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Capital Liberalization With the Introduction of

Hybrids

Chun Huang, CFA

Associate, Financial Services Ratings

June 16, 2005

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Topics

Proliferation of capital instruments

Characteristics of hybrids

Rating of hybrids & other regulator-approved capital instruments

Impact on banks & future developments

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Driving Forces

Need to replenish capital Regulatory consent

Calculation of Capital Adequacy Ratios

Pressure from financial markets/investors Limiting ownership/earnings dilution

Performance measurements Boost ROE/Capital Efficiency

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Asset Quality Burden

050

100150200250300350400450

1999 2000 2001 2002 2003 2004

(NT$ B

illions)

Write-offs

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Capital Trends

1250

1300

1350

1400

1450

1500

1550

1999 2000 2001 2002 2003 2004

(NT

$ B

illio

n)

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

Net Worth NW/Assets

* Numbers are on an unadjusted basis.

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Driving Forces

Need to replenish capital Regulatory consent

Calculation of Capital Adequacy Ratios

Pressure from financial markets/investors Limiting ownership/earnings dilution

Performance measurements Boost ROE/Capital Efficiency

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Components of Capitalization

0%

20%

40%

60%

80%

100%Pa

st

Now

Futu

re ?

?

Citi

grou

p

Maj

or U

K B

anks

Hybrids

SubordinatedDebentures

Adjusted CommonEquity

TAIWAN

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Hybrids 101

Equity No Fixed Obligations Deeply Subordinated Permanent Loss Absorption

Debt

Fixed Obligations Not deeply subordinated Fixed tenure Not loss-absorbing

HYBRIDS

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Examples of Regulatory-approved capital instruments

Perpetual non-cumulative preferred

Perpetual cumulative subordinated debt

Short-dated subordinated debt

Subordinated Debt

Term to Maturity

Restrictiveness of covenants

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Characteristics of Hybrids

Obligations are not fixed, similar to options Subordination ranking between senior

unsecured debt and common equity Long tenure: 5 Years plus Some loss absorption ability Credits toward the counting of bank’s

Capital Adequacy Ratio

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Rating of Hybrids

Is it ratable? Characteristics of the issue (hybrid)

Closer to equity or debt

General financial & operating profile of the issuer

Notched from the issuer’s senior unsecured rating

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Why notched?

To reflect the relative risk of the issue compared to its senior unsecured obligations Differences in risk profiles Subordination Generally notched down from senior unsecured

rating

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Critical Issues on Notching

Financial profile of the issuer

Covenants & Regulatory Intentions Capital Test Distributable profit test Conversion

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Notching of Hybrids

Common Equity

Not ratable

Senior Unsecured Debt

+/- 0

Very restrictive covenants

-2 or -3

Less restrictive covenants

-1 to -2

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Rating Example (Singapore)

Long-term Counterparty Credit Rating

A+

Perpetual Noncumulative preferred Capital and distributable profit tests

A-

Upper Tier II Subordinated Notes Interest deferral

A-

DBS Bank Ltd.

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Impact of Hybrids on Banks

Liberalization of capital management Increased flexibility Enhanced capital efficiency

Strengthening or weakening of banks’ capital position???

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Capital Strength of Various Instruments

Strongest

Weakest

Adjusted Common Equity

Short-term subordinated Debentures

Hybrids

Adjusted Total Equity

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Adjusted Common Equity

Strongest form of capital ACE = Common stockholders’ equity,

including minority interest less goodwill and dividends. Excludes revaluation accounts not arising from inflation accounting.

ATE = Incorporates the impact of hybrid instruments

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Future Considerations

The elusive ideal mix, if there is ever an ideal mix.

Suitability of issuers Uses and misuses

Investor profiles Holding company complications