Why Chinese banks are bolstering their capital ratios

The restructuring of the shadow banking sector and a looming Basel III deadline is prompting Chinese banks to increase their capital raising efforts, with a wave of transactions expected to hit the capital markets subject to regulatory sign off. 

First off has been Bank of China (Hong Kong), which raised $3 billion from a perpetual non-call five Additional Tier 1 (AT1) deal on Tuesday.

Investment bankers working in Asia’s financial institutions (FIG) sector say it is notable that the year's first Chinese dollar-denominated AT1 deal has come from a bank's overseas subsidiary. 

"Bank of China (HK) had far more freedom to manoeuvre because they're subject to the Hong Kong Monetary Authority's approval process," one banker said. "We've seen hold-ups with deals requiring onshore approvals."

FIG bankers attribute this to the merger, earlier this year, of the China Banking Regulatory Commission and China Insurance Regulatory Commission into the China Banking and Insurance Regulatory Commission (CBIRC). Since then, there have been, what bankers describe as "communication difficulties" with the China Securities Regulatory Commission (CSRC).

One high profile casualty was Bank of Nanjing's plan to supplement its Tier 1 capital with an Rmb14 billion ($2.04 billion) private placement this summer. The city commercial bank’s plan was rejected by the CSRC in late July despite having already gained CBIRC approval.

One thing all market participants agree on is the sector’s need to raise capital more urgently than before.

Dealogic figures show that across Asia ex-Japan as a whole, AT1 fundraising activity is way down on recent years (see table 1). So far, there has just one other dollar-denominated offering in 2018; for Taiwan’s E.Sun Commercial Bank in the Formosa bond market.

Bankers and fixed income analysts say Chinese banks fundraising needs are being driven by a number of factors.

From an offshore capital markets perspective, there is the fact dividend step-ups kick in next year for 2014’s initial wave of AT1 deals. This means that both Bank of China and Industrial and Commercial Bank of China (ICBC) are likely to be back in the offshore market to re-finance their respective $6.5 billion and $5.7 billion equivalent AT1 deals over the coming 12 months.

Both have announced plans to bolster bank capital, with ICBC securing shareholder approval to raise Rmb 100 billion ($14.56 billion) in AT1 paper and Rmb110 billion ($16.02 billion) in Tier 2 from both the onshore and offshore markets. Bank of China is also expected to return to the domestic Tier 2 bond market for a second time before 2018 is out too.

BASEL III

On the more immediate horizon, Chinese banks have a full Basel III compliance deadline to meet at the end of 2018. This means that systemically important banks need to achieve a minimum Tier 1 ratio of 9.5% and overall capital adequacy ratio (CAR) of 11.5%. It is one percentage point lower for all other banks.

However, both the banks and the government would ideally like to see capital cushions at least 100bp to 150bp above the minimum. The big four are all comfortably above these levels, but the same cannot be said of a number of mid-sized and city commercial banks.

S&P Capital IQ figures show that Hong Kong-listed Shengjing Bank is currently lurking towards the bottom of the pack with a core Tier 1 ratio of 8.6% at the end of June. Not far behind is China Minsheng Bank on 8.9%, Ping An Bank 9.2%, Hua Xia Bank 9.3%, with China CITIC Bank and Bank of Tianjin both on 9.4%.

Some financial institutions such as Guizhou Wudang Rural Commercial Bank are currently reporting negative Tier 1 ratios thanks to the impact of the government’s new non-performing loan (NPL) rules on their loan loss reserves.

However, in a recent research report HSBC says the government is showing “regulatory forbearance of bank sub debt” since Guizhou Wudang’s domestic tier 2 bond has not been written down despite the fact that its Tier 1 ratio has stood at -3% since the beginning of the year.

GOVERNMENT RECAPITALISATION LOOMING?

In the same report, fixed income analyst Helen Huang and head of China research, Zhi Ming Zhang, argue that the “key to breaking the vicious cycle of capital and funding shortage starts with a government-backed bank capital injection, including the central government on the national banks and local government on the regional banks".

They believe this will boost valuations, giving banks a much stronger platform to raise new equity and longer dated subordinated debt.

