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Chinese banks challenged to fill half-trillion TLAC capital gap
[HONG KONG] China's four largest lenders face starkly higher funding costs as a result of global rules designed to prevent a collapse of banks deemed too big to fail.
Having relied so far on domestic depositors and friendly local investors to fund their lending, the Big Four will need to issue hundreds of billions of dollars of capital to comply with worldwide standards on total loss-absorbing capacity, or TLAC.
Restrictions on cross-holdings between banks and China's limited institutional investor base mean much of that will have to come from the overseas markets at yields far higher than China's banks are accustomed to paying. "It will be more challenging than the Chinese think to find buyers for this paper," said a London-based portfolio manager at a major American asset manager. "There is a clear mismatch between the spreads they want to sell at and the spreads investors would demand. Given all the volatility in the Chinese market over the course of this year, there are no natural buyers, outside of Chinese banks themselves, for this type of risk at these levels." Estimates have varied, but, in a November 24 report, Moody's says the shortfall among China's global systemically important banks, or G-SIBs, will be US$553 billion. The figure is far more than the US$115 billion in TLAC needed for US banks and the US$201 billion for European banks.
China's G-SIBs are Agricultural Bank of China, Bank of China, Industrial Commercial Bank of China and China Construction Bank, which was added to the list at the start of November only days before the final TLAC rules were published.
Chinese lenders have a number of avenues, such as cutting risk-weighted assets and raising equity, to improve their TLAC buffers over the next 10 years, but bankers at Chinese G-SIBs have said that Additional Tier 1 and Tier 2 bonds will be a large part of the process.
Domestic regulators have yet to decide whether senior debt, which some European banks have made loss absorbing, will count towards TLAC, but analysts anticipate it will not be allowed.
This points to a flood of issuance of subordinated bank capital in the coming years, raising concerns over how much the Chinese and global markets can absorb.
Banks are, by far, the biggest buyers in China's domestic bond market and typically support PRC issuers in the overseas markets. However, that level of support will not be available for TLAC-eligible securities, since the rules are designed to spread the risk beyond the banking system.
G-SIBs will need to deduct any holdings of loss-absorbing debts from other G-SIBs from their own TLAC ratios, while Basel III rules already penalise banks for holding regulatory bank capital.
That leaves overseas buyers to play a bigger role, but several global fixed-income investors have said they are uninterested. Their concerns relate to pricing, risk and transparency.
Victor Rodriguez, the head of fixed income for Asia Pacific at Aberdeen Asset Management, said there was too much of an equity component in these bonds and, as such, it was not an asset class his firm was attracted to.
Others on the buyside argue that there are simply better opportunities elsewhere, both in bank capital and in other parts of Asia.
As an example, ICBC currently has US$2 billion Baa3-rated 10-year Tier 2 bonds yielding 4.699 per cent, while Macquarie has a Baa3-rated T2 quoted at 4.834 per cent.
China's banks only began issuing loss-absorbing capital in 2013, and issues of AT1 securities have relied heavily on PRC insurers and other state-owned enterprises as buyers.
It is difficult to estimate how much more these companies can buy, but some, such as China Huarong Asset Management and China Life Insurance, do have vast balance sheets. China Life's 2014 annual report shows it has total investment assets of 2.1 trillion renminbi (S$463.6 billion) - 940 billion renminbi of which is in bonds.
While meeting the TLAC requirements poses a challenge, a crucial advantage the Chinese G-SIBs will have is time. They will have until 2025 to reach the first benchmark of 16 percent of risk-weighted assets and 6 per cent of leverage exposure, and another three years to get to 18 per cent of RWA and 6.75 per cent of leverage exposure. Other G-SIBs will have until 2022 to reach the full requirements.
Yet, one drawback to the extension is that, when the first bonds come to the market, buyers will know there is considerably more supply coming, and may prefer to wait for more attractive yields. "The market is opaque and no one really has a lot of confidence that these numbers are correct and that there isn't going to be even more supply to come in the future," said another London-based asset manager. "That makes it hard to feel great about the technicals unless this stuff comes very cheap."