April 14, 2014 / 3:17 AM / 3 years ago

Fitch Assesses HK's First Basel III Additional Tier 1 Instrument

(The following statement was released by the rating agency) HONG KONG, April 13 (Fitch) Fitch Ratings assesses the risk in securities such as China CITIC Bank International Limited's (CNCBI; BBB/Stable/bbb) upcoming Additional Tier 1 (AT1) bond - the first issuance by a Hong Kong bank of that kind - to be equivalent to five notches below the banks' anchor rating. For CNCBI, the anchor rating is its Viability Rating (VR) of 'bbb', which would result in a 'B+' rating for its notes if Fitch were to rate them. This compares to the 'BBB-' rating assigned to the bank's recent Basel III Tier 2 issue, which was notched once from the anchor rating (refer to "Fitch Assigns CNCBI's USD Basel III-Compliant Notes 'BBB-' Final Rating", dated 5 November 2013). Fitch expects further AT1 securities to be issued over the next 12-18 months by Hong Kong banks to support their asset growth and the structure of this transaction to be broadly followed for other AT1 deals. The much wider notching relative to the Tier 2 instruments reflects the very high risk attached to non-performance as well as poor recovery prospects due to a going-concern loss absorption feature that can be activated prior to the point of non-viability (PONV). The Tier 2 instruments would need to absorb losses only when the PONV is triggered. Fitch breaks the notching into three notches for non-performance risk as coupon payments are fully discretionary and two for loss severity due to the instruments' poor recovery prospects. Fitch's criteria provides for even wider notching for non-performance risk than would have been the case for CNCBI. The degree of notching would depend upon the terms and conditions of the instrument being issued and bank's flexibility in limiting non-performance risk. CNCBI's instrument gives management full discretion to omit coupon payments in addition to mandatory deferrals prior to PONV due to insufficient distributable reserves and mandatory deferrals at the PONV. Fitch does not see higher incremental risk as CNCBI, and Hong Kong banks in general, maintain prudent margins above required capital levels. Fitch-rated Hong Kong banks' common equity Tier 1 ratios exceeded the 7% minimum requirement (4.5% common equity and 2.5% capital conservation buffer required to be met by 2019) by 3-12 percentage points at end-2013. CNCBI's common equity Tier 1 ratio was 10.10%, which gives a HKD4.7bn buffer above the 7% minimum without considering an increase in risk-weighted assets. The typical anchor for AT1 securities is an issuer's intrinsic strength as Fitch would generally not factor in external support for this type of instrument. Only if the agency was convinced that support from a parent would be made available to its Hong Kong subsidiary would the subsidiary's AT1 securities be notched from the parents' VR. The poor recovery prospects relative to senior unsecured instruments stem from the instrument's deep subordination. The write-off trigger is the familiar regulatory PONV that was previously used in transaction documents for subordinated Tier 2 notes. In the same spirit, CNCBI's AT1 notes can be written down in full or in part if the Hong Kong Monetary Authority considers this step necessary to maintain its viability. Fitch's base case is that such AT1 notes would highly likely be written down in full before Tier 2 instruments would be written off given the AT1 securities' deeply subordinated status - hence two notches for loss severity. CNCBI's PONV trigger is in contrast to AT1 securities issued in other jurisdictions where generally specific capital ratio triggers apply. Once these triggers are reached, there will be a full write-off or equity conversion. Only The Hongkong and Shanghai Banking Corporation Limited (AA-/Stable/aa-) and The Bank of East Asia, Limited had legacy Tier 1 hybrid securities outstanding that count towards Tier 1 capital at end-2013 - HKD37bn for the former and HKD3bn for the latter, which are equivalent to about 1% of their risk-weighted assets. Basel III-compliant instruments with PONV issued by Hong Kong banks thus far have been limited to an aggregate HKD16bn of subordinated debt. More details on how Fitch assesses risks in bank subordinated and hybrid securities are in "Assessing and Rating Bank Subordinated and Hybrid Securities Criteria", dated 31 January 2014. For Hong Kong banks' Basel III securities in particular, refer to "Hong Kong Banks: Notching Approach for Basel III Instruments", dated 11 July 2013. The two reports are available at www.fitchratings.com. Contact: Chikako Horiuchi Director +852 2263 9924 Fitch (Hong Kong) Limited 2801, Tower Two, Lippo Centre 89 Queensway, Hong Kong Sabine Bauer Senior Director +852 2263 9966 Ivan Lin Associate Director +852 2263 9984 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. Additional information is available on www.fitchratings.com 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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