Smaller banks stung by drop in capital bond sales

Threading caution: People play checkers outside a Baoshang Bank branch in Beijing. Tier-2 notes from the bank were written off in 2020 after it as taken over by Chinese authorities. - Bloomberg

BEIJING: Chinese lenders have been a refuge from the crisis of confidence that gripped banks globally. But a corner of the country’s credit market has been showing that smaller lenders aren’t without some challenges of their own.

The 954 billion yuan (US$139bil or RM612bil) market for capital bonds from China’s city and rural commercial banks started showing strains before the recent collapse of some lenders in the United States and Europe.

Issuance by those mainland banks of Additional Tier-1 (AT1) or Tier-2 notes slid 70% from a year earlier in January through March to the lowest quarterly level since 2019, according to data compiled by Bloomberg.

The regional lenders’ average capital adequacy ratios were more than 12% as of Dec 31, official data from China’s banking regulator show, above authorities’ 10.5% target.

But some firms will face capital pressure if the bond-issuance slump persists, potentially threatening financial stability and undermining the lenders’ ability to support the government’s economic-growth efforts.

“The main problem for small and medium-sized banks now is that localities want them to both put more loans to help the real economy and support local urban-investment companies while not having enough capital,” according to Shujin Chen, head of China FIG research at Jefferies Financial Group Inc. That as local governments face fiscal difficulties of their own, she said.

AT1 and Tier-2 bonds are key channels for Chinese banks to maintain sufficient capital ratios. But they’re considered among the riskiest debt sold by lenders since they can be written down if an issuer suffers significant stress.

The recent failure of Silicon Valley Bank and wipeout of Credit Suisse Group AG’s AT1 bonds reminded investors of the risks.

In 2020, Tier-2 notes from Baoshang Bank Co were written off after the company was taken over by Chinese authorities.

Behind this year’s evaporated demand for the capital bonds – which fellow lenders are major buyers of – include looming regulatory changes on risk weightings for commercial banks’ debt holdings and some firms’ surprise decisions to not redeem Tier-2 debt, according to analysts.

In China, investors expect issuers to redeem the notes on their first call date.

Meanwhile, investors are seeking higher risk premiums amid concerns about real estate loans and regional government debt, said Li Han, a fixed-income analyst at Citic Securities Co.

Average coupons on AT1 and Tier-2 bonds sold by smaller Chinese banks in 2023 have risen 35 basis points from the fourth quarter to 5.01%, the highest in two years according to Bloomberg-compiled data.Asset quality and capital levels have deteriorated at smaller lenders because of China’s slowed economy during the pandemic, said S&P Global Ratings analyst Michael Huang.

Though the government has a “high supportive attitude” for the sector, he added some banks could fall into crisis if that support becomes selective.

China’s regional lenders have more than 100 trillion yuan (RM64 trillion) of assets, according to government data, nearly one-third of the sector’s total.

Such banks’ bad-loan ratios are often higher than at the country’s giants because more of the smaller firms’ lending leans toward uncompetitive local companies and government pet projects.

There were 43 issuers that didn’t call a combined 52 of Tier-2 bonds as of late March, Tianfeng Securities Co analyst Sun Binbin wrote in a report last week.

Some aren’t doing so because redeeming the notes would lower capital levels, he said, and as a result smaller banks “might face greater difficulty” replenishing capital in the future.

Non-redemptions are happening elsewhere as well. Two German lenders said they won’t call AT1 bonds later this month as refinancing such notes got more expensive globally after the Credit Suisse wipeout. — Bloomberg

Capital bond issuance has also slowed at China’s six banking giants, dropping 32% in the first quarter to a two-year low of 150 billion yuan (RM96bil), according to Bloomberg-compiled data.

All the activity occurred in the final days of March amid efforts to rebuild capital following record new-loan activity to start this year.

The recent lack of new issuance by city and rural commercial banks might push them to other capital-replenishment options like selling new shares or convertible notes.

Meanwhile, some local governments have historically sold special bonds to fund capital injections at smaller lenders. — Bloomberg