TEXT-Fitch upgrades BCOM's IDR & ABC's VR; affirms China's other large state banks

Wed Feb 6, 2013 5:08am EST

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Feb 06 - Fitch Ratings has upgraded Bank of Communications' (BCOM) Long-Term Issuer Default Rating (IDR) to 'A' from 'A-', and its Short-Term IDR to 'F1' from 'F2'. BCOM's Support Rating Floor was also revised to 'A' from 'A-'. At the same time, Agricultural Bank of China's (ABC) Viability Rating (VR) was upgraded to 'bb-' from 'b+'. All other ratings of the five large state banks have been affirmed with Stable Outlooks. A full list of rating actions is below.

These actions were taken in conjunction with actions on 11 other Chinese banks (see "Fitch Affirms IDRs of 11 Mid-Tier China Banks; Downgrades VRs of CITIC, Ping An, Industrial" and "Chinese Banks: Mid-Tier Most Under Pressure" both dated 6 February 2013).

All of the IDRs are based on state support, and are at the banks' Support Rating Floors, reflecting varying expectations about prospects of extraordinary support from the central government in the event of stress.

The Support Rating Floor and Long-Term IDR of BCOM were upgraded, reflecting a reassessment of the probability of support for the bank relative to other state-owned banks. Despite BCOM's smaller size (4% of system deposits versus an average 12% for each of the other state banks), it is unlikely that state support would be materially less for BCOM than other state banks given the central government's substantial 40% direct ownership stake. BCOM has also been a recipient of state support in the past.

China's five large state-owned commercial banks possess Support Ratings of '1', the highest level on Fitch's scale of '1' to '5', and Support Rating Floors of 'A', one notch below China's sovereign rating. The five state banks account for a large 47% share of sector assets. The central government is the largest shareholder of each of the banks, and has a long track record of providing solvency and asset quality support to the entities. Consequently, the Support Rating Floors of these institutions continue to be closely linked to China's sovereign rating.

Any changes to IDRs will be tied to shifts in the perceived willingness or ability of the central government to support the banks. The government has substantial resources to address deterioration in the banking sector. Required deposit reserves of 18% of non-fiscal deposits in 2012 could be released in the event of banking system liquidity strains. Meanwhile, the government has demonstrated its willingness in the past to draw on part of its foreign exchange reserves (USD3.3trn in 2012) to recapitalise banks. At the same time, the large and increasing size of the banking system (Fitch estimates total credit/GDP at 193% at end-2012, compared with 120% pre-crisis) means that the cost of support could be substantial relative to even the sovereign's considerable resources.

The VRs of Chinese banks range from 'bb' to 'b', reflecting varying degrees of weak intrinsic strength (i.e. also taking into account off-balance sheet activity), risks over the level and pace of credit growth in the financial system, issues with data integrity, and nascent regulatory and legal systems. Corporate governance issues stemming from the continued predominance of state over institutional interests are also a constraint on VRs. The range of Chinese banks' VRs has not changed since their introduction in 2011.

The upgrade of ABC's VR reflects a reassessment of its rating based on relative intrinsic strengths, including greater stability over time compared with domestic peers. ABC has amongst the strongest deposit funding of any bank in China; robust liquidity; and below-average credit exposure and off-balance-sheet activity, including limited wealth management product (WMP) issuance.

The 'bb' range VRs of state banks, Bank of China (BOC), China Construction Bank (CCB), Industrial & Commercial Bank of China (ICBC) and BCOM, like ABC, are the highest in the sector, reflecting their strong nationwide franchises, funding and liquidity strength, smaller off-balance-sheet activities, and higher loss-absorption capacity relative to other domestic peers. These features also mean state banks would likely benefit from a flight to safety, providing further support to their VRs in a stress scenario.

Downgrades of VRs could be triggered if excessive growth renders capital more vulnerable to deterioration, if asset quality weakening begins to undermine solvency, or if funding and liquidity strains become more binding. Major disruptions in WMP issuance or interbank market distress could also lead to VR downgrades for those entities most exposed to such activities.

VR upgrades for China's banks are unlikely over the near- to medium-term. However, slower credit growth, reduced off-balance-sheet activities (or greater transparency around these activities), improved loss-absorption capacity, and stronger deposit funding and liquidity would help to stabilise the VRs at their current levels.

