* Banks may sell up to US$25bn in capital bonds
* Bank of China, ICBC lining up AT1s for September
* Flood of bonds likely to reprice high-yield sector
By Lianting Tu
SINGAPORE, Aug 29 (IFR) - An anticipated deluge of bank capital bonds from China’s biggest lenders is expected to change the makeup of Asia’s G3 high-yield market, as investors sell PRC property credits in exchange for similarly yielding Additional Tier 1 securities.
Bank of China and Industrial and Commercial Bank of China are preparing to sell Basel III-compliant AT1 preferred shares in the offshore markets in September.
China’s three other mega banks are likely to follow in the near future. Each deal is expected to be in the neighbourhood of US$5bn or more, meaning the total size of the first batch of AT1s may easily top US$20bn-$25bn. Total AT1 issuance from China’s 16 leading banks should exceed US$100bn eventually based on 1% of their risk-weighted assets, Morgan Stanley said in an August 22 report.
Private-bank investors, which own much of Asia’s high-yield debt, are expected to reposition their portfolios to make room for the flood of new securities, market participants said.
That means money managers may begin to trade out of Chinese property credits, the largest component of the PRC high-yield market, to buy the new bank capital bonds, sources said.
“Some people view Chinese AT1 paper as substitution for high-yield corporate bonds and they would prefer to hold AT1s from Chinese banks over property companies,” said a senior Hong Kong-based FIG banker.
Bank of China is expected to be the first PRC lender to come to market. The bank has shortlisted eight banks, including top choice Bank of China International, for an offshore AT1 of up to $US6.5bn. ICBC, expected to be second to market, has mandated seven banks for its transaction.
Agricultural Bank of China was mandating banks for a similar deal, market sources said, but there were no details yet on offerings from either China Construction Bank or Bank of Communications.
Under Basel III rules, AT1 capital is undated and loss absorbing, and can be written down or converted to equity when a bank’s common equity Tier 1 ratio drops below 5.125%. AT1 holders may also face the risk of coupon or dividend deferral.
Rating agencies consider AT1s to be high-yield securities. Moody‘s, for example, has rated Chinese AT1 paper three notches below banks’ standalone ratings to account for the subordination and coupon or dividend-skipping risks.
As the standalone ratings for BOC and ICBC are Baa2, a three-notch cut would make them Ba2, equivalent to a Double B rating from Standard & Poor‘s.
The rush of AT1 instruments could also lead to a repricing in the high-yield market, depending on where the bonds price.
Double B rated bonds trading at yields of 6.5%-7.0%, and mainly PB owned, could feel the pressure, Nomura said in a research report last week. These bonds include corporate perpetuals, Chinese high-yield industrials and property bonds, according to Nomura.
If the AT1s are well received, Morgan Stanley’s “bull case” is they fetch yields of 6%-7%. However, the fair value yield should be closer to 7%-8%, Morgan Stanley said. Double B property bonds currently trade at 6%-7%.
“One of the key things is the pricing level for the AT1s,” the FIG banker said. “If they came in tight, then they wouldn’t be attractive, compared with yields on other high-yield paper.”
At least one Singapore-based high-yield trader expects the AT1 supply to widen spreads on outstanding high-yield bonds.
“It’s hard to quantify the effect, but 1% [widening on Asian high-yield bonds] sounds like a good number.”
One comparable for the forthcoming AT1s is China Citic Bank International’s US$300m perpetual non-call five AT1 sold last March, the first and only US dollar AT1 from an Asian bank. Moody’s sees China Citic’s bonds as Ba3, three notches below its standalone rating.
China Citic’s AT1s priced to yield 562.7bp over US Treasuries, an all-in yield of 7.25%. The securities recently were quoted to yield only 6.2% in the secondary market.
Private banks are expected to be the main group of investors rotating out of existing holdings to buy the new bank capital. Market participants said the banks, which represent Asia’s high-net-worth individuals, are likely to be attracted to high-yielding securities from big state-owned Chinese banks, which many clients do not expect to fail.
About 40% of Asian private bank investments are in bank paper, a Singapore-based DCM banker said. Private banks are also expected to sell senior bank bonds to buy the higher-yielding sub paper.
Still, institutional investors, including mutual funds, pension funds, insurance companies and sovereign wealth funds, are likely to be keen AT1 buyers as well.
“Things have changed much in the last two years,” the FIG banker said. “PBs will be involved, but it will be mainly institution-driven.”
Indeed, institutional investors, with mandates including preferred shares, are likely to buy heavily, according to a Singapore-based fixed-income portfolio manager.
“The market will be liquid enough to absorb the AT1 paper. There is a lot of cash around. The bonds could be well supported,” the portfolio manager said.
Nonetheless, Chinese banks, which easily have enough capital to meet the PRC’s current bank capital requirements, are under pressure to raise capital to support their asset growth.
“All Chinese banks have significant ongoing capital needs as they grow their balance sheet at annual rates of mid-double digits,” said Stephen Long, managing director, financial institutions group at Moody‘s.
BOC’s T1 capital adequacy ratio at the end of the first half was at 9.37%, but lower than the 9.5% target systemically important banks in China are required to meet before the end of 2018. The T1 CAR for Agricultural Bank of China is even lower at 8.65%. (Reporting by Lianting Tu, editing by Abby Schultz, Timothy Sifert, Julian Baker)