Size matters

Bondholders Trust China Too Much

Not all Chinese financial institutions are equal, and their debt shouldn't be treated that way.
At Closing, June 18th
710.00 GBp

Since Chinese banks started selling perpetual bonds internationally in 2014, global bondholders have accepted that if Industrial & Commercial Bank of China Ltd., the world's largest lender by assets, faces insolvency, the least of their concerns is whether they'll be bailed in. Beijing won't let its large institutions fail.

Large -- note the adjective. There's no guarantee that the government won't let a couple of smaller banks go belly-up. That point may have been lost on some international investors.

China Zheshang Bank Co., the nation's 19th-largest listed lender by assets, on Wednesday sold $2.2 billion of additional Tier 1 notes, its first marketed to offshore fund managers. The bonds rank above equity only if the firm is liquidated; don't have a maturity date; and include clauses that could see them converted to potentially worthless shares if the institution's capital falls below a threshold. Oh, and they also lack a credit rating.

Despite all that, the yield on the securities was only 5.45 percent, 214 basis points more than 10-year Chinese government bonds. If that doesn't look too bad, let's put this in perspective.

Deepening Trust

Since Bank of China issued the nation's first international Tier 1 note, the yield to call on the security has dropped almost 280 basis points

Source: Bloomberg

Moody's Investors Service rated the senior debt of Zheshang Ba1. Usually, the credit company will grade subordinated perpetual debt, such as the securities just sold, four to six notches below the issuer's score. That would put the new notes almost at, if not inside, the C category, usually reserved for companies on the verge of default. Perhaps that's why Zheshang didn't get a rating for the debenture.

The securities that most closely resemble what Zheshang sold on Wednesday are the 8.25 percent perpetual bonds of Spain's Banco Popular Espanol SA, which is similar in size to its Chinese peer. Those securities, rated Caa1 by Moody's, offered a 12 percent return until the next date they can be redeemed, north of 12 percentage points more than German bunds.

Meanwhile, Standard Chartered Plc has perpetual bonds that are rated Ba1 -- six notches below the bank's A1 senior grade -- and were offering a yield of 7.3 percent on Wednesday. The return on Zheshang was closer to what can be achieved by investing in Australia & New Zealand Banking Group's 6.75 percent bonds. ANZ is only two steps from Moody's highest rating, at Aa2.

Spot the Anomaly

China Zheshang paid less than Standard Chartered and almost the same as ANZ for perpetual debt that can be written down if it becomes insolvent

Source: Bloomberg

* Yield to call, based on prices available on Bloomberg on March 22.

Sure, the 5.45 percent was 139 basis points more than the yield on perpetuals from Bank of China. But you shouldn't compare Zheshang with Bank of China.

This may just have been an outlier. However, many other small banks plan to raise capital internationally. Investors had better start adding some risk premiums -- Beijing shouldn't be expected to backstop everything, all the time.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Christopher Langner in Singapore at

    To contact the editor responsible for this story:
    Paul Sillitoe at

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