Fitch Affirms China's 5 State Banks at 'A'; Outlook Stable

Fri Sep 5, 2014 6:36am EDT

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(The following statement was released by the rating agency) HONG KONG/BEIJING, September 05 (Fitch) Fitch Ratings has affirmed the Long-Term Foreign-Currency Issuer Default Ratings (IDRs) of China's five large state-owned commercial banks at 'A' with Stable Outlooks. The Short-Term IDRs were affirmed at 'F1'. All other ratings of the five large state banks were also affirmed. A full list of the rating actions is at the end of this commentary. The five banks are: Industrial and Commercial Bank of China (ICBC), Bank of China Ltd (BOC), Agricultural Bank of China Limited (ABC), Bank of Communications (BCOM) and China Construction Bank Corporation (CCB). The review of the state banks' ratings took into account their 1H14 results, which highlighted the challenging operating and economic environment, with slower profit growth and higher impairment charges. To help offset this, the banks have given more focus to potentially riskier - but higher yielding - segments. As expected, the banks' reported NPLs and overdue loans continued to increase, though the increases are not as sizable as those at the mid-tier banks. Most state banks have announced plans for preference shares and/or subordinated debt issuance to replenish their capital and build buffers to help weather further deterioration in the operating environment and/or compensate for increases in risk appetite. KEY RATING DRIVERS - IDRS, SUPPORT RATINGS, SUPPORT RATING FLOORS All of the Long-Term IDRs are based on state support, and are at the banks' Support Rating Floors, reflecting an extremely high probability of extraordinary support from the central government in the event of stress. The state-owned commercial banks Support Ratings (SR) of '1' and Support Rating Floors (SRF) of 'A' reflect their systemic importance and thus an extremely high propensity for the state to support them, if required. Combined, the banks account for 45% of sector assets and are viewed as pivotal to the financing of China's economy. All state banks are expected to be designated as domestic systemically important financial institutions (SIFIs), while two of them (ICBC and BOC) are already designated as global SIFIs. The central government is the largest shareholder of all five state banks, and has a track record of providing solvency and asset quality support to the banks. Consequently, the banks' SRFs remain closely linked to China's sovereign rating (A+/Stable). As support is not expected to diminish in the foreseeable future, the Outlook on the IDRs remains Stable. RATING SENSITIVITIES - IDRS, SUPPORT RATINGS, SUPPORT RATING FLOORS Any changes to IDRs, SRs and SRFs will be tied to shifts in the central government's propensity and/or ability to support these banks. Persistent rapid growth across the financial system (including nonbank credit extension) means that potential claims on the state continue to increase. By Fitch's estimation, total credit (the central bank's measure of total aggregate finance as adjusted by Fitch) to GDP was 242% at end-1H14. The government still has substantial resources to address deterioration in the banking sector as central government debt/GDP was around 16% at end-1H14. In that regard, the government has previously drawn upon its foreign exchange reserves (USD4trn at end-1H14) to recapitalise the state banks. Nevertheless, the longer financial system leverage is permitted to rise, the greater the potential erosion of the state's ability to support the banks, leading to pressure on support-driven IDRs. However, Fitch believes that absent any negative action on the sovereign rating, support for the state banks is less likely to diminish than would be the case for other Chinese commercial banks. KEY RATING DRIVERS - VIABILITY RATINGS The Viability Ratings (VRs) of China's state banks are in the 'bb' category and remain the highest in the sector. They take into account the challenging operating environment, which the state banks are best placed in China to navigate given their large nationwide franchises and experienced management. Relative to other Chinese commercial banks, the state banks generally exhibit superior funding and liquidity, smaller credit exposure and off-balance-sheet activities, and higher loss-absorption capacity. In Fitch's view, the state banks would likely most benefit from depositor flight to safety, providing some support to their VRs in a stress scenario. While key financial metrics of the state banks appear comparable to highly rated banks in developed markets, many aspects of the state banks' financial profiles (for example, capitalisation, profitability, liquidity and off-balance sheet exposures) do not compare as well with major banks in other emerging markets, where, as in China, risks tend to be higher. Given the pace of credit growth and potential risk (including influence from authorities to extend credit in support of public policy), the state banks have struggled to boost capitalisation (or reduce leverage) and maintain strong risk buffers. This will be tested further when full interest rate liberalisation is introduced. Eventual asset quality deterioration and/or margin erosion is common in emerging markets that have experienced rapid accumulation of credit over a sustained period. Various reported measures in relation to asset quality (including non-performing, special mention and overdue loans as well as asset sale/write-offs) have been rising in recent years. Moreover, as in other banking systems that have grown rapidly for a sustained period, Fitch expects asset quality to deteriorate in the coming years. That said, reported asset quality metrics may benefit from informal/ordinary support from authorities to minimise defaults in the system, securitising credit into wealth management products (WMPs), offloading credit to nonbanks, and classifying credit as debt securities or interbank claims. Fitch's analysis of asset quality focuses more on loss-absorption capacity (including factors such as capitalisation, loan loss reserve coverage, and profitability) than loan classification data. In this regard, provision coverage ratios were all lower in 1H14 as provisioning did not keep pace with the growth in NPLs, even as more NPLs were written off or disposed during 1H14. Fitch's stress tests imply that the state banks can withstand a rise in impaired credit equal to around 6%-8% of total credit exposure, after which some form of state support or regulatory intervention may be required. However, recognition of greater asset impairment may only come after the banks have built up further buffers, credit/economic growth is deemed sustainable by China's authorities, and/or the system is viewed as less vulnerable to contagion. Alternatively, the state may assume certain exposures to