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Friday, 19 April 2019

Test case

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The first Chinese bank to sell Additional Tier 1 securities since the introduction of Basel III standards has paved the way for more key capital raisings from Asia’s biggest banks.

Rice saplings are seen in test tubes at the Beijing Genomics Institute in Shenzhen, southern China.

Test case

Source: REUTERS/Bobby Yip

Rice saplings are seen in test tubes at the Beijing Genomics Institute in Shenzhen, southern China.

Introducing the concept of loss-absorbing Tier 1 capital to Asia was never going to be straightforward, but Citic Bank International, a Hong Kong subsidiary of China Citic Bank, was determined to be the first to do so.

Before Citic’s US$300m deal in March, no Asian bank had braved the US dollar market with an offering of Basel III-compliant Additional Tier 1 capital, setting the scene for an important test of investors’ appetite – both for the issuer and the format.

As per Basel III requirements, the AT1 bonds will be permanently written, in part or in full, if the Hong Kong Monetary Authority deems Citic Bank International to be no longer viable – an event that carries no numerical trigger. The perpetual notes are callable with a rate reset after five years, but carry no step up in coupon. Coupon payments are non-cumulative and may also be stopped if the bank runs into trouble.

That structure matched Hong Kong’s interpretation of Basel III requirements, but earned Citic a relatively low Ba3 rating from Moody’s – four notches below Citic Bank International’s standalone rating of Baa2 from Moody’s and BBB from Fitch.

While the global standard for AT1 requires a three-notch penalty, the rating agency deducted an additional point for the uncertainty over SAR’s interpretation of non-viability, noting that the Hong Kong Monetary Authority has not defined the point at which a bank becomes non-viable.

Joint global co-ordinators Citigroup, HSBC and RBS marketed the deal alongside bookrunners ANZ, BBVA and CLSA (now a Citic Group company).

“The HKMA is relatively savvy about adopting new capital market instruments, including Basel III-qualifying securities.”

To compensate for the additional risks, as well as for the uncertainties attached to any new product, the bookrunners began collecting orders at a relatively high yield of 7.75%. That offered about 200bp over China Citic’s outstanding 6% Tier 2 bonds, which rank higher in the capital structure and come with no contractual loss-absorption clauses, since they were issued under Basel II rules.

Investors flocked to the deal, with orders climbing north of US$5.7bn from 260 accounts, and allowing Citic to pull the yield tighter to price at 562.7bp over US Treasuries, an all-in yield of 7.25%.

That price already showed that Asian banks could price inside their European peers on a relative value basis, since European AT1s typically offer around 200bp over T2 bonds. Citic’s AT1s jumped two points in the secondary market on their first day of trading, pushing the yield to 6.78%, and have continued to climb since launch as more investors warm to the format, touching 105 in early August for a yield of 6%.

Chong Hing Bank, which operates in Hong Kong, but is under the control of the Guangdong government’s Yuexiu Enterprises, priced its own US$300m AT1 issue in September at a yield of 6.5%, following a very similar format to Citic.

Chong Hing’s notes received a Ba2 Moody’s rating, three notches below its senior score and one above Citic’s securities.

The next big test will come from two of China’s largest state-owned banks, which are preparing to market offshore deals, where China’s banking regulator – not the HKMA – will decide on the point of non-viability.

Bank of China and Industrial and Commercial Bank of China are looking to sell a combined US$12.2bn of Basel III-compliant AT1 preferred shares overseas, with the first deal slated for next month.

Citic’s AT1 does not include a mainland China trigger and qualifies only as capital in Hong Kong.

“The HKMA is relatively savvy about adopting new capital market instruments, including Basel III-qualifying securities. The adoption takes longer in domestic China, which needs approval from both the securities and banking regulators,” said a banker close to the Citic trade. “That’s why the Hong Kong subsidiary went ahead first.”

Had Citic waited for others to set the precedent and launched in September, it may have saved on its cost of funding, but the deal provided an important test case for the HKMA’s Basel III rules, and paved the way for other lenders to follow.

The significance of the deal as a precedent will only grow. Fitch expects the big five Chinese banks to issue US$20bn in AT1 and T2 capital before the year ends. The rating agency estimates that Indian banks will need to issue around US$90bn of AT1s and raise a combined US$200bn of new capital come 2019.

To see the digital version of this report, please click here.

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