China Banks Poised to Sell Preferred Stock to Buffer Capital

Mar 31, 2014 10:48 pm ET

(Updates with share prices in sixth paragraph.)

April 1 (Bloomberg) -- Industrial & Commercial Bank of China Ltd. and its competitors are poised to issue preferred shares as soon as this year to shore up finances as slowing profit growth curbs their ability to retain earnings as capital.

ICBC, China Construction Bank Corp., Agricultural Bank of China Ltd. and Bank of China Ltd. said in the past week they’re preparing to sell the stock as they reported a combined 12 percent increase in 2013 profit, down from 15 percent a year earlier. Preferred stock, available under a trial approved by regulators last month, permits banks to raise capital without selling dilutive common equity. The shares can be converted into common stock if capital ratios fall below a certain level.

China introduced stricter capital requirements for banks in January 2013, posing another challenge for an industry facing slower loan growth and rising bad debts amid more competition and interest-rate deregulation. The four biggest lenders will face a capital shortfall of $87 billion under the new rules by 2019, Mizuho Securities Asia estimates.

“Banks might have to come to the market for equity-raising or they will have to restrict their loan growth in the next one or two years,” said Edmond Law, a Hong Kong-based analyst at UOB Kay Hian (Hong Kong) Ltd. “With the preferred share issuance, the problem will ease. That should minimize the market’s concerns and should be positive for stock valuations.”

The Hong Kong-traded stock of the four biggest banks fell by an average 8.2 percent this year amid weaker earnings prospects and rising loan delinquencies. The shares were valued at an average 0.85 times net assets, or book value, the lowest level since Agricultural Bank’s initial public offering in 2010, data compiled by Bloomberg show.

Bad Loans

ICBC fell 0.8 percent to HK$4.73 as of 10:34 a.m. Hong Kong time, while Construction Bank lost 0.4 percent. Bank of China dropped 0.3 percent and Agricultural Bank was unchanged.

ICBC, the world’s most profitable lender, reported last week a 10 percent increase in 2013 net income, the slowest pace since it was listed in 2006. Construction Bank said March 30 profit growth rose 11 percent, while Agricultural Bank’s expansion slowed to 15 percent. Bank of China’s 12 percent profit increase beat estimates as overseas lending rose.

The four banks wrote off and sold about 51 billion yuan ($8.2 billion) of bad debt in 2013, more than double the previous year. The total was the most since at least 2009 as lenders sought to rein in nonperforming loan ratios.

Capital Shortfall

Declining profit growth at the biggest lenders curbs their ability to retain earnings to fulfill capital requirements. Under rules that took effect in January 2013, systemically important banks need to have a minimum Tier 1 ratio of 9.5 percent, with overall buffers of 11.5 percent before the end of 2018, according to the China Banking Regulatory Commission.

The nation’s four biggest lenders are facing a combined shortfall of 538 billion yuan in common equity Tier 1 capital by 2019 under the new requirements, Jim Antos, a Hong Kong-based analyst at Mizuho, wrote in a March 25 report. At least half the total may be raised from share sales, he said.

The China Securities Regulatory Commission widened banks’ options to manage their capital when it issued March 22 rules for a trial allowing members of the Shanghai Stock Exchange 50 A-Share Index to issue preferred shares. Banks including ICBC and Agricultural Bank account for 40 percent of the index, according to data compiled by Bloomberg.

Unlike other companies, preferred shares issued by Chinese banks in a private placement are allowed to be converted into common equity if lenders’ capital ratios drop below a trigger level to absorb losses, according to the CSRC. The securities regulator is working with the CBRC to draft rules regarding the compulsory conversion.

Fixed Dividend

Preferred shareholders have a higher claim on a company’s assets than common stockholders in the event of liquidation. While they are usually accorded fewer voting rights, owners of preferred stock are typically entitled to a fixed dividend before funds are paid to common shareholders.

Each big bank may have to sell about 90 billion yuan of preferred shares to boost their Tier-1 ratio by 1 percentage point, UOB-Kay Hian’s Law estimates. China’s listed banks will need another 500 billion yuan of Tier-1 capital in 2015, according to a Changjiang Securities Co. report dated March 23.

Agricultural Bank’s Tier-1 ratio declined 2 basis points from the end of March to 9.25 percent as of Dec. 31, giving it the weakest buffer among the top lenders. The Beijing-based company may be the first to issue preferred stock, Michael Werner, a Hong Kong-based analyst at Sanford C. Bernstein & Co., wrote in an October report.

Closely Monitoring

The lender has completed preparations for a preferred share sale and is awaiting further rules from the CBRC, Vice President Li Zhenjiang told reporters on March 25.

Bank of China President Chen Siqing said March 26 the lender needs to sell preferred shares even after improving its Tier-1 ratio to 9.7 percent at the end of December.

ICBC, with a Tier-1 ratio of 10.57 percent, is closely monitoring and studying the new class of stock, and expects it to have a positive response from the market, Board Secretary Hu Hao said March 27. Construction Bank, with a Tier-1 ratio of 10.75 percent, has made preparations to issue the shares, which will depend on market conditions and capital needs, Vice President Zhu Hongbo said yesterday.

Chinese banks have relied on issuing common equity and retained earnings to boost core capital since they started trading publicly.

Sentiment Booster

Hong Kong-listed Chinese banks will see an earnings dilution of just 1.1 percent if they issued preferred stock to boost Tier-1 ratios by 50 basis points, assuming a dividend yield of about 10 percent, according to Bernstein’s Werner. The dilution would be 4.5 percent if they issue common equity at a 10 percent discount, he wrote.

“If they raise preferred, it will allow the Chinese banks to show a higher level of common equity Tier 1,” said Ismael Pili, Hong Kong-based head of financial research at Macquarie Group. “That might build some confidence or improve sentiment on the banks, which could then push the share prices above book value and, at that point, real capital can be issued.”

Preferred shares may comprise 5 percent to 10 percent of mainland banks’ total capital over the next two to three years, according to Mizuho’s Antos. That won’t be enough to satisfy their requirements through 2019, he wrote.

Chinese banks need to constantly replenish capital because of their strong credit growth and their profit accumulation will ease in the next couple of years, Standard & Poor’s said March 27. Lenders have doled out more than $7 trillion to state-owned companies, local governments and smaller businesses since the 2008 financial crisis, central bank data show.

ICBC, Construction Bank and Bank of China said last year they each plan to issue up to 60 billion yuan of a new type of debt with a writedown feature to boost Tier 2 capital. Agricultural Bank said last April it aims to raise 50 billion yuan in Tier 2 capital and 40 billion yuan of Tier 1 securities by the end of 2015.