means that Woori needs to maintain 0.875% on top of 4.5% minimal CET1 ratio, which will rise to 3.5% additional buffer by 2019. (2) Korean regulators are debating an introduction of IFRS 9 reporting standards in the country (potentially by 2018) that would result in harsher stance on the loan’s quality classification and loan loss provisions creation hence putting pressure on total capital. Thus Woori is creating additional capital buffer by issuing AT1 notes. Our conversations with S&P indicate that in order to mitigate presumably negative impact from IFRS 9, the regulators are contemplating to allow Korean banks to start including into CET1 capital the “Regulatory reserve for credit losses” that is being recorded by banks in the Equity part of their balance sheet, but not counted towards CET1. Based on the latest Jun-16 results, we estimate Woori’s CET1 improving from 8.8% to 10.25% as a result of such an inclusion (excl. IFRS 9 impact, which we have no data on how to quantify yet). Structure-wise, the new AT1 bond has two major differences from the previously issued paper: It is an undated perpetual instrument, as opposed to the 30Y (extendable by another 30Y) tenor of the original note. In our view, given that both bonds are being priced-to-call and that the conditions of the call options are equal we do not believe that the perpetual structure of the new instrument should command any meaningful spread/yield premium over the old instrument. It is issued subject to the new “capital trigger” regulation adopted in South Korea in Jan-16 which the old instrument is exempted from. That is where should a bank breach its regulatory capital ratios (i.e. 5.125% + necessary buffers for CET1, which in case of Woori currently stand at 6% and would peak at 8.625% by Jan-19), then a special “Net income retention” provision would kick-in (i.e. a mandatory requirement for a bank to retain potentially up to 100% of its net income and potentially prohibiting the distribution of dividends and coupons on AT1 instruments). Although technically it is possible in a worst-case scenario for Woori to pay the coupon on the old AT1 while being unable to do so on the new instrument, it is in our opinion difficult to imagine this actually happening from the _______________________________________________________________________________ _________________________________ Deutsche Bank AG/Hong Kong Distributed on: 22/09/2016 08:09:27 GMT DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016. 22 September 2016 Corporate Credit,Financials Woori Bank economical and political points of view (i.e. in case of a bank’s capital ratios breach payment of coupons would be restricted for all AT1 bonds). The rest of the main structural features are identical and include: (1) PONV event in the form of the designation of the bank as an “Insolvent Financial Institution” pursuant to the Act on the Structural Improvement of the Financial Industry; (2) Contains NO hard CET1 triggers to constitute PONV; (3) upon PONV, loss absorption is in the form of full and permanent principal write- down; (4) coupon payments are cancellable and non-cumulative; (5) Dividend stopper applies. It also important to consider the following: just hours after Woori Bank had announced its new AT1 bond issue S&P upgraded Woori Bank's ratings. S&P argues that the new AT1 bond will improve bank's capitalisation and that its risk-adjusted capital would remain above 7% in the next 12-24 months. The key positive trigger on Woori's RWA came from the recent upgrade of South Korea's ratings by S&P that pushed Woori’s RAC from 6.3% to above 7%. So from now on Woori's AT1s are rated BB+, T2 bonds are BBB, but the senior debt and the final issuer ratings remain unchanged at A/stable. The reason for the latter not to change is that S&P has reduced the number of notches uplift for the government support from 3 to 2. View on the bonds In our view, IPG of 4.75% YTC was too juicy to begin with as it offered over 100bp pick-up over the existing AT1s for 15 months longer tenor. A weaker (than a year ago) book building, despite such a lucrative IPG, in our view was a result of new (see above) regulatory features being introduced in Korea and investors trying to assess the likelihood of a differentiated impact on the new bonds vs. the existing Woori AT1s. The bonds priced at 4.5% YTC. Currently Woori 4.5% AT1 is quoted at 100.6/4.36% ask-price/ask-YTC (implying ~2.3x Perp-to-senior yield multiple ratio, which is higher than 1.7x-2x range currently observed in the region). First, we consider existing Woori 5% AT1 (104.6/3.6% ask-price/ask-YTC) callable in 2020 being fairly valued. Second, we believe that Woori’s story has a positive fundamental shift – Korean banking system is perhaps the only major one in Asia that has been coming out of the negative credit cycle for the past year or so, the government has been taking proactive steps in recapitalising banks and restructuring troubled corporate segments. Additionally, Woori is at the final stages of its privatisation which could bring additional benefits in the form of revamped strategy and new top management capabilities. Third, the Basel III regulatory language in Korean bank bonds is in our view the most investor friendly in the Asian region and perhaps globally too. Considering the above, we believe Korean banks’ AT1s deserve to trade at the lowest YTC in Asia hence our Hold recommendation on Woori 5% AT1 and Sell recommendation for existing Chinese banks’ AT1s. We consider a 4% YTC level as FV for the new Woori 4.5% AT1 hence initiate coverage with a Buy. Key risks: double-dip in the corporate restructuring in Korea, sudden deterioration of asset quality, Fed-related market sentiment deterioration, material worsening in macro-dynamics in Korea. Page 2 Deutsche Bank AG/Hong Kong 22 September 2016 Corporate Credit,Financials Woori Bank Appendix 1 Important Disclosures Additional information available upon request Disclosure checklist Institution Disclosure Woori Bank WOORIB 4.5% AT1 $500m perpc21 1,7,14,15 *Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg and other vendors . Other information is sourced from Deutsche Bank, subject companies, and other sources. For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr. Important Disclosures Required by U.S. Regulators Disclosures marked with an asterisk may also be required by at least one jurisdiction in addition to the United States. See Important Disclosures Required by Non-US Regulators and Explanatory Notes. 1. Within the past year, Deutsche Bank and/or its affiliate(s) has managed or co-managed a public or private offering for this company, for which it received fees. 7. Deutsche Bank and/or its affiliate(s) has received compensation from this company for the provision of investment banking or financial advisory services within the past year. 14. Deutsche Bank and/or its affiliate(s) has received non-investment banking related compensation from this company within the past year. 15. This company has been a client of Deutsche Bank Securities Inc. within the past year, during which time it received non-investment banking securities-related services. Important Disclosures Required by Non-U.S. Regulators Please also refer to disclosures in the Important Disclosures Required by US Regulators and the Explanatory Notes. 1. Within the past year, Deutsche Bank and/or its affiliate(s) has managed or co-managed a public or private offering for this company, for which it received fees. 7. Deutsche Bank and/or its affiliate(s) has received compensation from this company for the provision of investment banking or financial advisory services within the past year. For disclosures pertaining to recommendations or estimates made on a security mentioned in this report, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr Analyst Certification The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s) about the subject issuer and the securities of the issuer.
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