Beware the cynics of Chinese bank capital
With Chinese banks needing a recordbreaking amount of bank capital over the next few years and the first deal expected by the end of 2014, the scaremongers are out force. But as with so much to do with China, the reality is unlikely to be as bad as some would have us believe.
It's been a long time coming, but Chinese banks are preparing to bombard the market with Basel III deals — additional tier one (AT1) and tier two. The four big banks are expected to need $15bn-$19bn each of AT1, according to Morgan Stanley estimates, of which about 40%, or $30bn in total, is expected to be issued offshore.
This flood of deals will happen sooner rather than later. Chinese banks have no existing inventory of tier one capital so they need to get a move on. And with a number of the banks already talking to investors, the first AT1s are expected before the end of the year.
But the numbers involved have got some of Asia's bankers and investors in a spin. So far this year, Asia ex Japan banks have raised just $6.8bn in Basel III bonds — and that's across only 10 deals, according to Dealogic. In that context, it’s easy to view the needs of Chinese banks as a problem.
The cynics certainly have plenty of arguments to deploy.
Prime among them is that the market will not be able to absorb that amount of supply, which will hurt the rest of the pipeline and cause a secondary market sell-off as investors struggle to digest the new deals.
But while in the context of Asia, $5bn-$6bn of deals per bank seems an impossibility, in the global context this is hardly unprecedented. Just a few weeks ago HSBC raised $5.75bn in a dual currency AT1 transaction that attracted more than $28bn of demand. In fact, so far this year European banks have raised $42.6bn in AT1.
If Chinese banks were only selling to fund managers in Hong Kong and Singapore, then they might indeed have a problem. But lenders have signalled that the issues will be sold to investors globally and are likely to include euro and dollar tranches. And it remains to be seen whether they will try to raise the amount in one go or in multiple deals.
The naysayers also question the ability of Chinese banks to execute a deal according to international market standards. It’s no secret that Chinese debt markets do not adhere to market forces. Set a price and set a size target and, voilà, the deal is done regardless of the market backdrop. There is little or none of the price and volume discovery that takes place offshore.
But even if Chinese banks are too foolish or headstrong to listen to their international advisers, time and time again global markets have proved their ability to set issuers straight about what will and will not be accepted.
There’s even a school of thought that the large volume of bank capital deal swill reprice the Chinese high yield market. The theory goes that investors will jettison Chinese property bonds in favour of AT1 which comes a similar rating but offers a substantial pick-up.
But for that to be true investors would need to ignore the fact that bank capital is a completely different product with a completely different risk profile.
That is not to say that China does not come with risks. Shadow banking, an overheating property market, weaker GDP growth — the list goes on. But none of that has stopped Chinese borrowers raising a record $64bn in G3 debt markets this year and it is unlikely to stop Chinese banks raising the capital they need.
China’s size means that anything to do with the country is always of a magnitude that at first glance makes the jaw drop. But big doesn’t have to mean scary — and certainly not the end of bond markets as we know it.