Hybrid Capital: Overview

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Hybrid Capital: Overview
I B A 1

Overview of bank capital structure
Components of a bank’s capital (hierarchical) Cost/Risk for investor Tier III Subordinated debt (Dated) Approved by BIS in 1993 Not yet issued in India Low Lower Tier II Subordinated debt (Dated) Approved by BIS in 1988 Already issued in India Max up to 50% of Tier I “Supplementary” capital Upper Tier II Subordinated debt (Dated & Perpetual) Max up to 100% of Tier I (along with Lower Tier II Approved by BIS in 1988 Not yet issued in India Regulatory Capital Hybrid Tier I “innovative” Approved by BIS in 1998 Not yet issued in India Max up to 15% of Tier I Tier I 50% at least of minimum capital ratio of 8% “Core” capital Common Equity & Retained earnings High Recognition of hybrid capital Hybrid capital combines characteristics of both debt and equity, and has been recognized by BIS as a form of bank capital since 1988 BIS guidelines recognize hybrid capital instruments as either Tier I (Hybrid Tier I) or Tier II (Upper Tier II) Hybrid Tier I carries more risk for investors, but provides more capital support Upper Tier II is less risky for investors, but only provides supplementary capital support 2

Increasing equity characteristics
Each capital instrument adds more equity features along the spectrum from debt to equity Increasing equity characteristics ¹ Inclusion of an interest rate step-up will relegate an instrument to "innovative" status Key differentiating features for Upper Tier II and Hybrid Tier I 3

What is Hybrid Tier I Main characteristics of Hybrid Tier I
Main components of Tier I as per the Basel Accord Perpetual and senior only to equity No fixed costs (Coupons are deferrable and non- cumulative) Loss absorption (Interest and principal can be loss absorbing) Can be innovative (limited to 15% of total Tier I) or non-innovative Ordinary shareholders’ equity (net of any own shares held); Retained earnings, i.e., internally generated capital from accruing profit to reserves; Perpetual non-cumulative preferred stock (what is known in the market as “Tier I preferred”) and other hybrid capital securities; Reserves created by appropriations of retained earnings, share premium and other surpluses; Minority interests created when a bank has a subsidiary that it does not wholly own What is innovative Hybrid Tier I The new BIS guidelines laid emphasis on the significance of equity and retained earnings as the key components of Tier I capital To preserve the sanctity of capital structure of banks, BIS stated that total Tier I capital “with any explicit feature— other than pure call option – which might lead to the instrument being redeemed is limited—at issuance—to 15% of the consolidated bank’s Tier I capital” Hence this draws a clear line of distinction between innovative and non-innovative Hybrid Tier I capital, the latter not being subject to 15% limit Innovative Hybrid Tier I A fixed income instrument Structured as to create economic characteristics of a directly issued Tier I preference share Retaining sufficient debt-like characteristics as to remain tax-deductible Economic maturity (due to step-up and call date) 4

What is Upper Tier II Main characteristics of Upper Tier I
Key characteristics Maturity: The UK FSA and some other regulators require that UT II is perpetual, but this is not a requirement in the Own Funds Directive or under BIS Deferrable coupons: Coupons can be deferred at the option of the issuer but they are cumulative, so the issuer has to pay deferred coupons in the future. This can include interest on interest Loss-absorbing: Principal and interest must be suspended to allow the issuer to remain solvent. In some early instances of UT II guidelines, the principal and interest could be written down, but this is largely not in use today Step-up: The use of coupon step-ups has given these otherwise long dated/perpetual bonds a shorter economic maturity date. The amount of step-up on UT II varies across jurisdictions Ranking: UT II is subordinated to senior debt, but ranks ahead of all forms of Tier I capital. It may or may not be subordinated to LT II depending on jurisdiction Senior to equity (including preferred), but junior to all forms of senior debt, including deposits Coupons are cumulative, but deferrable Loss absorption (Interest and principal can be loss absorbing) Can include a step-up in most jurisdictions Main components of Tier II as per the Basel Accord Includes general provisions, up to a maximum of 1.25% of risk-weighted assets, but excluding specific provisions Revaluation reserves from fixed assets and fixed asset investments Instruments that combine the characteristics of debt and equity / dated deferrable subordinated debt 5

Regulatory review of hybrid capital
BIS guidelines, 1998—Hybrid Tier I Features To qualify as Tier I, securities must Be issued and fully paid up Be permanent Have non-cumulative interest deferral (linked to dividends) Be able to absorb losses within the bank on a going concern basis Be junior to depositors, general creditors, and all indebtedness Neither be secured nor covered by a guarantee of the issuer or related entity or other arrangement that enhances the seniority of the claim vis-à-vis creditors Hybrid Tier I with an 'economic' or final maturity is limited to 15% of total Tier I capital Hybrid Tier I can have a call option after a minimum of five years, although redemption is subject to regulatory approval A step-up of the greater of 100 basis points or 50% of the original issue spread is permitted after a minimum of ten years BIS guidelines, 1988—Upper Tier II Features The Cooke Committee put a further distinction on subordinated debt when it divided Tier II into Upper and Lower categories Upper Tier II may not be reimbursed on the bearer's initiative or without prior agreement of the supervisory authority The debt agreement must provide for the credit institution to have the option of deferring payment of interest on the debt The lender's claims on the credit institution must be wholly subordinated to those of all non-subordinated creditors The documents governing the issue of the securities must provide for debt and unpaid interest to be such as to absorb losses, while leaving the credit institution in a position to continue trading Only fully paid-up amounts shall be taken into account Limit: Up to 100% of Tier I capital 6

Value of hybrid capital
Benefits of hybrid capital Hybrid capital provides operating and strategic flexibility for bank management in pursuing performance objectives While common equity is the most common type of Tier I capital, it is also the most expensive form of capital to raise Increasingly banks are facing growing pressure from shareholders to maintain and improve returns As a result, the ability to raise cost-efficient non- dilutive subordinated capital is increasingly recognized as a means of balancing the often divergent interests of banking industry regulators, whose overriding objective is to preserve and strengthen the integrity of a bank’s balance sheet, and shareholders who are demanding high returns on their equity investments For banks, the issuance of hybrid qualifying capital is an attractive means to address the needs of both of these important constituencies Hybrid capital helps improve return on equity as it is non-dilutive and significantly lower cost compared to equity Non-dilutive Tax-deductible Senior creditor protection Cost-effective Economic maturity 7

Why do banks issue hybrid capital
The cost of issuing HT I is typically much lower than the cost of equity on a pre-tax basis, and even lower on a post-tax basis, since there is no tax benefit associated with the cost of equity Unlike Tier II, HT I can directly replace common equity to help offset such items as Goodwill. It has therefore been used extensively as an acquisition currency The effect of adding HT I to a capital structure is to further lower the Weighted Average Cost of Regulatory Capital The most cost-effective capital structure can be created using a barbell approach Note: Illustrative cases based on indicative $ LIBOR levels 8

Key provisions of hybrid capital
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Understanding key provisions of hybrid capital: Maturity
Status Interest deferral Loss absorption Maturity Understanding key provisions of hybrid capital: Maturity BIS requirement Hybrid Tier I Upper Tier II “Permanent form of capital” Silent on this Most jurisdictions Perpetual. Some dated (Germany, US, Korea) Perpetual with step-up and Dated What’s prevalent Trade-off—dated v perpetual 10

Understanding key provisions of hybrid capital: Interest deferral
Status Interest deferral Loss absorption Maturity Understanding key provisions of hybrid capital: Interest deferral BIS requirement Hybrid Tier I Upper Tier II Optional interest deferral link: Non-payment of common share dividends Optional interest deferral link: Dividends, or breach of minimum capital ratio What’s prevalent Trade-off—dividends v capital ratios 11

