China regulators snuff credit enhancement joy
* ICBC and CCB offer letters of credit for dollar bonds
* Structure allows banks to earn fees without funding loans
* Regulators indicate they want the practice to slow down
By Nethelie Wong and Christopher Langner
SINGAPORE, Dec 6 (IFR) - Just as more Chinese banks start providing standby letters of credit for US dollar bonds, bankers are predicting an end to the use of the credit enhancement.
ICBC and China Construction Bank each backed US dollar bonds with letters of credit this week for the first time, in line with a trend Bank of China started in 2011.
However, while it might seem like the fad is spreading, bankers are saying it is just the opposite.
Chinese bankers say banking regulators have told them not to issue any more standby letters of credit for offshore bonds.
"The regulators are worried about the fast growth in standby letters of credit being granted and used for bond issuance. The SBLCs are meant to promote trade and provide trade financing to corporate entities, not for long-term bond guarantees," explained a banker familiar with the matter.
BOC started the structure in July 2011 to back Zijin Mining's US$480m bond issue. So far, the largest offering backed by a standby letter of credit has been China Cosco's US$1bn 10-year bond in November 2012, which helped the troubled shipper raise enough money to ride out a tough patch. BOC supported five more issues in the past year, most related to embattled state-owned enterprises.
The controversial structure, however, has attracted a lot of attention and some criticism. Pundits noted that banks offering standby letters of credit still had to set aside capital as if it were a loan, given that new Basel rules required them to treat contingent liabilities in the same way as fully funded commitments.
Providing a standby letter of credit for a long-term bond, therefore, results in the same capital charge without the structural security, seniority and covenants that loans entail.
"Supposedly, a company that goes for a standby letter of credit has trade financing needs. By using it effectively as a bond guarantee, the same standby letter of credit may be supporting two transactions. That makes regulators uncomfortable," said another banker.
FEES WITHOUT FUNDING
The only advantage, said DCM bankers, was the fact that the bank could charge fees without having to fund a loan. With onshore liquidity tight, and fears of US tapering in the offshore market, that could be a very attractive option.
Chinese banks are also looking to increase fee-generating businesses in anticipation of shrinking lending margins as the country liberalises interest rates.
ICBC (Asia) backed a US$500m bond for developer China Merchants Land, priced on Wednesday at 260bp over Treasuries. On Thursday, it was the turn of China State Shipbuilding Corp, which priced a three-year bond backed with a standby letter of credit from China Construction Bank's Hong Kong branch at 225bp over US Treasuries.
The first CCB-backed deal did well as it offered a juicy pickup over the 175bp spread on Zijin Mining's BOC-backed bonds due in June 2016. Investors were also drawn to the rarity value of CCB risk, as the bank has yet to issue dollar-denominated bonds.
It may also have been their last chance to lay hands on a Chinese bond with a standby letter of credit for a while. (Reporting By Nethelie Wong and Christopher Langner; Editing by Steve Garton and Abby Schultz)
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