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Banks are rushing to replenish their balance sheets to meet new global capital rules to be enforced by Beijing. Photo: Bloomberg

Chinese banks boost capital through hybrid securities

Chinese banks plan to raise capital by issuing preferred shares and other hybrid securities

Mainland banks are poised to raise a record US$120 billion in the next two years to shore up their balance sheets in the face of slowing growth and rising bad debts, but the funds could prove expensive and hurt earnings as investors demand a premium.

For the first time, banks will raise capital by issuing preferred shares and other so-called hybrid securities, a funding technique that avoids the need for issuing ordinary shares in a badly hit stock market.

In the past two weeks, Agricultural Bank of China and Bank of China announced plans to raise about US$29 billion in preferred shares between them.

The banks are rushing to replenish their balance sheets to meet new global capital rules known as Basel III. Beijing has been rigorously enforcing these regulations in its efforts to ward off a financial crisis following a huge run-up in debt since 2008 and a marked slowdown in economic growth.

Analysts said investors are expected to drive a hard bargain given the concerns about the mainland's opaque financial system and the worrying rise of toxic debt.

"Given the size of the proposed capital issues and the concerns about transparency in the Chinese banking system, it may be hard to price aggressively versus the Western structures currently out there," said Ivan Vatchkov, the chief investment officer of Algebris Investments (Asia).

The first few deals should give banks an idea of the returns that investors will demand on hybrid capital securities.

China Citic Bank International sold capital securities in the offshore market last month at an interest rate about 1 percentage point above that available on the bank's subordinate bonds.

Benchmark five-year subordinate debt from the mainland's top-rated banks trades at a yield of 5.25 per cent, suggesting banks will have to price yields at about 6.3 per cent for preferred shares to lure investors.

Some analysts warn that forcing banks to pay hefty yields on new hybrid capital instruments would not only pressure their profitability but also threaten their ability to continue lending aggressively as bad loans rise in a slowing economy.

The total assets of the mainland's banking industry reached about US$24 trillion - more than twice the size of its economy - at the end of last year, according to the China Banking Regulatory Commission. That is why investors are confident the government will prevent a Greek-type debt crisis from ever emerging.

Investors in preferred shares demand a premium for the added risk that their holdings may be converted into common equity if the bank's capital ratio falls below the trigger level.

Last month, Beijing unveiled rules on bank issuance of preferred shares, paving the way for lenders to begin fundraising to enable them to withstand an expected rise in bad loans.

In all, analysts estimate mainland lenders are likely to raise at least US$55 billion through these bond-like products in the next two years. That is on top of previously announced plans to raise up to US$64 billion in Basel bonds, taking the total to almost US$120 billion over two years.

Raising funds in a weak stock market is not an attractive option for banks, as it would be expensive and would dilute existing shareholders.

This article appeared in the South China Morning Post print edition as: Borrowers to pay dearly in US$120b rush
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