Understanding key provisions of hybrid capital: Loss absorption
Status Interest deferral Loss absorption Maturity Understanding key provisions of hybrid capital: Loss absorption BIS requirement Hybrid Tier I Upper Tier II Conversion into directly issued preference shares in the event of breach of CAR Mandatory non-payment of interest / principal if profitability cannot support What’s prevalent Trade-off—suspension v conversion 12

Understanding key provisions of hybrid capital: Status
Interest deferral Loss absorption Maturity Understanding key provisions of hybrid capital: Status BIS requirement Hybrid Tier I Upper Tier II Rank junior to Equity but ahead of depositors, general creditors and all indebtness of the bank Rank ahead of all Tier I but is sometimes junior to Lower Tier II What’s prevalent Trade-off—pari passu v junior 13

Regulators have placed different requirements on how Hybrid Tier I is implemented in various regions
Tier I—regulatory differences in selected jurisdictions 14

The key is to frame Hybrid Tier I guidelines under terms that would offer most value to the banking system Hybrid Tier I 15

Upper Tier II hybrid instruments are available to most jurisdictions that follow BIS guidelines—but with significant variation Comparison of Upper Tier II provisions across the world Some of the provisions will have significant impact on the pricing of an Upper Tier II subordinated debt issue Investors will often compare the provisions across different jurisdictions to understand the relative value among subordinated debt issues by banks in different locations 16

The key is to frame Upper Tier II guidelines under terms that would result in the most efficient structure Upper Tier II 17

Value of hybrid capital for Indian banks
I B A 18

Primary drivers for incremental capital need
The Indian banking sector’s strong growth will require additional capital Strong growth in credit Indian banks are entering a phase of loan growth, giving rise to a large funding/capital requirement Loan growth has been strong at 32% oya and is expected to remain strong at 20—25% in near future Shareholder value Increasing competition will lead managers to place more focus on shareholder value Hybrid capital plays a role in managing capital to generate a better return on capital Basel II compliance Adoption of Basel II norms (w.e.f. 2006) increases sensitivity to asset quality Banks need to meet operational and market risk related capital charges Primary drivers for incremental capital need Balance sheet clean up Although banks have made considerable progress in bringing down net NPLs, average gross NPLs still remain high at 7%—9% Banks will need additional capital to improve significantly on asset quality metrics 19

Banks in India would need to raise approx
Banks in India would need to raise approx. $9—12bn in capital to meet expanding credit demand and fuel economic growth Key assumptions Key findings Based on study of 13 banks representing 80% of the sector’s assets Key drivers based on the latest research analyst estimates of: Net Income Dividend pay-out ratio RWA and Asset growth Reclassification of Investment Fluctuation Reserve We estimate that these banks will need approx. INR 552bn in capital to maintain its current CAR levels (as of Mar 05) Although banks will be able to use subordinated term debt (Lower Tier II) to finance much of their capital requirement, this would not meet the total capital requirement To avoid further equity dilution and optimize the capital structure in line with international standards, banks will need to make use of new category of low cost non-dilutive capital, including Upper Tier II and Hybrid Tier I which are available internationally to banks Some banks will also need to raise Core Tier I, but Core Tier I requirements can be minimized by use of non-dilutive subordinated capital Capital requirements for Indian banks 2006—2010 (INR bn) Finance Minister on Indian banks’ capital requirements "Banking capital has to be augmented every year. The additional capital formation has been estimated at Rs 8,000-9,000 crore annually. My own calculations suggest that an additional Rs. 60,000 crore capital might be required by the banks over the next five years" P Chidambaram, Honorable Finance Minister, 24 October 2005 Source: JPMorgan 20

Relevance of Hybrid Capital for Indian Banks—Hybrid Tier I
Advantages of Hybrid Tier I Shareholding restrictions: While Tier I capital provides the most financial flexibility, raising new equity may not be feasible for many Indian Banks due to: Government of India (GOI) minimum shareholding restrictions of 51% or 55% in state-owned banks (SOEs) With GOI holding nearing its threshold levels, the quantum of equity capital that can be raised is restricted Foreign institutional ownership limits in case of both public (20%) and private sector banks (74%) This restricts the foreign investor participation in future equity offerings which are close to such FII limits Absence of FII participation may impact the valuations given their strong interest in the sector Domestic consolidation: Hybrid Tier I is widely used by international banks in conjunction with acquisitions, as it can replace Tier I lost through goodwill, unlike Tier II capital. At the same time, Hybrid Tier I is non-dilutive in nature and allows for re-rating of the stock GOI holding nearing its limit in most State-owned banks FII ownership being exhausted FII limits: SOE: Max. 20% allowed PSB: Max 74% allowed Note: As on 30 Sep 05, except UBI as on 30 Jun 05 *Holding in UBI will come down to 55% post its planned equity offering of US$300mm in 4Q05/1Q06 21

Relevance of Hybrid Capital for Indian Banks—Upper Tier II
Advantages of Upper Tier II Balance sheet expansion remains a primary driver for incremental capital requirements, especially as macroeconomic factors continue to improve and asset quality remains robust Tier II capital supports strong loan growth without diluting existing shareholders’ equity As banks in India have already made aggressive use of non-dilutive low cost Lower Tier II capital, additional capacity is not enough to meet the estimated whooping capital need INR bn for the sector With Investment Fluctuation Reserve’s (IFR) reclassification as Tier I, capacity for term subordinated debt (Lower Tier II) has expanded but this is still not sufficient to meet the estimated capital needs for Indian Banks Under BIS guidelines, banks are allowed to raise Subordinated Tier II capital up to 100% of Tier I and can issue the remaining balance of 50% in form of Upper Tier II capital Need to explore other alternatives to meet capital shortfall INR bn Capital shortfall Estimated capital need at Target CAR 12.0% (for 13 banks under study) 22

Basel II implication for Indian banks
Basel II attempts to build a regulatory capital framework that more closely reflects the underlying risk profile of banks As banks would need to create a capital charge for market and operational risk in addition to credit risk, the Risk-weighted assets of the banks will substantially increase under Basel II Also risk-weightings for different borrowers will change with adoption of Basel II which would be more closely linked to the inherent riskiness of the borrower Such a move will help strengthen the risk management practices at the Indian banks and will realign regulatory and economic capital needs of the banks A critical innovation under Basel II is the use of credit ratings to differentiate the credit quality of assets held by banks and provide for capital accordingly REAL ECONOMIC CAPITALISATION MAY NEED TO BE STRENGTHENED IN THE WAKE OF BASEL II “The key concern remains the ability of the weaker PSBs and small private sector banks to raise fresh capital, especially in view of the upcoming Basel II accord to be adopted by FY2007. Consolidating with bigger banks with a stronger capital base would be an alternative for these banks, while RBI has also indicated that foreign banks would be allowed to participate with majority shareholdings in banks being restructured. Moody’s expects that the new Basel II norms are not likely to have a significant impact on the PSBs’ capital needs with regard to their credit risk profile under the standardized approach” Moody’s April 2005 IFR balance to be treated as Tier I capital “This move eases the burden on Tier 1 capital requirements prior to full implementation of Basel 2. Tier 1 ratio improves by 150bps for our coverage universe given that avg IFR was 4.61% at Mar05. However, Tier 2 ratio reduces correspondingly & total CAR remains constant. While banks will still need to raise capital, they can now raise more Tier 2 capital as pressure on Tier 1 has reduced. Hence, banks with low govt. holding will find it easier to raise capital” JPMorgan 14 Oct 2005 Basel II—Capital treatment Economic capital as % assets High risk Low risk Probability of default (%) 23

