RPT-Fitch Affirms IDRs of 10 Mid-Tier China Banks; Downgrades VRs of Minsheng and Pudong

Thu Dec 12, 2013 2:01am EST

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Dec 12 (Reuters) - (The following statement was released by the rating agency)

Fitch Ratings today affirmed the Long-Term Foreign-Currency Issuer Default Ratings (IDRs) of 10 Chinese mid-tier commercial banks with Stable Outlooks. At the same time, the Viability Ratings (VRs) of China Minsheng Banking Corporation (MIN) and Shanghai Pudong Development Bank (SPDB) were downgraded to 'b+' from 'bb-'. Fitch affirmed the VRs of the other banks. A full list of rating actions is at the end of this rating action commentary.

KEY RATING DRIVERS - IDRS, SUPPORT RATINGS, SUPPORT RATING FLOORS

All of the IDRs are based on state support, and are at the banks' Support Rating Floors, reflecting continued expectations that extraordinary support from the central government would be forthcoming in the event of stress. China Merchants Bank (CMB), China Everbright Bank (CEB), and China CITIC Bank's (CNCB) Support Ratings of '2' and Support Rating Floors of 'BBB', indicate a high probability of state support, if needed. This is based on a combination of factors such as size and domestic significance (for CMB and CNCB), ownership by fully state-owned conglomerates (all three), direct central government ownership (for CEB), and a history of past government support (for CEB).

The remaining eight banks have Support Ratings of '3' and Support Rating Floors of 'BB+', indicating a moderate likelihood of central government support if needed. Banks in this group are smaller in size - their deposit market shares are 2.5% or less each - and have no direct central government ownership. Three of the banks have local governments as their largest shareholders. However, in a stress scenario, Fitch believes that the ability of local governments to support banks on a timely basis would be limited, and hence support would effectively need to flow from the central government.

RATING SENSITIVITIES - IDRS, SUPPORT RATINGS, SUPPORT RATING FLOORS

Any changes to IDRs and Support Rating Floors will be tied to shifts in the perceived willingness and/or ability of the central government to provide extraordinary support to the banks, taking into account also relative systemic importance and ownership. The banking system's continued rapid growth, combined with the rise in nonbank credit extension, means that the potential claims on the state are increasing. Over time this could erode the state's ability to support less systemically important banks, leading to pressure on mid-tier banks' support-driven IDRs.

China's government currently has substantial resources to address deterioration in the banking sector. The central government's debt/GDP ratio was just 19% in 2012. Meanwhile, the government has demonstrated its willingness in the past to draw on part of its foreign exchange reserves (USD3.7trn in 3Q13) to recapitalise banks. Required deposit reserves of 18%-20% of CNY deposits also could be released in the event of banking sector liquidity strains.

KEY RATING DRIVERS - VIABILITY RATINGS

The VRs of China's 10 mid-tier banks range from 'bb-' to 'b', reflecting varying degrees of weak intrinsic strength (taking into account off-balance sheet activity), concerns about the level and pace of credit growth in the financial system, issues with data integrity and corporate governance, and nascent regulatory and legal systems.

Today's rating actions reflect the relative deterioration in intrinsic strength of MIN and SPDB compared to peers at the same rating level. VRs were affirmed for those entities that did not demonstrate clear improvement or deterioration in such parameters as funding and liquidity, loss-absorption capacity, involvement in off-balance-sheet activities, and franchise strength, relative to similarly rated banks. Fitch took into account situations where capital had been raised (or firm plans are in place to raise equity) by banks to offset rapid growth and maintain loss-absorption capacity at levels in line with similarly rated peers.

The chief drivers behind the VR downgrades were:

-MIN: volatile business strategy; rapid growth; large exposure to microenterprises; high counterparty risk from greater interbank lending, including to some smaller, weaker financial institutions; thinning liquidity; and modest loss-absorption capacity.

