* China banks turn to hybrid securities to boost capital
* Banks prepare for slowing economy, rising bad loans
* Pressure from Basel III capital rules drives fundraising
* Investors concerned on yield, liquidity, economic risk
By Gabriel Wildau and Lawrence White
SHANGHAI/HONG KONG, May 21 Chinese banks are
poised to raise a record $120 billion in the next two years to
shore up their balance sheets in the face of slowing growth and
rising bad debts, but the funds could prove expensive and hurt
earnings as investors demand a premium.
For the first time, banks will raise capital by issuing
preference shares and other so-called hybrid securities, a
funding technique that avoids the need for issuing ordinary
shares into a badly hit stock market.
Just in the past two weeks, Agricultural Bank of China
and Bank of China
announced plans to raise about $29 billion in preferred shares
As growth slows and bad debts build up, the banks are
rushing to replenish their balance sheets to meet new global
capital rules known as Basel III. The Chinese government has
been rigorously enforcing these regulations in its efforts to
ward off a financial crisis following a huge run-up in debt
since 2008 and a marked slowdown in the economy.
Analysts say the flood of regulatory capital will help
investors diversify their portfolio, but they are expected to
drive a hard bargain given the concerns about transparency in
China's opaque financial system and the worrying rise of toxic
debt in recent years.
"Given the size of the proposed capital issues and the
concerns about transparency in the Chinese banking system, it
may be hard to price aggressively versus the western structures
currently out there," said Ivan Vatchkov, chief investment
officer of Algebris Investments (Asia).
The first few deals should give banks an idea of returns
that investors will demand on hybrid capital securities.
China CITIC Bank International, a Hong Kong-based affiliate
of China CITIC Bank , in April sold capital
securities in the offshore market at an interest rate about 100
basis points over the same bank's subordinate bonds.
Benchmark five-year subordinate debt from China's top-rated
banks currently trades at a yield of 5.25
percent, suggesting banks will have to price yields at around
6.3 percent for preferred shares to lure investors - a side
effect of an economy growing at its slowest pace in decades.
PRESSURE ON LENDING, EARNINGS?
Some analysts warn that forcing banks to pay hefty yields on
new hybrid capital instruments would not only pressure their
profitability, but also threaten their ability to continue
lending aggressively as bad loans rise in a slowing economy.
Chinese banks' non-performing loan figures rose to a two-year
high at the end of 2013, according to official data.
However, the risk that investors may lose their money in a
potential banking collapse is slim as many of the state firms
have an implicit government guarantee - a back-stop that is
similar to a deposit guarantee scheme, which China is planning
to introduce later this year in line with a market reform drive.
Total assets of China's banking industry reached around $24
trillion at the end of 2013, according to the China Banking
Regulatory Commission -- at more than twice the size of the
country's economy it shows why investors are confident the
government will prevent a Greek-type debt crisis from ever
China's big four lenders enjoy the equivalent of single-A
ratings from credit ratings agencies such as Standard & Poor's
and can fund relatively cheaply in the straight bond markets.
Investors in preference shares, however, demand a premium
for the added risk that they may see their holdings converted
into common equity if the bank's capital ratio falls below the
"A price discovery process has to take place for first time
issues. Those investors who have more conservative investment
policies might also adopt a more cautious stance towards such
instruments," said Angus Hui, fund manager at Schroders
In April, China unveiled rules on commercial bank issuance
of preferred shares, paving the way for lenders to begin
fundraising designed to enable them to withstand an expected
rise in bad loans.
In all, analysts estimate China's lenders are likely to
raise at least $55 billion through these bond-like products in
the next two years.
That is on top of plans to raise up to $64 billion in Basel
bonds that banks have previously announced, taking the total to
almost $120 billion over two years - the most ever raised by
Chinese banks over such a time frame, Thomson Reuters data show.
Raising funds in a weak stock market is not an attractive
option for banks, as it would be expensive and would dilute
The Shanghai Composite Index has tumbled 13 percent in the
(Additional reporting by Steve Garton at IFR and Shanghai
Newsroom; Editing by Denny Thomas and Shri Navaratnam)