Generating superior ROE will drive the valuation at Indian banks
Shareholder value will become an increasingly important benchmark for Indian banks Increasing focus on ROE requires focus on capital management With increasing domestic competition, Indian banks face greater pressure to focus on return on equity as a measure of performance In addition, increased competition from the foreign banks in near future will further drive domestic banks to be more efficient in managing their operations and capital structure Capital management is an important component in any strategy to optimize shareholder return, with hybrid capital playing an important role in supplying additional capital support Increasing leverage moves banks towards a capital structure designed to optimize ROE With capital requirements expected to increase in the near future, hybrid capital provides non-dilutive support with lower negative impact on EPS than core equity In addition, the cost of hybrid capital (including Hybrid Tier I and Upper Tier II) is lower than that of core equity Raising non-dilutive hybrid capital will enable banks to fund growth and with minimum negative impact on stock ratings ROE coming under pressure Source: Company reports, Mean IBES estimates for 2006 through 2008 Note: Average industry ROE calculated for 13 banks Generating superior ROE will drive the valuation at Indian banks 24

impact ROE and COE, and P/B
A bank’s capital structure is critical to valuation as it has a direct impact on sustainable ROE ROAE v P/BV of regional banks¹ Indian banks Other banks Equity requirements impact ROE and COE, and P/B ROE - G P/BV = COE - G Where: ROE = return on equity G = growth COE = discount rate Source: JPMorgan research, Company reports and industry data Note: Book value and ROE for FY04; Market data as of 15 Nov 2005 ¹ Graph data is for regional banks in Hong Kong, Malaysia, Singapore, Korea, India and Taiwan 25

Importance of accessing international markets
With lower funding costs, domestic markets may be the first funding option for most Indian banks. However, access to international markets remain important for several reasons Individual investors represent a significant part of the domestic market, but banks should be cautious about relying on this investor base Domestic investors may not fully understand the implications of subordination provisions inherent in Lower Tier II structures Banks create moral hazard by selling to its own depositors, since there is a risk that RBI will intervene to protect depositors from loss Banks will also be limited in selling to each other, since regulators will place strict limits on the capacity of local banks to own local bank securities Limits will be imposed to restrict systemic risk, since cross holdings amongst banks will likely magnify the impact of financial distress within the system Accessing international investors provides a counterweight to over-reliance on domestic investors, promoting overall stability for the system 26

Applications Structural considerations Markets
Hybrid Tier I Applications Structural considerations Markets I B A 27

Why Banks issue Hybrid Tier I?
Increasing Tier I capital provides the greatest degree of financial flexibility and highest level of capital support Supports reductions made in balance sheet clean-up Additional capital is required to write-off non-performing loans and to increase coverage Creates capacity to issue additional Tier II Replaces capital spent on acquisitions HT I can directly replace goodwill reductions created by an acquisition HT I provides support for core capital ratio, while allowing time for the stock to be re-rated post-realization of revenue and cost synergies Hybrid Tier I allows banks to achieve the benefits of raising Tier I while minimizing financing costs and dilution Maintains expectations of shareholders’ return through its non-dilutive and low cost nature Optimizes capital structure, bringing it in line with international peers as issuing tax-deductible Hybrid Tier I will reduce WACC and improve valuations 28

Issuers face several decisions in designing an optimal HT I issuance structure
Tier I issuance options Issuers have multiple considerations in designing the structure for a Hybrid Tier I issue, with implications on pricing, tax effects, and target investor base Tier I issuance decision tree Tier I Summary of key considerations: Core has no step-up and is therefore perpetual; Innovative has a step-up after year 10 Headroom: Innovative is capped at 15% of total Tier I and non-innovative is capped at 30% of total Tier I Core Innovative Indirect issuance: Commonly used for tax efficiency, but subject to stricter regulatory scrutiny Direct issuance: Features can be potentially be included to provide tax efficiency Direct Direct Indirect International market deeper while domestic may have limited capacity Danger of systemic risk Cost of raising funds off-shore vs. on-shore issuances INR INR $ INR $ 29

Permitted features vary across jurisdictions, with some more favorable for investors
Hybrid Tier I Preferred Non-preferred 30

Bank capital evolution in United Kingdom (UK)
Hybrid Tier I regulatory requirements Hybrid Tier I—regulator’s views Guiding principle Deeply subordinated, undated and non-cumulative Structure Preference shares (perpetual non-cumulative) Call Only after 5 years Call option at discretion of issuer (5 year intervals between calls) Must have no other provisions which require future redemption Step-up Only after 10 years Interest accrual Non-cumulative (but may be paid in scrip) Interest deferral Yes Loss absorption Ranking Junior to Tier 2 capital except for dated preference shares with which it is pari passu Eligibility Tier I ratio of at least 4% over risk-weighted assets (Initially it was at 6%) Indirectly issued Tier I doesn’t exceed 15% of Total Tier I Key components of HT I remain as in BIS guidelines, 1998 FSA has divided capital into three tiers for regulatory purposes, reflecting the extent to which instruments meet the underlying principles of capital—loss absorbency and permanence Preference shares have long been used by U.K. banks to reach target Tier I ratios In January 1998, the Financial Services Authority (FSA) published guidelines which favor a tax-deductible Tier I structure involving the use of a non-operational special purpose vehicle (SPV) as the issuer of the preferred securities In November 2003, FSA issued a consultative paper (CP155) on proposed changes in bank capital instruments, particularly Tier I capital Structure approved by FSA—innovative HT I issue via an SPV SPV is integrated in the solo-consolidation of the parent company and consolidated basis (i.e. through creation of Minority interest) Issue is effectively tax-deductible The instrument’s main features are as follows: Loss absorption on an ongoing basis is required; A call is permitted every 5 years or a 100 bps step up can occur from year 10; issuers need a minimum Tier I equity ratio of 6%; and total use is limited to 15% of Tier I capital 31

Bank capital evolution in United States (US)
Tier I guidelines (US) Hybrid Tier I—regulator’s views Structure Indirect trust preferred permitted. Combined with other cumulative preferreds limited to 25% of Tier I capital Maturity Trust preferred securities are dated. Minimum 30 years Call No puts but can call with Fed permission Step-up No Interest deferral Yes case by case basis Loss absorption No specific regulations Ranking Junior to Tier II Eligibility Equity to asset ratio greater than 3% The components of Tier I capital remains as in BIS guidelines, 1998 Fed allows limited amount of cumulative preferred perpetual securities in Tier I capital (25% of Total Tier I but in practice it is limited to 15% of Tier I) In US the regulators look at preferred securities and subordinated notes and debentures as an additional cushion above equity to protect depositors and other senior creditors Capital requirements are an important aspect of capital adequacy, which is one key component of the regulators’ assessment of the safety and soundness of banks and Bank Holding Companies Structure approved by Fed—Innovative HT I issued via an SPV Trust preferred securities were first approved by Fed in October (Cumulative preferred securities) Issued out of special purpose subsidiary that is wholly-owned by the parent bank / company The proceeds on-lent to the parent in form of a very long-term deeply, subordinated note To be eligible as Tier I capital, these securities must provide for a minimum five-year consecutive deferral period on distributions to preferred shareholders In addition, the inter-company loan must be subordinated to all other subordinated debt and have the longest feasible maturity. Typically, this has been 30 years 32

Singapore and Korea are the only two jurisdictions in non-Japan Asia to have issued international Hybrid Tier I Best deal records—JPMorgan led transactions Singapore was the first jurisdiction in non-Japan Asia to issue international Hybrid Tier I, followed by Korea—JPMorgan is the only house to have executed deals for banks in both jurisdictions, and have done so in both an innovative and non-innovative format JPMorgan issued the first ever Hybrid Tier I transaction for a Korean Bank, with a $200mm perpetual step-up 10 issue for Hana Bank No other house has issued perpetual Hybrid Tier I in Korea In Singapore, JPMorgan has executed both innovative and non-innovative Hybrid Tier I for OCBC, both in a perpetual format No other house has executed both formats for Hybrid Tier I in Singapore 33

