China sees first TLAC bonds

IFR 2534 - 18 May 2024 - 24 May 2024
9 min read
Emerging Markets, Asia
Pan Yue

Industrial and Commercial Bank of China has become the first Chinese bank to sell a total loss-absorbing capacity bond, raising Rmb40bn (US$5.54bn) on Wednesday from a dual-tranche trade that was quickly followed by an almost identical transaction from Bank of China.

TLAC debt can be bailed in when failing banks need to be resolved, allowing them to continue critical operations and maintain financial stability by imposing losses on investors rather than drawing on public funds.

The People’s Bank of China announced its TLAC rules in October 2021, setting the definition, calculation and rules for disclosure, but banks have taken their time to issue ahead of a 2025 deadline for the biggest institutions.

ICBC and Bank of China are classed as global systemically important banks along with Agricultural Bank of China, Bank of Communications and China Construction Bank. They are required to meet TLAC ratios of 16% of risk-weighted assets by 2025 and 18% from 2028. Bocom joined the G-SIB list in November and has a three-year phase-in period.

ICBC's market-opening deal was split between a Rmb30bn 2.25% four-year non-call three and a Rmb10bn 2.35% six-year non-call five. The notes, called TLAC-eligible non-capital bonds, were upsized from an initial target of Rmb30bn.

More than 150 investors participated, including state-owned banks, joint stock banks, rural commercial banks, funds and insurers. A banker on both deals said the majority of the participation was from banks, similar to other onshore senior bond offerings from Chinese financial institutions.

"It's the first TLAC bond, an innovative structure, so many investors want to wait and see the response," said the banker.

Before the deal launched, a Beijing-based source questioned whether insurers would participate because there used to be strict rules on what insurance companies can invest in and they remain quite conservative despite a relaxation of rules in the past few years. She said if the regulator made an explicit announcement that insurance companies are allowed to participate, it would greatly increase their involvement.

Bankers said regulatory concerns were not material but insurance companies were mostly absent because of pricing, which also deterred many institutional investors.

Little premium was paid over ICBC's senior bonds, in line with expectations. Considering the relative seniority, TLAC paper should be priced between Tier 2 and senior notes, but ICBC's deal was priced 2bp–3bp over the comparable senior unsecured bond for the four-year non-call three and around 10bp premium for the six-year non-call five. The notes were around 6bp and 13bp–15bp inside Tier 2 notes.

Low risk

China's Big Five banks are viewed as low risk given likely government support in times of stress.

"We expected the pricing to be tight, but the final pricing is at the lower end of our expectation," said another banker on both deals. "It's the first deal so ICBC tried to squeeze the pricing."

Before the new issue, many analysts had expected the banks to issue in tenors longer than four-year non-call three, which will not be TLAC-eligible by the 2028 deadline, as TLAC-eligible instruments need to have a remaining maturity of more than a year.

"It's a new product so it's better with shorter tenors that will be less difficult to market even though under current market conditions it'll be cheaper to issue longer tenors," said the first banker.

Follow up

ICBC was followed on Thursday by Bank of China, which also sold a Rmb40bn deal with the same pricing. BOC's transaction comprised Rmb25bn 2.25% four-year non-call three and Rmb15bn 2.35% six-year non-call five tranches.

"The market conditions on Thursday were not as good as Wednesday but the market knew that BOC would price at the same level as ICBC," said the second banker.

ICBC and BOC's TLAC bonds are rated Triple A by onshore rating agencies, in line with their issuer ratings.

Agricultural Bank of China is likely to be the next, with the second banker expecting it to tap the market in July or August. He said BOC and ICBC's deals would provide a pricing template for ABC.

"ABC won't price at exactly the same coupon, but it's likely they will use BOC and ICBC's secondary performance as reference, and price at similar spreads over CDB rates or government bond rates," said the second banker, referring to China Development Bank's bonds, which are used as a benchmark.

Testing the market

After the TLAC rules in China were announced in 2021, the PBoC and China Banking and Insurance Regulatory Commission in April 2022 released the framework for TLAC bonds, which clarified TLAC bonds’ seniority and required features. Chinese TLAC bonds will rank below excluded liabilities like deposits but above capital instruments and are required to have writedown or equity-conversion features.

The two regulatory announcements addressed most of the questions about TLAC bonds, and many expected to see the first deal soon after that. But regulators have spent the past two years consulting the market and deciding the details of the terms.

"One of the arguments was whether it should be more similar to Japanese banks' senior holding debt or like European peers' senior non-preferred debt," said the first banker. He said ICBC also started to consult the market and talk to investors about a year ago.

The subordination of the ICBC and BOC notes is realised by contract, which is expected to be applied by the other banks. The five Chinese G-SIBs do not have holding companies.

Banks are expected to use the onshore market for their debut issues due to the cheaper funding costs. Some said banks may tap the US dollar market to maintain their offshore profiles or use TLAC bonds to refinance senior notes. Deputy governor of the PBoC, Xuan Changneng, said in a speech in November 2022 that he encourages Chinese banks to issue TLAC offshore, which some analysts said indicates the government wants to keep the risk in the financial system broadly distributed.

ICBC obtained board approval earlier this year issue to Rmb60bn of TLAC paper onshore in the next 24 months, while BOC, ABC and Bocom plan to issue TLAC notes in renminbi or other currencies. The three banks have respective board approval to issue Rmb150bn by August 2025, Rmb50bn by the end of 2024 and Rmb130bn by the end of 2024. CCB has not made any announcements about TLAC issuance.

Other questions remain, including how deposit insurance should be calculated into TLAC. China allows deposit insurance to be included as TLAC for up to 2.5% of RWAs by 2025 and 3.5% by 2028, but it did not clarify whether the maximum will be applied in each case. By the end of last year, China’s deposit insurance stood at Rmb81bn, which Fitch said only accounted for 0.1% of the sector’s RWAs.

Fitch said in a webinar that excluding the deposit insurance, the five G-SIBs will need to issue Rmb1.6trn by 2025 and Rmb6.2trn by 2028, but if the maximum amount is applied, no issuance will be needed by 2025 and the gap will drop to Rmb1.6trn by 2028.

For ICBC's deal, Citic Securities was lead underwriter and bookrunner. China Securities, China International Capital Corp, China Merchants Securities, Guotai Junan Securities, Huatai Securities, Industrial Securities, China Galaxy Securities, Haitong Securities, BOC International (China), GF Securities, Shengwan Hongyuan Securities, Everbright Securities, Orient Securities Investment Banking, Guosen Securities, Zhongtai Securities and Ping An Securities were joint lead underwriters.

Standard Chartered (China), Deutsche Bank (China) and HSBC Bank (China) were also part of the syndicate.

For BOC's deal, BOC International (China) was lead underwriter. Agricultural Bank of China, China Construction Bank, Bank of Communications, Postal Savings Bank of China, China Citic Bank, China Zheshang Bank, Citic Securities, China Securities, Huatai Securities, China International Capital Corp, Guotai Junan Securities, Shenwan Hongyuan Securities, China Development Bank Securities, China Galaxy Securities, China Merchants Securities, GF Securities, Guosen Securities and SDIC Securities were joint lead underwriters. First Capital Securities was underwriter.