China’s bank capital market comes of age
Baoshang Bank’s complete write-down of close to $1bn of tier two debt offers an invaluable lesson to investors in China’s domestic bond market.
Chinese regional lender Baoshang said last week that the country's regulators declared it non-viable, and it will fully write-off Rmb6.5bn ($984m) of domestic subordinated debt. Given the beleaguered firm’s long-running troubles, and a missed coupon payment on the tier two bond last December, the news should have come as little surprise.
Baoshang was taken over by the People’s Bank of China and the China Banking and Insurance Regulatory Commission in May last year, with the initial one-year takeover period extended by six months.
Earlier this year, China set up Mengshang Bank to undertake Baoshang’s Inner Mongolia business, where the lender is based, while its assets outside of the autonomous region were transferred to another city commercial bank, Huishang Bank. In August, the central bank allowed Baoshang to file for bankruptcy — an unprecedented move for China’s banking industry.
As some of Baoshang’s senior creditors had already suffered material losses from the takeover there was little chance subordinated debt investors would go through the turmoil unscathed.
Investors were not happy. After all, no bank in China has been deemed non-viable until now, and no tier two notes have been written down.
Market watchers had hoped the regulators might step in to support tier two bondholders, in a similar way to the help they offered subordinated debt investors at Bank of Jinzhou and Hengfeng Bank. For Baoshang, the government bailout reduced losses for a small group of large wholesale creditors from over 40% to just 10%, with most noteholders not suffering any losses. It wasn’t the same for the tier two holders, however.
The write-down will undoubtedly be painful — not just for the bondholders but also for Baoshang’s peers.
Investors in the Rmb6.5bn bonds will suffer from a complete loss of principal, together with unpaid interest. That will test their trust in implicit government support for such deals. Other small-to-medium sized Chinese lenders could find themselves faced with a higher cost of capital, or even restricted access to funding.
The impact is already showing. Fujian Haixia Bank, a regional lender based in Fuzhou city in Fujian province, pulled a planned Rmb500m tier two deal on Monday. Bookbuilding for the 10 year non-call five notes was scheduled for Tuesday, and price guidance had been released. The issuer simply cited “market volatility” for the cancellation, but onshore bankers said the Baoshang news was a big factor.
But there are lessons to be learnt from the event. The Chinese regulators have asked lenders to push down their profit margins this year to support the pandemic-hit economy. They have also stressed keeping risks at smaller lenders under control.
The incident serves as a much-needed confirmation of the ranking of bank securities and a timely reminder of the loss-absorbing nature of subordinated debt.
Issuers and investors should reassess the pricing of onshore bank capital instruments to properly reflect the risk they bear, rather than automatically factoring in implicit government backing for these deals.
In a wider bond market that is worth more than Rmb110tr but still lacks credit differentiation, the Baoshang write-down should help raise awareness of the risks involved in bank capital. This can only be a good thing for the long-term health and development of the Chinese bond market.