Regulatory differences across Asia
Singapore—Hybrid Tier I regulatory requirements Korea—Hybrid Tier I regulatory requirements Type Innovative capital with non-cumulative dividends 10 year step/call allowed, callable only with MAS approval Subordination Ranks below all classes of subordinated debt Interest deferral Optional deferral if no common dividend paid in past or current fiscal year or if payment would cause breach of CAR requirements Mandatory deferral? Mandatory deferral if no positive distributable profits at last earnings period Loss absorption Mandatory exchange to preferred shares if breach of CAR requirements or other signal of serious deterioration of financial position Limit Upto 15% of total Tier I capital Type Innovative capital with non-cumulative dividends 10 year step/call allowed, callable only with FSS approval Subordination Ranks below all classes of subordinated debt, senior to junior shares Interest deferral Optional deferral of dividends if no common dividends paid in past 12 months, mandatory dividend payment otherwise Mandatory deferral? Mandatory deferral if designated (or payment of dividend would cause designation as) a "non-performing financial institution" or under a management improvement order or recommendation (CAR<8% qualifies subject to FSC discretion) Loss absorption No conversion conditions Limit Upto 15% of total Tier I capital Structure of HT 1 deals out of Singapore Structure of HT I deals out of Korea JPMorgan has executed both innovative and non-innovative HT I offerings by OCBC In Jan 2003, OCBC issued its first ever non-equity Tier I transaction with $500mm of Perpetual Preferred Shares sold in the domestic market, being the second Perpetual Preferred to be issued by a Singapore bank Recently JPM acted as a joint manager for OCBC’s first HT I deal amounting S$400mm in perpetual 10-year step-up format Post successful offering of innovative HT I in local currency OCBC is now preparing for issuing innovative HT I in foreign currency and the issue is being arranged by JPMorgan JPMorgan issued the first ever HT I transaction for a Korean Bank, with a $200mm perpetual step-up 10 issue for Hana Bank Only the second out of non-Japan Asia despite the fact that the deal was done in worst month (December) of year This was also Hana’s debut international issue and is generally unusual for a bank to tap the global capital markets with a HT I issue 34

Overview of Hybrid Tier I Structures
Regulatory considerations Due to lack of clarity on what was acceptable as Tier I, the banks’ efforts led creation of a wide range of Tier I structures (tax- efficient), thus being advantageous to certain banks Hence to create a level playing field among the international the banks, BIS in October 1998 issued a clarification on: Type (Structure) of instruments to be included in Tier I, The limits on types of Tier I (15% limit), Step-up guidelines, and Limitations on issuing tax-deductible instruments The new BIS guidelines were framed to ensure equal access to all international banks to cost-effective tax-efficient Tier I capital issued through Special Purpose Vehicle (SPV) in domestic and international markets Tier I structures—strong v weak Most common form Note: 1 being the most safe and 5 being the most risky 35

The question of which structure to use is ultimately driven more by regulatory and tax considerations Except for dated Hybrid Tier I structures, pricing and trading performance between categories is similar Which structure is chosen is ultimately driven more by regulatory considerations: What is required to achieve Tier I status? Is equity accounting treatment required for Tier I status? Does the issuer have capacity to issue “innovative” Tier I? What factors impact the characterization of Tier I as “innovative”? Is it possible to create tax efficiency from a direct issue? Drawing line between innovative and non-innovative Tier I structures Vanilla Tier Is Issued via SPV and with step-ups Direct issues (RCIs / PROs) Issued directly by the bank, so no SPV, but with step-ups and coupons are effectively cumulative Equity settlement They have no step-ups but all have equity settlement features Tax-efficient, non-innov. HT I They have no step-ups but effectively tax-deductible (franked with tax-credits) Non-innovative No step-up, directly issued, no stock settlement, non-cumulative coupons Pure Innovative Pure non-innovative A B C D E 36

Direct issue structure
Direct vs. indirect Direct issues Indirect SPV structure Features of non tax-deductible direct issues No step-up Directly issued No stock settlement Coupon mechanism is ‘non-cumulative’ However the success of such structure by and large depends on whether there exists a domestic retail base to sell such securities This structure achieves both the objectives of HT I issue efficiently Use of step-up create an economic maturity for the instrument, thus making it attractive to institutional investors Use of SPV structure to create “cumulative dividend payments on the security, thereby making coupon payments effectively tax-deductible Direct issues How the SPV structure creates tax deductibility Direct issue structure SPV issue structure Bank Bank Potential distribution 3 1 4 Inter-co security Preferred proceeds Common security proceeds 5 Preferred shares Preferred proceeds Guarantee 1 Separate tax treatment 6 2 SPV Common securities Investors Preferred shares 2 Preferred proceeds Investors 37

Tier I structures Vanilla SPV issues
Innovative Hybrid Tier I issue through an SPV In complying with the BIS requirements such as perpetual, non-cumulative with discretionary payments, tax deductibility would be lost in most jurisdictions if directly issued. As a result, most Hybrid Tier I is issued via a Special Purpose Vehicle (“SPV”) and then on- lent to the bank via a deeply subordinated perpetual instrument, which contains deferrable (but cumulative) interest payments Regulators lay down mandatory conversion features of Hybrid Tier I issues, in the event of financial distress. For example, in Singapore, this structure would provide a mandatory exchange of the preference shares for Tier I-qualifying shares issued directly by the Bank to investors. Further The MAS has recently tightened requirements with regards to this new security In a consultation paper published in August 2005, the MAS wrote: “At the minimum, this mandatory exchange shall be triggered and shall take effect immediately….”. In a footnote, MAS further clarified that: “The Authority considers it unacceptable for substitution to be contingent on any event, and for the issuance of shares by the Reporting Bank qualifying as Tier I capital to be subject to any delays, such as receipt of approval from investors. How SPV structure works Bank Bank Potential How the structure achieves tax-deductibility: 1 distribution 3 4 The Bank contributes common equity to establish a fully owned, controlled and consolidated SPV 1 co Common Guarantee Inter - - Preferred security 5 security proceeds SPV issues preference shares to investors 2 proceeds 6 Separate The issue is guaranteed by the parent bank or the holding company on a preferred basis this allows the funds to be rated directly on par with directly issued securities 3 tax treatment SPV Common Funds from preference shares are lent to parent bank via a deeply subordinated loan 4 securities Preferred shares 2 Preferred proceeds The interest payments on the loan are paid out of pre-tax income by the bank and flow through the SPV directly to investors 5 Investors As the SPV is not liable for tax if it distributes all of its income, the dividends on the preference shares are effectively tax deductible 6 38

Tier I structures “Payment in kind” structure
The bank can issue a perpetual preferred instrument by using “Payment in Kind” structure, which effectively would be tax-deductible (due to effectively cumulative coupons) and a dated maturity (due to equity put or conversion option at the end of the year 5) The key features are highlighted below: Maturity: Undated, perpetual instrument with issuer call option at par, but no economic incentive attached to the call Dividend payments: Dividends at the discretion of the board and deferrable if dividends are not declared on common stock Non-cumulative: Deferred dividends do not accumulate. Deferred payments, however, are typically cumulative as deferred coupons must be settled by the proceeds from the fresh sale of equity shares Ranking: Senior to common equity in right of dividends and liquidation preference, but junior to all forms of debt, including Tier 2 subordinated debt As a debt instrument in form, the bank can offer the instrument directly to a large pool of international fixed income investors In addition, as a debt instrument, the instrument may offer tax deductibility on payments How the structure works? How is tax-deductibility achieved? Cash dividend payment or “payment in kind” via the issuance of common equity to a trust. This makes the coupon deferral effectively cumulative in nature How is 5-year effective economic maturity created? If the securities are not called at the call date at the end of the year 5, the investor can effectively put bonds back to the bank, which has to sell fresh equity in order to repay the bonds at the par The Bank Perpetual preferred instrument Preferred proceeds Investors 39

