Bank of Communications (Bocom) on Wednesday became the first Chinese bank this year to raise additional Tier 1 (AT1) subordinated bank capital in the offshore markets.
The Basel III-compliant preference share offering was not as large as ICBC's $2.94 billion transaction from December in terms of issue size or investor demand, but the $2.45 billion deal arguably had a lot more momentum given how subdued market conditions remain.
Bocom's $9 billion book of demand also contrasted sharply with the most recent AT1 deal from Asia - Woori Bank's $500 million deal, which scraped together $1 billion in early June.
Woori's Ba2/BB rated deal was priced at 5% and Bocom's Ba3 deal has followed suit at exactly the same level after setting off with initial guidance around the 5.25% level. Pricing of the perpetual non-call five deal was fixed at par, equating to 334.4bp over Treasuries.
However, the big difference between Woori and Bocom is the huge benefit Chinese banks derive from an enormous backstop of private banking demand from mainland-based investors.
Bankers said their participation in the new deal has been no different to usual. And unsurprisingly 95% of the deal went to Asia and only 5% to Europe.
By investor type 48% went to asset and fund managers, 19% to sovereign wealth funds, 18% to banks, 12% to insurers and 3% other.
Domestic demand has not only enabled the Chinese banks to continually price through every other comparable bank around the world, but also pulled their secondary levels consistently tighter, both on an absolute basis and relative to their Tier 2 debt.
Bocom management may have noted with a wry smile the fact that relative to their rating they have achieved the kind of pricing level the international banks in their syndicate (Citi, Deutsche Bank, Goldman Sachs, HSBC and JP Morgan) can only dream of.
At one end of the scale HSBC has a 5.625% Baa3-rated AT1 deal callable in 2020 bid at 4.933% and JP Morgan has a 6.125% Baa3-rated 2024 callable deal at 5.865%.
At the other end Deutsche Bank has a BB/Ba3 rated 6.25% 2020 callable deal at 6.056% and Citi a 6.3% BB/Ba2 rated 2024 deal at 6.355%.
The other syndicate banks for Bocom's deal comprise Bocom International, CCB International and Citic CLSA.
Inherent value or momentum driven?
In a sales note published on Wednesday, an analyst at one Chinese bank concluded that Bocom's 5% yield offered "decent value" and believed it should "do quite well" in the secondary market.
At 5% it has priced 29bp wide of ICBC's AT1 paper without taking into account the seven-month maturity extension and its one-notch lower rating of Ba3 to ICBC's Ba2/BB.
The latter's 6% perpetual non-call five deal was trading yesterday on a mid-yield of 4.71% to its December 2019 call date.
The spread differential between the two is exactly the same as the 29bp difference between ICBC and Bocom's outstanding Tier 2 deals, which have maturity dates one month apart.
ICBC's 3.875% September 2024 bullet deal was trading on a Z spread of 217bp on Wednesday, while Bocom's 4.5% October 2024 deal was trading on a Z spread of 246bp.
What may help Bocom to perform in the secondary market is the ongoing momentum, which is progressively closing the gap between the Chinese banks' AT1 and Tier 2 debt.
In October 2014, when Bank of China launched its AT1 deal, the gap between the two was about 200bp in line with European credits. By the time of Woori's deal in early June it had narrowed to around 130p.
Yesterday it stood at 96p, based on the 313bp Z spread of ICBC's Tier 1 deal and 217bp Z spread of its Tier 2 deal. Bocom has priced at a 101.5p differential given the 3.985% mid-yield of its outstanding October 2024 bullet deal.
By contrast, Woori's AT1 deal traded down once it hit the secondary market and continues to trade below its issue price at 99.75 on a yield of 5.05%.
The structure of the Chinese banks AT1 debt differs from the Koreans in a number of respects. Both ICBC and Bocom have dividend re-sets after five years, dividend stoppers and full or partial conversion into equity in the event of a non-viability event should Tier 1 capital fall below 5.125%, or as determined by the China Banking Regulatory Commission.
The point of non-viability is defined by law in Korea and the government also has the ability to make pre-emptive capital injections before it is breached. Korean deals are also subject to full principal write-down rather than conversion into equity.
Secondary markets give few pointers to where Bocom may trade. Analysts report selling activity from prop desks making way for new issues, but little end client activity.
On Wednesday secondary markets were fairly flat, with the notable exception of CCB Leasing, whose new $500 million five-year deal tightened in 7bp from its launch spread of 190bp over Treasuries.
Profit taking then pushed it back out to 186bp at Asia's close.
Trendsetter
Analysts are expecting relatively weak second quarter earnings from China's state-owned bank sector with NPL's on the rise.
However, Bocom is hoping to break away from the pack now the State Council has approved its reform plan. The government wants to improve the state-owned bank sector's governance and operational ability by bringing in more strategic investors and encouraging mixed ownership while retaining overall state control.
HSBC already owns a roughly 19% stake in Bocom, close to the regulatory ceiling. In recent interviews Bocom President Niu Ximing has suggested the two banks may increase their co-operation by bringing a non-executive vice chairman on board from HSBC.
He also indicated that Bocom plans to turn some of its subsidiaries into joint stock companies and introduce strategic investors that way. Chinese newspapers suggest that Fosun and Tencent are likely candidates given the deep pockets required to purchase a stake and technological skills they could potentially offer the bank.
Bocom has long viewed itself as a path setter for the mainland banking sector having been the first state-owned bank to list and the only one to maintain a decade-long strategic partnership with a major international bank.
Yet analysts say it needs to distinguish itself from increasingly successful rivals such as Minsheng and China Merchants.
At the end of December its overall capital ratio stood at 14.04% of which Tier 1 capital constituted 11.3%. NPL's stood at 1.25%, rising to 1.3% in the first quarter.
