Chinese bank sounds AT1 alarm

IFR 2299 7 September to 13 September 2019
6 min read
Emerging Markets, Asia
Carol Chan

Embattled Bank of Jinzhou is set to become the first Asian bank to skip a payment on its offshore Additional Tier 1 securities, reminding investors of the risks associated with loss-absorbing capital instruments from smaller Chinese banks.

Bank of Jinzhou said on September 1 its board had proposed cancelling the dividend on its offshore preference shares for one year from October 27 2018 to October 26 2019 as its capital adequacy ratios had fallen below regulatory requirements. Assuming shareholders approve, that would rule out the next payment, due on October 27.

The news caught investors by surprise, coming after Industrial and Commercial Bank of China and other state investors agreed to buy a stake in the city commercial bank in July.

Analysts said the move would make it harder and more expensive for smaller Chinese banks to issue AT1s in the offshore market.

“AT1 coupon and extension risks will now be front of mind for investors,” said CreditSights in a research note. “Investors will be on their toes now when investing in China, which will engender a flight to size and quality.”

S&P said the event was likely to increase the risk premium for smaller banks, which have issued US$7.5bn of hybrid capital overseas. The rating agency defines small banks as those with less than Rmb1trn (US$140bn) in assets.

“Broadly, it aggravates mid-small banks’ funding-cost issues, with lenders struggling to regain the confidence of investors,” said S&P.

Bank of Jinzhou, which has been under scrutiny since it delayed publication of its 2018 results and said auditor EY had resigned in late May, finally announced its 2018 results on August 30, revealing a net loss of Rmb4.593bn (US$642m) after a surge in impairments. For the six months ended June 30 2019, it reported a Rmb998m loss, versus a Rmb4.229bn profit in the same period last year.

DETERIORATING CAPITAL

The dismal results were somewhat expected, but a missed payment on the offshore AT1s still came as a shock in a market that has long assumed the Chinese government would step in to preserve the stability of the banking system. Chinese AT1s have traded much tighter than their global peers since Bank of China opened the market in October 2014, and investors are watching closely as the first call dates approach for the smaller banks in the next two years.

“For large banks, such as the big six state-owned banks, I don’t think there’ll be any risk of AT1 coupon cancellation or a non-call event, but for smaller city commercial and rural commercial banks, investors will need to rethink the potential risks,” said the head of fixed income at a Chinese investment bank.

“There’ll be more credit differentiation among Chinese bank AT1s and smaller banks will need to pay more premium over large banks’ AT1s going forward,” the banker said.

Indeed, in the past two years, several small Chinese lenders have priced US dollar AT1s in a 5.45%–5.60% range, with practically no differentiation between the credits. A large portion of these AT1s are cross-held by peer banks in China, according to S&P, along with other domestic investors.

Nomura’s trading desk said in a note to clients that none of the other small banks with offshore AT1s are at risk of suspending coupon payments at present, as none have made sizeable losses and all are still reporting capital ratios above regulatory requirements. However, it stopped short of recommending an investment.

“Current valuations still do not, in our view, adequately compensate investors for the coupon cancellation (as well as extension) risks of AT1s, especially now that we have a clear precedent for a Chinese bank cancelling AT1 coupons”, analyst Nicholas Yap wrote.

WRITEDOWN RISK

Bank of Jinzhou reported a core Tier 1 ratio of 5.14% at the end of June, down from 6.07% six months earlier and well below the regulatory requirement of 7.5%.

That puts the Liaoning-based lender within a whisker of the 5.125% trigger, at which point the AT1 securities will be mandatorily converted into H-shares – again an unprecedented event in the Asian bank capital market.

But CreditSights said it does not expect Jinzhou’s AT1s will be written down, noting that the introduction of state-owned investors suggested that the authorities will provide support to the bank.

ICBC, China Cinda Asset Management and China Great Wall Asset Management in late July agreed to buy a stake in Bank of Jinzhou from existing investors, assuaging concerns that it would become the next lender to be taken over by the state after regulators took control of Baoshang Bank in May.

Jinzhou’s US$1.496bn of 5.5% Additional Tier 1 bonds, callable in 2022, fell more than 20 points on September 2 and continued to slide during the week. They were quoted at 55/75 on Friday morning, according to Tradeweb.

Other small Chinese banks’ offshore AT1s also dropped by a few points on the news, as analysts saw the rapid deterioration as further evidence that China’s smaller banks are in a precarious position.

“The speed by which capital could erode to the point of falling short of the minimum regulatory requirements so quickly that led to the dividend stopper reinforces or builds suspicions that it may not take much to knock these smaller banks over, even if most are currently meeting the regulatory floors,” said CreditSights.

Jinzhou’s stock tumbled by 17% to HK$5.80 on Monday after a five-month suspension, following the belated publication of its 2018 annual results. The shares were last seen at HK$5.50 on Friday.

Bank of Jinzhou