Tier I structures Direct issues (PROs, RCIs…)
Achieving tax efficiency through a direct issuance Direct issue structure Direct issues popularly known as Perpetual Regulatory Tier I securities (PROs) or Reserve Capital Instruments (RCIs) have the following features: Directly issued long-dated or perpetual securities Have a call and step-up without the use of an SPV Coupons are effectively cumulative—deferred coupons must be satisfied via the sale of equity to raise cash. This ensures the reserves of the bank are not depleted. Also at times interest on interest is payable Interest on such securities is paid out of pre-tax income and hence tax-deductible How does this differ from UT II PROs/RCIs rank ahead of equity in liquidation and behind all debt (including UT II). Also spreads on such securities are likely to be more volatile than UT II Such securities (with a step-up coupon) are subject to the 15% limit for Hybrid Tier I Bank Tax treatment:. Dividends are deductible pretax due to cumulative nature Cash dividend payment or “payment in kind” via the issuance of common equity to a trust Preferred shares Preferred proceeds Investors 40

Traditional Preferred Structure
Tier I structures Tax-efficient, Non-innovative Tier I Preference Shares How it works Through the “franking” of preference share dividends with a tax credit section, the cash portion of the coupon can be reduced by approximately 20% of the gross amount An added advantage is that this is achieved without using any of the 15% allowance for tax deductible innovative Hybrid Tier I With regulatory approval for this structure existing in Singapore, DBS and OCBC have issued a significant amount of preference shares without diluting existing shareholders equity and through the dividends, utilize existing tax credits. This in effect creates the equivalent of tax deductible Tier I if the bank has unutilized tax credits JPMorgan has worked with both DBS and OCBC in issuing non-innovative preference shares, and possesses a unique familiarity with the allowable features of this product Traditional Preferred Structure Bank Investors Preferred shares Preferred proceeds Cash dividend payment with linked tax credit 1 2 JPMorgan assisted OCBC’s offering of $500mm tax-efficient non-innovative Hybrid Tier I perpetual securities JPMorgan executed a similar structure for OCBC, which operates in a similar tax regime, and as such is the only international bank with the familiarity and understanding of the issues involved Importantly, while OCBC is a major underwriter in Singapore, where 100% of the securities were placed, they saw the clear benefit of hiring JPMorgan to advise and structure the transaction in a manner that ensured regulatory approvals, a smooth execution process in partnership with OCBC, and the necessary investor confidence In relation to the latter, JPMorgan prepared detailed materials to educate investors so that it was feasible to issue an instrument far superior to an earlier issuance in Singapore by DBS Bank Beyond the structure adopted, JPMorgan also reviewed structures that had incremental cost benefits that are the subject of on-going work in Singapore Terms of conditions OCBC issued its first ever non-equity Tier I transaction with S$500mm of Perpetual Preferred Shares sold in the domestic market The transaction is a Perpetual issue, with a call option at the end of year-5, year-10 and every dividend date thereafter, and provides OCBC with greater flexibility in managing its capital structure going forward By using section 44 tax credits, OCBC is able to make the issue effectively tax-deductible Tier I, while retaining non- innovative Tier I status With the nervousness in the equity markets, average returns in the corporate bond market and low deposit rates, the issue provides an attractive tax-advantaged yield relative to bonds/deposits and good returns for the risk relative to equities The deal was extremely well received, resulting in an over- subscription Size S$500,000,000 Lead Mngrs JPMorgan, OCBC Bank Ratings A2/A (Moody's / Fitch) Format Perpetual Non-Call 5&10 Mat. Perpetual Ranking Pari passu with other Tier I preferred, junior to deposits and subordinated debt Interest Semi-annual, fixed in perpetuity Spread SOR % Net Yield 4.500% (excluding Section 44 tax credits) Listing Singapore Exchange Securities Trading Ltd Background: The equity conversion option was introduced in the aftermath of the 1998 market dislocation, which left institutional investors in step-up perpetual preferred skeptical as to the likelihood that issuers had sufficient incentive to call. The equity conversion option was designed to reassure investors that issuers would make all possible efforts to call the instruments, i.e., in order to avoid potentially significant dilution 41

Tier I structures Non-innovative Tier I preferred securities
How the structure works? The regulator recognizes that capital instruments that are economically equivalent to preference shares could be eligible for non-innovative Tier I treatment. These non-innovative Tier Is are defined as instruments that feature the following No step-up Directly issued No stock settlement Coupon mechanism is ‘non-cumulative’ With BIS guidelines limiting innovative HT I to 15% of consolidated banks’ Total Tier I capital and most banks in UK nearing the 15% limit The UK banks wanted to raise Tier I capital without being counted as Tier I capital and hence FSA issued a Consultation paper in October giving more clarification as to what counts as innovative and subject to 15% limit and what is non-innovative, thus being out of 15% limit However the success of such structure by and large depends on whether there exists a domestic retail base to sell such securities The Bank Perpetual preferred instrument Preferred proceeds Investors 42

Hybrid Tier I issuance has increased manifold post BIS guidelines in 1998
From the beginning European and US Banks have been active issuers of Hybrid Tier I capital By far, European Banks have been the largest issuer of Hybrid Tier I capital with more than half of Hybrid Tier I issued in Euro Amount of Hybrid Tier I issued internationally ($ mm) Top HTI issuers globally Source: Bondware Note: Issuances in $, Euro, STG, Yen, KRW, S$ Source: Company reports, JPMorgan estimates 43

Due to inclusion of equity-like features, hybrid capital exhibit greater volatility
SMFG Upper Tier II UFJ Hybrid Tier I 29 July 03: Market sentiment leads to short-term drop in demand 25 May 05: UFJ deferred coupon payment on its OPCO Tier I securities 26 May 05: Immediate impact on pref share price Source: JPMorgan Source: Bloomberg Subordination increases volatility in price performance hybrid capital instruments, leading to potential for equity–like volatility 2003: Temporary mismatch in demand led to dramatic drop in SMFG Upper Tier II pricing before demand re-stabilizes 2005: Deferral of coupon payment (first ever deferral by Hybrid Tier I issuer) leads to substantial drop in UFJ Hybrid Tier I pref share price 44

HSBC’s perpetual subordinated bond price performance during Asian financial crisis
Increased volatility in bond prices during Asian financial crisis Source: Bloomberg 45

International investor base for Hybrid Tier I is extremely broad and well-developed
The investor base in Hybrid Tier I has become broader and deeper over the past five years Private banks form largest part of investor base contribution approx. 60% of the demand for HTI Rationale for each investor category Widening investor base for UT II issuances Private clients Will often buy Hybrid Tier I as a means to achieve a yield pick-up relative to cash deposits that would otherwise be placed with the bank. Private clients are often not sensitive to the risk provisions of capital instrument and will instead focus on name and yield Investor breakdown by industry Bank While restrictions are imposed on banks holding the capital of other banks, some jurisdictions do permit up to a % of the banks capital base to be held in the capital instrument of another bank Investor breakdown by geography Funds Fixed income funds have become increasingly attracted to HT I. Typically rate of return orientated, these investors often find significant value in the instrument relative to corporate senior debt Other Includes some insurance, asset management, and other clients Source: JPMorgan 46

