Chinese perpetual bonds: capital idea

Bank of China’s landmark onshore perpetual bond deal opens up a new fundraising avenue for the capital-strapped banking sector.
When the credits roll on 2019, there is one bond offering that will almost be certainly viewed as one of the year’s defining transactions and that is last Friday’s Rmb40billion ($5.9 billion) perpetual by Bank of China. 
 
The deal was symbolic on a number of levels, not least because it has created an important new financing option for Chinese banks as they seek to bolster their capital ratios to meet tougher regulatory minimum levels and boost private sector lending.  
 
Prior to Friday, Chinese banks could raise additional tier 1 capital (AT1) onshore, but they had to do so in preference share format, which necessitated shareholder and China Securities Regulatory Commission (CSRC) approval. 
 
The previous regulations also limited Rmb-denominated issuance to financial institutions, which were listed in China. This ruled out Hong Kong-listed entities such as Huarong and Cinda not to mention banks, which are not listed anywhere at all such as Shanghai Pudong Development Bank and Industrial Bank.
 
The new rules widen the net to all financial institutions and allow them to issue without seeking CSRC approval first. Other new regulations also support issuance by boosting secondary market liquidity and the prospective investor base. 
 
These include the People’s Bank of China (PBOC) new central bank bills swap (CBS) facility and the China Banking and Insurance Regulatory Commission’s (CIRC) decision to allow insurers to invest in perpetual bonds and tier-2 debt. 
 
Angus To, ICBCI’s deputy head of research, told FinanceAsia that the PBOC has sent a strong signal of support. “It helps alleviate concerns about increasing supply of subordinated bank paper,” he said. 
 
To explained that perpetual bond issuers (subject to a AA ratings cap) will be able to swap their paper for central bank bills, using the latter as collateral for PBOC funding.
 
Many analysts view it as a quasi-banking sector re-capitalization. 
 
On January 28, Natixis wrote that: “banks will be supported while obliged to lend for China to stem off its rapid deceleration. China is ready to do whatever it takes to grow, whether you define it as QE (quantitative easing) or not.”
 
Likewise, London-based Enodo Economics commented that: “Beijing has gone for perps, as it realizes the dire need to recapitalize its state-owned banks but has no intention of giving up control. The continuous need to find other assets to recap the banks, but not via the sale of voting shares, suggests (China’s) bad debt problem is not as small as the official figures would make you believe.”
 
But the general conclusion is that move is credit positive. Nicholas Zhu, Moody’s vice president and senior analyst, told FinanceAsia that: “This CBS facility is significant for capital raising by banks and supporting perpetual bonds in China.”  
 
ONSHORE-OFFSHORE DIFFERENTIAL
 
Bankers and analysts believe that more onshore perps mean less offshore ones, thereby supporting current offshore trading levels.
 
This is because Bank of China was able to issue more cheaply onshore both on an absolute and relative basis. It was also able to save on tax since issuers pay it offshore, while investors do onshore. 
 
As a result, HSBC’s fixed income analyst, Christopher Li, said the bank does not “expect to see a significant offshore primary pipeline other than that related to re-financing needs.”
 
Final pricing for the onshore perp was fixed with a 4.5% coupon, or 157bp over Chinese government bonds (CGBs). By contrast, the $3 billion 5.9% perpetual, issued last September via Bank of China's Hong Kong branch, is currently trading around the 5.59% level. 
 
Lee-shin Koh, a Hong Kong-based director in Citi’s debt capital markets origination team, told FinanceAsia that: “the potentially reduced supply and the regulatory changes expanding the investor base of perpetual bonds may lead to better technicals for offshore perpetual tier-1 (bonds). 
 
“This may result in a gradual narrowing of yield differentiation between the onshore and offshore tier-1 perpetuals markets,” he added.
 
Bankers also calculate that Bank of China’s new AT1 deal has priced about 50bp to 80bp over onshore tier-2 debt. Offshore, there is typically a 200bp differential between the two instruments.
 
However, as one banker commented, “DBS prices at a very tight differential in the Singapore dollar market just as Bank of China has in the renminbi market. Call it the home market advantage.”

The PBOC released a statement saying the order book for Bank of China’s new perp closed two times oversubscribed with participation by 140 domestic and international investors. This was also significant since the deal was the first high yield corporate bond offering offered via Bond Connect.

Previously, onshore high yield debt was traded exclusively through the exchange market, whereas CGB and policy bank paper is available via the interbank market, which is linked to Bond Connect.

However, bankers do not believe many foreign investors participated in Bank of China’s deal given the onshore-offshore differential.

“The only foreign investors who participated would be the ones who have offshore Rmb assets and where there’s a natural fit,” said one debt capital markets banker. “This is still a highly symbolic deal for the internationalization of the Rmb, but as usual it’s an evolution not a revolution.”

 
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