HSBC notes how difficult it has become for Chinese banks to raise pure equity. The Hang Seng Mainland Banks Index is down 29% from its January peak, pushing the whole sector back below one times book value - the regulatory threshold to raise new equity. 

Only two banks have also completed IPOs so far this year, both in Hong Kong: Jiangxi Bank in June and Bank of Gansu in January.

However, the CSRC has recently approved four banks to list domestically - Bank of Changsha, Bank of Qingdao, Bank of Zhengzhou and Jiangsu Zijin Rural Commercial Bank. Postal Savings Bank has also been waiting for conducive market conditions for over a year. 

The HSBC analysts further note that reported capitalisation levels are not as rosy as they initially appear since many banks have historically purchased each other’s bank capital transactions. “Capital available from outside the banking sector is limited,” they conclude.

DELEVERAGING SHRIVELS DEMAND

Other analysts, including Mizuho’s Mark Reade, also note the drop off in “leveraged note-driven appetite” by onshore investors, which helped lower-rated banks like Bank of Chongqing, Bank of Jinzhou and Bank of Zhengzhou to achieve 5.4% to 5.5% AT1 coupons when the sector hit its peak around the end of last year.

Today those deals are yielding 8% to 9% to their call dates, making fresh fundraising far more challenging. It is the main reason why credits like Harbin Bank and Huarong Asset Management have longstanding AT1 mandates outstanding.

A similar demand pattern has been at work with Bank of China HK’s AT1 deal. Where its parent achieved a peak order book of $21.8 billion for the Chinese sector’s debut offshore deal in 2014, the Hong Kong subsidiary has had to be content with $5.4 billion.

It is also notable that private banking demand only accounted for 18% of demand this time round compared to 29% four years ago.

But fixed income analysts believe the investment rated deal (Baa3/BBB) was priced at the right level after its coupon was fixed at 5.9% on an issue price of par.

For example, JP Morgan’s fixed income analyst, Matthew Hughart, has assigned fair value at 5.9%.

He argues that Bank of China’s AT1 paper deserves to trade through both ICBC Asia’s AT1 paper, which was quoted at 6.3% at the time of pricing and HSBC’s, which has a split rating and was quoted at 6.2%. He also notes that Bank of China (Hong Kong’s) dividend stopper diminishes the likelihood of skipped coupon payments.

One thing, which analysts do not agree on is what impact the restructuring of the Rmb22.2 trillion shadow banking sector will have on bank capital ratios. Some believe ratios will come under pressure as banks’ asset mixes shift to back to higher risk weighted assets (RWA).

However, Nicholas Zhu, Moody’s senior analyst for financial institutions, has a much more positive outlook.

“The overall situation is stable,” he told FinanceAsia. “Some of the smaller banks have individual challenges, but the largest banks have robust capital ratios.

“Their pricing power is also increasing on the asset side,” he explained. “The restructuring of the shadow banking sector means corporates are returning to banks for loans that will cost them more as lending rates are rising.”

He believes this will benefit banks’ net interest margins (NIM), feeding through into retained earnings and capital. Zhu also dismisses some FIG bankers concerns' about a potential acceleration of Total Loss Absorbing Capital (TLAC) rules.

A number of bankers believe China is close to the 55% corporate debt-to-GDP threshold, which would trigger it. However, Zhu says this is not the case once policy bank bonds are stripped out of the equation.

Under the rules, systemically important banks have to issue bail-in instruments equivalent to 16% of their RWA by 2025. Moody's has previously estimated that the big four will need to raise Rmb2.85 trillion to meet these stricter buffers.

Zhu says the market is now waiting for more information about TLAC capital raising from the government.

“It published some initial guidance earlier this year, but since then its priorities have shifted,” he commented. “It’s become more focused on gradually overhauling the shadow banking sector and providing more liquidity to offset the impact of global trade tensions."

Bank of China, Cinda International, Citi and Goldman Sachs were joint global co-ordinators of Bank of China (HK)’s AT1 deal. Joint leads were BNP Paribas, Guotai Junan International and Morgan Stanley.