Applications Structural considerations Markets
Upper Tier II Applications Structural considerations Markets I B A 47

Why Banks issue Upper Tier II?
Banks prefer to issue UT II as compared to raising equity or Hybrid Tier I capital when Capacity to issue Lower Tier II is full as they must decide between raising more Tier I/equity or issuing Upper Tier II Supports growth without diluting the current shareholders’ equity At the time of acquiring another bank, to provide support for capital ratios, while allowing time for the stock to be re-rated post-realization of revenue and cost synergies Additional capital is required to write-off non-performing loans and to increase coverage Equity markets are unfavorable for new issuance resulting in low valuations Upper Tier II offers value to banks as it is significantly lower cost than tax deductible Tier I or equity 48

While Lower Tier II is uniform, significant variation exists with Upper Tier II across jurisdictions
Efficient Inefficient 49

Banks should avoid the inefficiency caused by regulatory amortization on dated Tier II capital
BIS guidelines require the reduction in capital treatment for Tier II by a cumulative 20% per annum over the last 4—5 years of the issue’s life As senior debt can be funded at a much lower rate, the amortization creates an incremental cost to the Lower Tier II raising exercise (i.e., the entire amount of debt remains outstanding but an increasing amount counts only as senior debt but pays a subordinated coupon) 50

A coupon step-up or extension option can avoid the cost of regulatory capital amortization
Although the principal remains outstanding for 10 years, the regulator gradually amortizes the capital treatment over the final 5 years 100% Capital treatment No capital treatment 0% Years 5 10 The coupon step-up combined with the call option signal an “economic maturity” 4% Coupon Call option or extendible feature 3% X% % Years 0% 5 Economic Maturity 10 Legal maturity 51

Minimizing withholding tax is a critical consideration in structuring Upper Tier II
Repatriation of funds Interest payments to Non-resident investors is governed by Section 115A of the Income Tax Act, As per the section, the applicable tax rate for the amount of income-tax on the interest income amount is 20% The rates of tax will stand reduced if there is any relevant tax treaty with the beneficial recipient’s country However, in case the proceeds of the issue are retained and used outside India, then non-resident investors may not be liable to suffer any Indian withholding tax on the coupon paid on the Notes Issuing entity If interest payable on the Notes is subject to tax in India, there is a requirement to withhold tax presently at the rate of 20%. (subject to any applicable tax treaty and surcharge) However if the bank issues through its offshore branch, then withholding tax can be avoided and interest payments can be made free of any withholding tax Also in other jurisdictions, like Taiwan, the bank can avoid withholding tax if it raises funds through its Overseas Banking Unit (“OBU”). JPMorgan worked with tax authorities to allow such exemption in case the funds are raised through OBU 52

There were a number of structural complexities that made an offshore issuance attractive for Chinatrust Bank Case study JPMorgan used offshore branch structure in March 2005 to issue International Tier 2 (first ever UT2 out of Taiwan) for Chinatrust using the Hong Kong branch as the issuing entity Because the Hong Kong branch was the same legal entity as the Taiwanese company, the issue qualified as Tier 2 capital First ever international Bonds offering from any Taiwan company First issuance of Upper Tier II qualifying capital in the international markets by a Taiwan Bank Debut US$ Bonds offering for Chinatrust Commercial Bank Co., Ltd., the largest private commercial bank in Taiwan Transaction priced through initial price guidance of 90bp area, and within the revised price guidance of 85—87bp Deal generated approximately $3.9 billion of orders from 155 accounts and was nearly 13 times oversubscribed on its initial announced issuance size of $300 million. On the back of the over- whelming strong demand, the transaction was upsized to US$500million JPMorgan played a critical role in working closely with the Company and regulators to establish Upper Tier II and the appropriate issuance structure for international Bank Capital transactions from Taiwan JPMorgan is the Sole Bookrunner and Lead Manager for the transaction One legal entity Mar 2005 $500mm Chinatrust Lead managed CT’s $500mm Upper Tier II (RegS/144A) offering Global Co-ordinator and Sole Bookrunner Chinatrust Taiwan Chinatrust HK branch $ 500mm T 2 Bonds $ 500mm Bond proceeds Investors 53

Internationally, banks have made use of the Upper Tier II capital
Although banks across the regions have access to Lower Tier II (except Singapore), most European and Asian banks (Japan, Singapore and Korea in particular) have been active issuers of Upper Tier II in the international market These banks have commenced active capital management by utilizing its maximum available LT II capacity, thereby requiring UT II capital Top 10 European issuers in International Upper Tier II Top 10 Asian issuers in International Upper Tier II Source: Bondware, JPMorgan. Only includes Publicly placed international bonds, excludes domestic issuances. For example, German banks domestic UT2 issues likely exceeds $ 29 bn equivalent Source: Bondware, JPMorgan. Only includes Publicly placed international bonds; Excludes domestic issuances. For example, in the past 5 years, the volume of UT2 issued by Japanese banks in the domestic market exceeds $ 10 billion equivalent 54

Regulators across the region have recognized the value of Upper Tier II capital
Bank Capital issuance in non-Japan Asia UT 2 UT 2 LT 2 LT 2 LT 2 LT 2 UT 2 LT 2 UT 2 LT 2 UT 2 1999 2000 2001 2002 2003 2004 2005¹ Source: Bondware Note: Only $ subordinated issuances with minimum maturity of 5-years New issuance has been highlighted in bold for the respective type of capital ¹Included deals done up to 2005 YTD 55

From an investor’s perspective, Upper Tier II has proved a challenging but rewarding product
Notwithstanding the higher risk that comes with the subordination, interest deferral and loss absorption provisions, the default history for UT II is low (Barings default in 1996 is a rare example) However investors must be ready to accept greater price volatility of the product The product provides a leveraged exposure to credit spreads. When credit spreads are narrowing the product tends to outperform. In a deteriorating credit spread environment, demand will often be limited and spreads will underperform other credit instruments The greater volatility arises from the higher risk nature of the instrument and that in a down cycle the risk of default is greater and the instrument therefore becomes inherently more risky It is for this reason that the current market conditions provide and excellent opportunity to issue Credit spreads are at historic lows, investors seek yield and are willing to accept the risk of Upper Tier II at a low premium to Lower Tier II The spread differential between Upper and Lower Tier II could be as low as 0.20% when it is favorable and 1% when it is not so favorable 56

The international investor base for Upper Tier II is extremely broad and well-developed
The investor base in Upper Tier II has become broader and deeper over the past five years Predominantly consists of fund (pension and mutual) managers, life insurance companies, corporates, banks and private clients Rationale for each investor category Widening investor base for UT II issuances Life insurance companies Are typically buy and hold in nature and often require long duration instruments. As UT II instruments must have a minimum maturity of 10 years the product is often ideal, though demand varies according to the type of fund Investor breakdown by industry Mutual funds managers Fixed income funds have become increasingly attracted to UT II. Typically rate of return orientated, these investors often find significant value in the instrument relative to corporate senior debt Corporates/ private clients Will often buy Upper Tier II as a means to achieve a yield pick-up relative to cash deposits that would otherwise be placed with the bank. Private clients are often not sensitive to the risk provisions of capital instrument and will instead focus on name and yield Investor breakdown by geography Bank While restrictions are imposed on banks holding the capital of other banks, some jurisdictions do permit up to a % of the banks capital base to be held in the capital instrument of another bank Source: JPMorgan 57

