OREANDA-NEWS. Fitch Ratings' approach to rating Basel III-compliant Tier 2 bonds in Indonesia means that PT Bank Permata Tbk's (Permata; AAA(idn)/Stable) proposed US-dollar denominated subordinated bonds - which are intended to qualify as Tier 2 capital under the Basel III regime - would likely be rated 'BB' or higher.

Permata's proposed issuance will be the first offshore subordinated debt denominated in foreign currency issued by an Indonesian bank under Basel III capital regulations.

Under the Basel III capital framework, Tier 2 debt instruments issued by banks can be converted to equity or be written down (either of the principal and/or of the interest, in full or in part) when the banks approach the point of non-viability (PONV) as determined by local regulators. The Basel III Tier 2 instruments for Indonesian banks will retain the cumulative deferral features that already exist in legacy Tier 2 securities. Under the deferral features, issuers may defer coupons or principal payments if their capital positions fall below minimum capital regulatory requirements.

Fitch has rated legacy Tier 2 debt issued by Indonesian banks at three notches below the banks' anchor ratings in the past, due to their embedded going-concern loss-absorption features; the rating is lowered by one notch for legacy Tier 2 debt to account for loss severity and two notches for non-performance risk.

The agency is likely to continue the notching for loss severity for Basel III Tier 2 instruments. This is because the proposed notes will rank pari-passu with other Tier 2 securities - including legacy Tier 2 debt. Fitch will likely apply the same notching for non-performance risk for Basel III Tier 2 instruments, reflecting the agency's view that principal and/or interest deferral - which may be triggered when capitalisation breaches regulatory minimum levels - are likely to occur well before the equity conversion and/or write-down triggered upon PONV.

However, for foreign-owned banks with strong institutional support from their parents, such as Permata, which is about 45% owned by Standard Chartered Bank (SCB, AA-/Negative), the rating on their Basel III Tier 2 instruments will be notched twice from the issuer's anchor ratings. The notching comprises once for loss severity and once for non-performance risk, as the non-performance risk is partly neutralised by potential parental support, according to Fitch's rating criteria.

Permata's anchor rating - given its support-driven Long-Term National Rating of 'AAA(idn)'- will likely be no lower than 'BBB-' on the international scale. Accordingly, the issue rating for the proposed Basel III Tier 2 debt will likely not be lower than 'BB'.