-SPDB: high and rapidly rising credit exposure, of which an increasing share resides in non-loan channels; deteriorating liquidity; fast expansion of wealth management product issuance; and low and eroding capital, which in turn constrains loss-absorption capacity.

RATING SENSITIVITIES - VIABILITY RATINGS

Additional downgrades of VRs could be triggered if (absent adequate external or internal capital being raised) 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 the issuance of wealth management products, quasi-substitutes for time deposits, or interbank market distress could also lead to VR downgrades for those entities highly exposed to, or that experience a material increase in, these activities. VR upgrades for China's mid-tier banks, while unlikely over the near term, would be supported by a more manageable and sustainable pace of credit growth, reduced off-balance-sheet activities (or greater transparency around these activities), improved loss-absorption capacity, and stronger deposit funding and liquidity.

Over the medium term, Fitch is concerned about the asset quality of the entire sector given the magnitude of the post-global financial crisis credit boom. The total stock of credit in the financial sector will have tripled between 2008 to 2013, while GDP will have risen only 85%-90%. Nonperforming, special mention, and overdue loans have been rising since 4Q11. However, Fitch believes reported metrics understate the magnitude of impaired credit as larger amounts of credit are informally securitised into wealth management products, passed on to nonbanks, and transformed into private-placement debt securities and interbank claims.

Given 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 mid-tier banks can withstand a rise in impaired credit to the mid-single digits, after which varying degrees of support would be required. However, recognition of asset impairment is likely to 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.

Mid-tier banks' large off-balance-sheet activities and rapidly expanding transactions with nonbanks are also a concern. Non-loan credit now comprises 40% of total financial sector credit outstanding, up from 21% in 2008. Meanwhile, issuance of wealth management products - which stood at an estimated CNY15trn outstanding in 3Q13 - continues to grow as competition for deposits intensifies.

These products are changing the nature of banks' stable, cheap deposit base into one that is more expensive, mobile, and short-term. Wealth management products' short tenors, asset-liability mismatches, and poor disclosure about underlying assets present a significant contingent risk to issuing banks. Mid-tier banks derive a larger share of their funding through these products than state banks.

The full list of rating actions on China's 10 mid-tier banks is as follows:

China Merchants Bank (CMB)

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

-Support Rating affirmed at '2'

-Support Rating Floor affirmed at 'BBB'

-Viability Rating affirmed at 'bb-'

China CITIC Bank (CNCB)

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

-Support Rating affirmed at '2'

-Support Rating Floor affirmed at 'BBB'

-Viability Rating affirmed at 'b+'

China Everbright Bank (CEB)

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

-Support Rating affirmed at '2'

-Support Rating Floor affirmed at 'BBB'

-Viability Rating affirmed at 'b+'

China Minsheng Banking Corporation (MIN)

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

-Support Rating affirmed at '3'

-Support Rating Floor affirmed at 'BB+'

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

Shanghai Pudong Development Bank (SPDB)

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

-Support Rating affirmed at '3'

-Support Rating Floor affirmed at 'BB+'

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

Industrial Bank (IB)

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

-Support Rating affirmed at '3'

-Support Rating Floor affirmed at 'BB+'

-Viability Rating affirmed at 'b'

Ping An Bank (PAB)

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

-Support Rating affirmed at '3'

-Support Rating Floor affirmed at 'BB+'

-Viability Rating affirmed at 'b'

Hua Xia Bank (HXB)

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

-Support Rating affirmed at '3'

-Support Rating Floor affirmed at 'BB+'

-Viability Rating affirmed at 'b'

China Guangfa Bank (CGB)

-Long-term Foreign-Currency IDR affirmed at 'BB+'; Stable Outlook

-Support Rating affirmed at '3'

-Support Rating Floor affirmed at 'BB+'

-Viability Rating affirmed at 'b+'

Bank of Beijing (BOB)

-Long-term Foreign-Currency IDR affirmed at 'BB+'; Stable Outlook

-Support Rating affirmed at '3'

-Support Rating Floor affirmed at 'BB+'

-Viability Rating affirmed at 'bb-'

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