Hybrid Capital: Case study
I B A 58

Banks have actively used non-dilutive capital to bridge the difference between economic requirements and target CAR DBS Group capital ratios Standard Chartered Plc capital ratios DBS has actively managed its capital structure MAS guidelines have changed from a minimum Tier 1 ratio of above 10% to now a minimum of 7% DBS has made use of Hybrid Tier 1 capital as well as Upper Tier 2 to boost its capital adequacy The capital policy is to maintain a Tier I ratio of 7—9% and CAR of 12—14% Its aggressive use of Tier II capital, going to limits of 50%, has resulted in high return on equity for its shareholders It has further improved returns and capital adequacy through the issue of innovative Hybrid Tier I capital AA-¹ AA-¹ A+ A+ A A A- A- BBB+ BBB+ BBB BBB ¹ Current rating, post-upgrade on 10 Jul, 2005 HSBC Plc capital ratios Chinatrust Commercial Bank capital ratios HSBC seeks to maintain a prudent balance between the different types of capital With the advantage of higher returns using leverage, it uses a 8.25% Tier I benchmark for its long-term capital planning It has also made use of innovative Hybrid Tier I capital Post the SE Asian crisis Chinatrust has raised Tier I capital to shore up capital adequacy With reduced levels of subordinated capital after 1998, it recently issued $500mm of UT II capital in the form of perpetual preference shares AA-¹ AA-¹ A+ A+ A A A- A- BBB+ BBB+ BBB BBB Source: Company reports, Central Bank website ¹ Current rating, post-upgrade on 10 Jul, 2005 59

Summary of BIS guidelines JPMorgan pricing methodology Case studies
Appendices Summary of BIS guidelines JPMorgan pricing methodology Case studies I B A 60

BIS Hybrid Tier I guidelines, 1998
“In order to protect the integrity of Tier I capital, the committee has determined that minority interests in equity accounts of consolidated subsidiaries that take the form of SPVs should only be included in Tier I capital if the underlying instrument meets the following requirements, which must at a minimum, be fulfilled by all instruments in Tier I” Dated 27 October 1998 61

BIS Upper Tier II guidelines, 1988
Features The Cooke Committee put a further distinction on subordinated debt when it divided Tier II into Upper and Lower categories Upper Tier II may not be reimbursed on the bearer's initiative or without prior agreement of the supervisory authority The debt agreement must provide for the credit institution to have the option of deferring payment of interest on the debt The lender's claims on the credit institution must be wholly subordinated to those of all non-subordinated creditors The documents governing the issue of the securities must provide for debt and unpaid interest to be such as to absorb losses, while leaving the credit institution in a position to continue trading Only fully paid-up amounts shall be taken into account Limit: Up to 100% of Tier I capital Upper Tier II is the second most senior form of hybrid capital behind Lower Tier II, and can be issued up to 100% of the amount of Tier I and is typically used to provide additional leverage to a bank’s equity base Upper Tier II must contain provisions that allow interest payments to be deferred and in some jurisdictions, Upper Tier II must also be perpetual Due to the significant variance in Upper Tier II guidelines, it is important for national regulators to introduce regulations that efficiently reflect the operating environment for their banks Failure to do so will leave the banking sector at a disadvantage relative to international peers, while not improving the strength of the system 62

Column: Clustered Example only (bp over $ LIBOR) Step up required to
Deeper level of subordination than Upper Tier II in liquidation Mandatory non- payment of coupon in event of capital ratio breach Optional non- payment of coupon if dividends are not made Loss absorption features Subordinated to all other instruments Ultimate loss absorption instrument Step up required to compensate investors for incremental risk: Deeper level of subordination than Lower Tier II in liquidation Interest deferral in event of capital ratio breach Partial loss absorption features Deeper level of subordination in liquidation, i.e., will only receive funds after senior creditors have been made whole Increased credit risk related to higher risk of default Funding instrument 63

Tier I and subordinated bank capital pricing methodology
JPMorgan has adopted a building block approach in devising valuation methodology for Tier I and subordinated debt Building the model: Tier I features and pricing implications Recovery rate: As the most subordinated class of bank debt, Tier I has lower recovery rate as compared to other subordinated debt and senior debt in the event of liquidation Coupon deferral: Tier I coupons may be deferred under certain conditions without causing default and are non- cumulative Extension risk: Tier I bonds may not be called at the first call date under certain circumstances without causing a default for the issuer, however presence of step-up creates an economic maturity for it Principal write-down: Subject to regulatory discretion, some Tier I bonds can suffer principal write-down (in line with or after equity write-down) under certain conditions without causing a default of the issuer. However this risk is not substantially incremental to investors over and above what they normally assume in holding senior debt Valuation with adjustment for Tier I features Basis points Extension risk Coupon deferral option 0% recovery rate Our pricing approach gives theoretical spread value for subordinated debt Source: JPMorgan 64

Hana Bank $200mm Hybrid Tier One Offering Perpetual Step-up 10-year Tier One Preferred Securities (“TOPS”) Transaction highlights Summary of terms First ever non-investment grade Hybrid Tier I issue globally, first Hybrid Tier I issue out of Korea, and only the second out of non-Japan Asia despite the fact that the deal was done in worst month (December) of year Established an important benchmark for other Korean banks which eventually came to the Hybrid Tier I market, attracting 90% offshore demand Unusual for a bank’s debut international issue of bank capital in the global capital market to be Hybrid Tier I Hana successfully introduced its credit story to the global investor base through carefully-managed roadshows in Hong Kong, Singapore and London Orders by geography Non-Korean Asia 58% Europe 32% Korea 10% December 2002 65

Oversea-Chinese Banking Corporation Ltd (“OCBC”) S$500 million Perpetual Preferred Shares
Summary of terms Transaction highlights OCBC issued its first ever non-equity Tier 1 transaction with S$500mm of Perpetual Preferred Shares sold in the domestic market The transaction is a Perpetual issue, with a call option at the end of year-5, year-10 and every dividend date thereafter, and provides OCBC with greater flexibility in managing its capital structure going forward By using section 44 tax credits, OCBC is able to make the issue effectively tax-deductible Tier I, while retaining non-innovative Tier I status With the nervousness in the equity markets, average returns in the corporate bond market and low deposit rates, the issue provides an attractive tax-advantaged yield relative to bonds/deposits and good returns for the risk relative to equities The deal was extremely well received, resulting in an over-subscription of 2 times, and allowed OCBC to increase the issue size from the originally planned S$300mm to S$500mm Orders by investor type January 2003 66

Shinhan Financial Group (“Shinhan”) KRW 900 billion ABS notes with redeemable preference shares as underlying assets Transaction highlights Summary of terms JPMorgan acted as sole underwriter for a KRW 900 billion offering of ABS notes issued by Strider Securitization Specialty Co. Ltd. First-ever KRW ABS structure with preference shares as underlying assets Largest single issuance from private sector arranged by a sole underwriter in domestic Korean market The underlying assets are KRW preference shares issued by Shinhan Financial Group ("SFG") to partly fund its acquisition of Cho Hung Bank shares A three-year, five-year, and seven-year tranche were issued in amounts of KRW 525bn, KRW 365bn, and KRW 10bn respectively and carried annual coupon rates of 7.00%, 7.46%, and 7.80% Strong demand was received for the issue and the paper was fully placed with Korean institutional investors Orders by investor type Others 8% Banks 6% Gov’t funds 11% NACF 28% Insurance 27% Mutual funds 1% ITCs 1% KFCCC 18% KRW 900bn August 2003 67