prevent banks from incurring large impairment charges. Until such time as asset quality is addressed in a more permanent manner, rising delinquencies could weigh on liquidity and cash buffers from time to time. Although China's banking system has been accumulating large off-balance-sheet exposures, including through transactions with nonbanks, and such transactions are not always transparent about with whom ultimate risks resides, the state banks are considered to be less exposed to such activities than other Chinese commercial banks. Non-loan credit accounted for 35% of total financial sector credit outstanding at 1H14 (2008: 21%). WMPs outstanding were CNY12.7trn at 1H14, according to the China Banking Regulatory Commission, and these products continue to grow as competition for deposits intensifies, leading to an increase in the cost - but shortening of tenor - of bank funding. WMPs' short tenors, asset-liability mismatches and limited disclosure of underlying assets have the potential to pose meaningful contingent risk to the banks. So far this year net interest margins (NIMs) are little changed for all except BCOM, whose improved loan/investment yields were insufficient to offset higher deposit funding costs arising from BCOM's weaker retail deposit franchise. Core capital ratios were also broadly flat to higher, but banks are also implementing the internal ratings-based approach for the calculation of risk weights, and this will impact reported capital to varying degrees. However, tangible common equity/tangible assets is little changed despite higher off-balance sheet exposures, meaning total leverage remains high by emerging market standards. While the banks are audited, local requirements for disclosure and accounting detail could be enhanced relative to other highly rated jurisdictions and bank systems. Should Chinese authorities (as key stakeholders or owners) influence bank risk appetite, it could potentially overshadow strategic decision making, governance and risk management. Consequently, while this can constrain the VRs of the state banks, it further underpins prospects of ordinary and extraordinary support from the same authorities, which can be made available in various forms. RATING SENSITIVITIES - VIABILITY RATINGS VR upgrades for the state banks, while not anticipated in the near term, are possible if Fitch considers the operating environment to have stabilised. This would likely be evidenced by the pace of credit growth slowing to a more sustainable level, off-balance-sheet activities reducing or being less of a concern (including due to greater transparency around such activities), greater confidence that reported asset quality ratios will hold, or the banks having improved loss-absorption capacity (building risk buffers such as raising of additional capital) and/or strengthened their deposit funding and liquidity. Downgrades of VRs could be triggered by further excessive growth, which renders capital more vulnerable to deterioration, if asset quality deterioration undermines solvency, or if funding and liquidity strains become more binding. The latter could be manifested in market dislocation, such as abrupt disruption in issuance of WMPs - often substitutes for deposits - or interbank market distress, particularly if a bank is more exposed to such activities than its peers. Although much of the sector benefits from a degree of ordinary support from Chinese authorities in the form of forbearance, whether in relation to on/off balance sheet exposures or strict interpretation of prudential limits, the state banks arguably benefit most. However, if this was to reduce, VRs could come under pressure as vulnerabilities would become further exposed. SUBSIDIARY AND AFFILIATES - KEY RATING DRIVERS AND SENSITIVITIES Amipeace Limited is a wholly owned special purpose vehicle (SPV) of Bank of China Group Investment Limited in Hong Kong, while CCBL Funding Plc is a wholly owned SPV of China Construction Bank (London) Limited. Both SPVs were established with the sole purpose of undertaking offshore debt issuance of their parent entities. As wholly owned subsidiaries, Fitch expects both SPVs would receive very strong support from their ultimate parents in the mainland in the event of repayment strains. In fact, current senior debt issuance by Amipeace Limited is guaranteed by BOC's Macau branch, while CCBL Funding Plc's debt is guaranteed by CCB. Hence, the Long- and Short-Term Ratings of these instruments are derived from those of their parents at 'A' and 'F1'. The full list of rating actions on China's five large state banks are as follows: Agricultural Bank of China Limited: - 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- ' Bank of China Ltd: - 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' - Senior unsecured medium-term note programme affirmed at 'A'/'F1' - Senior unsecured Bons a Moyen Terme Negociables (BMTN) programme Long-Term Rating affirmed at 'A(EXP)'. - Chinese yuan senior unsecured note (issued by Bank of China Taipei Branch) affirmed at 'A' /'AA+(twn)' - Chinese yuan senior unsecured note (issued by Bank of China Paris Branch) affirmed at 'A(EXP)' Amipeace Limited - Senior, guaranteed medium-term note programme affirmed at 'A' - USD600m 2% guaranteed notes due 2016 affirmed at 'A' Bank of Communications: - 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 Corporation: - 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 - Senior, guaranteed medium-term Chinese yuan bonds affirmed at 'A' Industrial and Commercial Bank of China: - 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' Contact: Primary Analyst Jonathan Cornish Managing Director +852 2263 9901 Fitch (Hong Kong) Limited 2801, Tower Two Lippo Centre 89 Queensway, Hong Kong Secondary Analyst (BOC, CCB) Katie Chen Associate Director +86 10 6533 0606 Secondary Analyst (BCOM) Jack Yuan Associate Director +86 21 2028 9898 Secondary Analyst (ICBC, ABC) Benjamin Lin Associate Director +86 21 2028 9898 Committee Chairperson James Watson Managing Director +7 495 956 9901 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. ICBC DID NOT PARTICIPATE IN THE RATING PROCESS, OR PROVIDE ADDITIONAL INFORMATION, BEYOND THE ISSUER'S AVAILABLE PUBLIC DISCLOSURE. Additional information is available at www.fitchratings.com. Applicable criteria, "Global Financial Institutions Rating Criteria" dated 31 January 2014, "Assessing and Rating Bank Subordinated and Hybrid Securities" dated 31 January 2014, and "Rating FI Subsidiaries and Holding Companies" dated 10 August 2012, are available at www.fitchratings.com. Applicable Criteria and Related Research: Global Financial Institutions Rating Criteria here Assessing and Rating Bank Subordinated and Hybrid Securities Criteria here Rating FI Subsidiaries and Holding Companies here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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