Fed hawks push top Chinese banks to pay off US$12 billion of perpetual debt as funding costs surge, market reputation at stake

Perpetual securities sold by Chinese lenders to replenish their capital in 2017 are due for a big coupon step-up in the coming weeks, if not redeemed
For the Bank of Jinzhou, the move to repay its perpetual preference shares next month will come at a cost.

Banking & finance

Iris Ouyangin Shenzhen

Published: 10:30am, 19 Sep, 2022

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Chinese lenders including the Postal Savings Bank and China Merchants Bank are preparing to pay off more than US$12 billion of perpetual debt before funding costs tied to US Treasuries surge further, while hoping to protect their market reputation at the same time.

The Postal Savings Bank will redeem US$7.25 billion of non-cumulative perpetual preference shares on September 27, while Merchants Bank will repay US$1 billion of similar notes on October 25, according to stock exchange filings. Bank of Jinzhou, a regional lender bailed out by state-run bad loan managers in 2020, will call its US$1.5 billion of such securities on October 27.

Others including Bank of Qingdao will settle US$1.2 billion of notes on September 20 while Bank of Zhengzhou will call its US$1.19 billion notes on October 18. Bank of Zheshang completed its move in March.

Four successive rate hikes in the US this year have ended decades of cheap money for borrowers in offshore markets, as the benchmark 10-year Treasury yields rose to 3.45 per cent this month, a level not seen since April 2011. Another 50- or 75-basis point increase this week could make it uglier for these lenders, whose perpetual notes issued in 2017 are due for a coupon reset every five years, if not redeemed.

A trader works at the New York Stock Exchange on September 13. Four successive rate hikes in the US this year have ended decades of cheap money for borrowers in offshore markets, as the benchmark 10-year Treasury yields rose to a level not seen since April 2011. Photo: Xinhua

With no maturity dates in perpetual debt, borrowers are not obliged to repay noteholders. Market norms require the borrowers to redeem the debt at the first call date as a show of financial strength to assure investors, and to avoid punitive step-ups in annual bond coupons.

“It is aimed at reviving offshore investors’ confidence, although more importantly they are considering lowering financing costs,” said Iris Tan, senior equity analyst at Morningstar. These 2017 perpetual notes pay 4 to 6 per cent coupon annually, about 2 percentage points higher than current domestic interest rates, she added.

The coupon on Postal Savings Bank’s notes will reset to 6.294 per cent if not redeemed, based on the prevailing five-year US government bond yield of 3.66 per cent plus 2.634 per cent margin, according to its prospectus. Merchants Bank’s perpetual notes will reset to 6.103 per cent based on a 2.443 per cent margin. Bank of Jinzhou’s notes will reprice to 7.146 per cent, given the 3.486 per cent reset margin.

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The redemption plans are a relief for credit investors, with sentiment hammered by a slew of challenges at home and abroad. China’s economic inertia amid a property market slump, an energy crisis stoked by Russia’s invasion of Ukraine, and policy tightening in developed economies have raised concerns about debt defaults.

“At least for Chinese banks, it’s more likely for these issuers to exercise the call on the first call date,” said Jessica Chen, an executive director at JPMorgan, at a Wednesday banking industry webinar held by the Fitch Ratings.

For large banks, redemption is viewed as a normal market move, according to Harry Hu, a senior director at S&P Global Ratings. Small- to medium-sized banks may be trying not to break the market expectation [of a redemption], otherwise, future issuance by these outfits could be affected, he added.

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For the Bank of Jinzhou, however, the move to repay its perpetual preference shares next month will come at a cost. Its Tier-1 capital adequacy ratio will weaken to 8.36 per cent, against the regulatory threshold of 8.5 per cent, said Harry Hu, senior director at S&P Global Ratings.

The lender, based in northeastern China’s Liaoning province, has not signalled how it could replenish its capital with onshore financing after the redemption is completed, something worth monitoring, analysts said.

While the bank could choose not to redeem the notes, it avoided that route “surely because of reputation” risk, said BofA Securities’ director Li Lefu during the same Fitch webinar. “The strong reputational sense is backed by strong government support. It is one of the key reasons [why] many credit investors are still interested in this sector.”

Analysts expect Chinese banks will continue to redeem their offshore securities amid the higher interest rates overseas. The banks, especially the smaller ones, may pay off their costlier overseas debt and refinance onshore where costs are falling amid policy easing, they said.