JPMorgan leads eurodollar $1.0bn retail Tier 1 for HBOS
Transaction summary Transaction highlights Joint largest Eurodollar retail tier 1 by a UK bank. JPMorgan has been a bookrunner on all three of the largest transactions launched into this market Significant level of over-subscription allowed the transaction to be upsized from $750 million, highlighting both the high credit quality of AIB in this environment and the continued appetite for this type of product, in particular from Asian Private Banking clients Exceptional pricing at 6.85%—tighter than price talk—and broadly flat to the trading levels of RBS and Lloyds TSB in this market and therefore including no new issue premium JPMorgan Private Bank delivered a superior contribution to the order book with $210 million of orders (versus $3.5 million for Lehman Private Bank) Pricing discipline among syndicate members and quality distribution were ensured as each manager was required to certify in writing the authenticity of its Private Banking orders Allocation by region Allocation by type Number of investors by ticket size Insurance 7% EU 6% Switzerland 7% Insurance 7% Other 5% Other 2% Bank/ private bank 91% Asia 82% Total: 69 investors March 2003 68

Banca Monte dei Paschi di Siena (BMPS) bolsters core capital by €700 million via FRESH
FRESH (Floating Rate Equity-linked Subordinated Hybrid) Preferred Securities Terms of the bond A structure that provides core capital for BMPS Second FRESH style convertible, following the Fortis FRESH last year, providing Core capital recognised as equity by the regulator for the full amount Positive treatment from rating agencies (non-leverage) Treatment as debt by tax authorities resulting in tax deductible coupon Deferred EPS impact (considered non-dilutive by most analysts) Variation of a groundbreaking structure As with Fortis, automatic conversion occurs if the underlying stock reaches a pre-defined trigger level after a pre-defined date Structural details adjusted to ensure approval by Italian regulator: Delaware-based Trust and LLC Non-cumulative coupon (can be omitted if no dividends are paid on share capital or if Bank of Italy declares that capital base would be “deficient” following a coupon payment) Early redemption possible following certain tax and regulatory events Automatic conversion if Bank of Italy declares BMPS’s capital base to be “deficient” Efficient and flawless execution The offering was launched the same day BMPS called the EGM to approve the capital increase without pre-emptive rights The book was well covered and closed before noon Minimal share price impact with BMPS shares falling only 1.9% on the day of launch despite trading nearly 7 times the average trading volume BMPS share price performance in November 2003 Share price (Eur) Share price Volume (shares ‘000) Volume (‘000) Break up of demand by geography Switzerland 4% RoE 3% Italy 6% -1.9% Germany 9% France 12% UK 44% US/Offshore 22% Source: Bloomberg Source: JPMorgan November 2003 69

JPMorgan leads RBSG—$650 million Tier 1 offering
Transaction highlights Transaction summary The Royal Bank of Scotland Group plc priced $650 million of a Tier 1 trust preferred issue at an aggressive level The PerpNC30 priced at the tight end of guidance at T+125bp The offering received over $1.25 billion in orders and was upsized from $500 million RBSG was able to take advantage of strong technicals in its outstanding PerpNC30 issue and investor demand for long duration paper to attractively price the deal Achieved historically tight Libor pricing for a PerpNC30 Tier 1 offering (inside L+100bp) RBSG took advantage of a “same day” execution strategy to minimize market risk RBSG was able to leverage off of investors’ knowledge of the credit on a day in which nearly $9 billion of new issues priced Approximately 70 investors placed orders for the offering Nearly 25% of the orders originated in Europe The deal performed very well in the aftermarket Freed to trade at +124bp and closed the day at +123bp Distribution by investor type December 2003 70

JPMorgan acts as joint bookrunner on Sampo Bank’s €125 million Perp-nc-10 Tier I issue
Transaction summary Transaction highlights JPMorgan acted as joint-bookrunner on Sampo Bank’s €125 millio Tier I issue—the first Tier I issued out of Finland since 1999 The deal is part of a two-tranche funding exercise for Sampo Bank and completes the €150 million Lower Tier II issue that priced on Monday this week at 3-month Euribor +52bp. The two transactions substantially fill Sampo Bank’s hybrid capital and Lower Tier II baskets, bolstering the capital base for future balance sheet growth and improving the cost-efficiency of the bank With a new issue spread of 115bp over mid-swaps, the Tier I transaction benefited from the good momentum created by the earlier Lower Tier II tranche and subsequently printed at the tight end of the price guidance The relatively modest size of the transaction did not attract a significant liquidity premium as investors took the rarity value of the paper into account Sampo will return to the capital markets with a subordinated and senior debt raising for its holding company in relation to the debt-financed acquisition of 52% of the “If…” shares later this month. JPMorgan will also act as joint-bookrunner on Sampo Bank’s parent company issues Allocation by region Allocation by type Number of investors by ticket size Source: JPMorgan (€mm) March 2004 71

Millennium bcp €500mm Perp-nc-10 Tier I transaction
Transaction summary Transaction highlights JPMorgan has acted as Joint Lead Manager and Bookrunner on the new Perpetual nc 10 Tier 1 issued by Millennium bcp and priced on June 2, 2004 Supported by an effective communication strategy and a strong marketing effort, the book has quickly grown up, reaching an amount of more that €800 million in 2 days of bookbuilding The book gathered a strong interest from all Europe, with orders significantly broaden Millennium BCP’s investor base and substantial geographic diversification was achieved Such a strong response of the market has allowed Millennium bcp to issue €500 million, up from a planned amount of €400 million The bond priced at Mid swap + 107bps, at the tightest end of the spread guidance, essentially flat to the outstanding Banco Espirito Santo 5.58% Tier 1 its main comparable and at a very attractive level for Millennium bcp In the secondary market the deal has performed well, tightening 2bp and outperforming the Tier 1 market by 1bp after the first day of trading Allocation by region Allocation by type Total : €500mm Total : €500mm 1 Germany 2%, Scandinavia 2%, France 2%, Belgium 2%, Italy 2%, and Greece 0.5% Source: JPMorgan June 2004 72

Danske Bank—$750 million Tier 1 offering
Transaction highlights Transaction summary Danske Bank priced $750mm perpetual capital securities at an aggressive level The first Danish Tier I issue ever Achieved aggressive pricing versus peers Priced at historically tight Libor levels for a PerpNC10 Tier 1 offering (L+66 bps) Initial size of $500mm more 6 times oversubscribed Took advantage of investor demand for new names and yield The deal was announced as a $500mm PerpNC10 144A/Reg S Tier I transaction and marketed via Red herrings Bloomberg roadshow Global investor conference call and telephonic one-on-ones Approximately 150 investors participated in the offering generating an order book over $3.25bn The investor list consisted of prominent investors including insurance companies, asset managers and hedge funds International investors contributed 18% of the the orders and were allocated 11% of the deal The offering was upsized to $750mm on strong investor demand Priced at T+115bp after initial price guidance of +120A and launch at +115—117 Good after-market performance: broke syndicate at +111 bid and closed the day at T+113 bid Allocation by investor type June 2004 73

JPMorgan places €125mm CMS-linked Tier I for Jyske Bank
Transaction highlights Transaction summary JPMorgan priced €125mm perpetual capital securities for Jyske Bank, the second largest independent bank in Denmark The deal was the first ever Nordic issue to use the innovative CMS-linked Tier I structure and only the second Danish Tier I issue to date The structure comprised an annual pay fixed coupon of 6% for the first year and a semi-annual pay floating coupon of 15bp over the 10-year “Constant Maturity Swap” Jyske Bank achieved very attractive funding level on an after-swap 3-month Euribor basis Investors were able to familiarise themselves with Jyske Bank’s credit story and the deal structure throughout the 1-week bookbuilding process Marketing material consisted of the preliminary offering circular and a detailed internal Jyske Bank information sheet for discussion with the fragmented retail investor base The deal was distributed mainly to private banks and retail investors with the bulk of the demand coming from the Netherlands, Switzerland and Luxembourg Allocation by region June 2004 74

Hybrid Capital: Overview

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