Over the medium term, the sector faces asset quality risk given the magnitude of the post-global financial crisis credit boom. By end-2013, the total stock of credit in the financial sector will have tripled since 2008, while GDP will have risen only 85%-90%.

Nonperforming, special mention, and overdue loans have been rising since Q411, but Fitch believes reported metrics understate the magnitude of impaired loans. The reliability of data is worsening as larger amounts of credit are informally securitised into WMPs, passed on to nonbanks, and transformed into private-placement debt securities and interbank claims. Hence, even though rising delinquencies are expected to persist in 2013, reported levels are likely to remain low, giving the appearance of benign asset-quality pressure.

Given these issues with data integrity, Fitch's analysis of asset quality places a much heavier emphasis on loss-absorption capacity (which includes factors such as capitalisation, loan loss reserve coverage, and profitability) than loan classification data. Most of the banks under Fitch's coverage can withstand a rise in impaired credit to the mid-single digits, after which varying degrees of extraordinary state support would be required. However, recognition of asset impairment will be a protracted process. In the meantime, delinquencies will continue to manifest in eroding liquidity and cash buffers, as inflows from distressed borrowers remain weak and more resources are directed at forbearance and support.

Chinese banks' large off-balance-sheet activities and rapidly expanding transactions with nonbanks are also a risk. Non-loan credit now comprises one-third of total credit outstanding in the financial sector, up from 15% in 2006. A key risk over the short-term is Chinese banks' issuance of WMPs, substitutes for time deposits, which have been growing rapidly as competition for deposit funding intensifies. The balance of outstanding WMPs stood at CNY12trn in Q312, up from CNY8.4trn at end-2011.

WMPs are changing the nature of Chinese banks' stable, cheap deposit base into one that is more mobile, expensive and short-term. The products' short tenors, frequent mismatching of assets and liabilities, and poor disclosure about underlying assets present a significant contingent risk to the issuing banks. Because most WMPs are managed on a pooled basis, it is difficult for banks to demonstrate underperformance on the underlying assets, impeding their ability to impose losses on investors. State banks derive much less of their funding through this channel than mid-sized banks.

The current ratings of China's five large state banks are as follows:

Bank of Communications (BCOM):

Long-Term Foreign-Currency IDR upgraded to 'A' from 'A-'; Stable Outlook

Short-Term Foreign-Currency IDR upgraded to 'F1' from 'F2'

Support Rating affirmed at '1'

Support Rating Floor revised to 'A' from 'A-'

Viability Rating affirmed at 'bb-'

Agricultural Bank of China (ABC):

Long-Term Foreign-Currency IDR affirmed at 'A'; Stable Outlook

Short-Term Foreign-Currency IDR assigned at 'F1'

Support Rating affirmed at '1'

Support Rating Floor affirmed at 'A'

Viability Rating upgraded to 'bb-' from 'b+'

Industrial & Commercial Bank of China (ICBC):

Long-Term Foreign-Currency IDR affirmed at 'A'; Stable Outlook

Short-Term Foreign-Currency IDR affirmed at 'F1'

Support Rating affirmed at '1'

Support Rating Floor affirmed at 'A'

Viability Rating affirmed at 'bb'

China Construction Bank (CCB):

Long-Term Foreign-Currency IDR affirmed at 'A'; Stable Outlook

Short-Term Foreign-Currency IDR affirmed at 'F1'

Long-Term Local-Currency IDR affirmed at 'A'; Stable Outlook

Short-Term Local-Currency IDR affirmed at 'F1'

Support Rating affirmed at '1'

Support Rating Floor affirmed at 'A'

Viability Rating affirmed at 'bb'

CCBL Funding PLC (CCBL)

Senior, guaranteed medium-term CNY bonds affirmed at 'A'

Bank of China (BOC):

Long-Term Foreign-Currency IDR affirmed at 'A'; Stable Outlook

Short-Term Foreign-Currency IDR affirmed at 'F1'

Long-Term Local-Currency IDR affirmed at 'A'; Stable Outlook

Short-Term Local-Currency IDR affirmed at 'F1'

Support Rating affirmed at '1'

Support Rating Floor affirmed at 'A'

Viability Rating affirmed at 'bb'

Senior unsecured certificate of deposit programme affirmed at 'A'/' F1'

Senior unsecured euro commercial paper and certificate of deposit programme affirmed at 'A'/'F1'

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