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China's Ping An sells 'Basel bonds' amid doubts how other banks will fare
March 6, 2014 / 11:47 AM / in 4 years

China's Ping An sells 'Basel bonds' amid doubts how other banks will fare

* Ping An Bank sells 9 bln yuan in tier-2 capital bonds

* Chinese banks plan to sell up to 400 bln in ‘Basel bonds’

* Banks need capital to absorb rise in bad loans

* But fund managers wary over lack of liquidity

* Limited demand from banks and insurers

By Gabriel Wildau

SHANGHAI, March 6 (Reuters) - Ping An Bank Co Ltd on Thursday became the first publicly listed mainland Chinese lender to sell special loss-absorbing bonds, but doubts linger about market demand for such debt, which give investors reduced protection against failure.

China’s bank regulator began phasing in new higher capital adequacy requirements last year, in line with the global rules known as Basel III.

Aggressive implementation of Basel III is a key element of Chinese policymakers’ plan to fortify banks against the risks from a slowing economy, and the so-called “Basel bonds” are designed to help China’s banks withstand an expected rise in bad loans.

China embarked on a massive credit-fueled economic stimulus program from 2008 to 2010 in order to pull the economy through the global financial crisis. Many analysts expect a large portion of the bank loans extended during that time to turn sour, with loans to local governments and industries suffering from overcapacity a key source of concern.

While Ping An’s current capital ratios are comfortably above the minimum threshold, the mid-sized bank needs more capital if it wants to expand lending in coming years without running afoul of the rules. It is the the biggest mainland bank to have issued “Basel bonds” so far. Two smaller, unlisted lenders had made earlier issues.

Ping An sold 9 billion yuan ($1.47 billion) in 10-year bonds on Thursday at an average interest rate of 6.80 percent, in the middle of its guidance range of 6.50 to 7.00 percent, according to an announcement on China’s main bond clearinghouse.

The yield compares to a risk-free benchmark of 4.52 percent on 10-year Chinese government bonds and 5.63 percent on non-Basel bonds from a comparable bank, Shanghai Purdong Development Bank.

CITIC Securities was lead manager on the Ping An deal, while Guangfa Securities was joint lead.

LIQUIDITY WORRY

Investors in “Basel bonds” demand a higher yield because they are riskier than other forms of bank debt due to the “write down” provisions that expose investors to losses if the bank gets into trouble.

Though Beijing could be expected to rescue a failing bank, in principle the China Banking Regulatory Commission (CBRC) could force losses onto the bondholders via a write down before offering funds for a bailout.

While Ping An’s issue appeared relatively successful, market watchers pointed out that the bank also relied heavily on sales to its own wealth management clients, casting doubt on to what extent the relatively low interest rate reflects market demand.

Chinese banks, including state-owned giants like Industrial and Commercial Bank of China and China Construction Bank , have announced plans to sell as much as 400 billion yuan in so-called “Basel bonds” in the next two years to boost their capital bases.

There are concerns that demand for all these issues will be disappointing unless yields are sufficiently attractive.

“People are worried that the liquidity isn’t very good,” said Wang Ming, partner at Yaozhi Asset Management in Shanghai. “But, based on the coupon rates, there’s no obvious advantage over other corporate bonds or financial institution bonds.”

Liquidity is important for fund managers, who need to be able to sell bonds quickly to meet redemptions.

Market watchers say that banks are the main investors in “Basel bonds”, with an unspoken understanding between banks that banks will support one another’s issuances.

“There’s an element of shared interest among the banks. The banks say to each other ‘This time you buy mine, and next time I’ll buy yours,'” said Wang.

But there is a limit to how much help banks can provide each other. CBRC rules limit banks investment in “Basel bonds” to no more than 10 percent of their core tier-one capital.

At the same time, insurance companies, which are traditionally among the biggest buyers of riskier long-term bonds, have so far remained on the sidelines. That’s because the China Insurance Regulatory Commission has not yet issued rules permitting insurers to buy “Basel bonds”.

HYBRID CAPITAL

Chinese regulators have traditionally only permitted banks to use equity and retained earnings to shore up their capital buffers. Capital adequacy is a key measure of a bank’s ability to absorb losses from loan defaults, interest-rate swings, and other kinds of risk.

But along with the demand for higher capital levels under Basel III, Chinese regulators for the first time have also permitted banks to issue hybrid securities with characteristics of debt and equity.

In addition to “Basel bonds”, regulators are also preparing rules to allow banks to sell preferred shares.

Ping An’s “Basel bonds” qualify as tier-2 capital under the CBRC’s rules, while only equity and retained earnings qualify as tier-one capital.

Ping An’s total capital adequacy ratio, including tier-1 and tier-2, stood at 9.93 percent at end-September. CBRC’s phase-in schedule for the new capital adequacy requirements calls for mid-sized lenders to meet a ratio of 8.9 percent by the end of this year and 10.5 percent by end-2018. The requirement for the biggest banks is one percentage point higher. ($1 = 6.1282 Chinese yuan) (Editing by Simon Cameron-Moore)

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