Investors May Sell Junk Debt Ahead of Chinese Tier 1 Deals

Investors may sell Chinese junk-rated bonds to make room in their portfolios for additional Tier 1 bank capital securities from the world’s second-largest economy, according to a survey of money managers by Morgan Stanley.

Bank of China Ltd. hired nine banks for its Basel III-compliant Reg S issue, which will count as additional Tier 1 capital, and plans to meet with investors in Asia and Europe from tomorrow, people familiar said. Meetings finish Oct. 14 and the sale could come as early as next week, the people said, asking not to be identified because the matter is private. Reg S transactions can’t be marketed or sold to investors in the U.S.

Almost 40 percent of investors would consider selling other Chinese non-investment grade bonds to buy Chinese Tier 1 bank capital securities if they offer a similar yield, a Morgan Stanley survey of investors by analysts Desmond Lee and Kelvin Pang found. Average rates for speculative-grade debt in Asia climbed to 7.26 percent yesterday, the highest since May 27, JPMorgan Chase & Co. indexes show.

“I’m concerned about oversupply of Chinese bank capital paper in the short run,” said Ken Hu, the Hong Kong-based chief investment officer for Asia-Pacific fixed income at Invesco Ltd. “We have to use careful analysis and look at the relative value” versus similar U.S. and European securities, he said.

High-Yield Bonds

Bank of China, the nation’s fourth-largest by market value, has regulatory approval to issue as much as 40 billion yuan ($6.5 billion) of offshore preference shares, according to a preliminary offering circular dated Oct. 8 and obtained by Bloomberg News. Chinese companies have sold some $8.8 billion of high-yield Reg S dollar-denominated securities this year, data compiled by Bloomberg show.

The yield on Bank of China’s $2.5 billion of 5.55 percent 2020 notes sold in February 2010 has risen 12 basis points to 3.715 percent since mid August, when news of its planned transaction was first reported. The yield touched 3.989 percent on Sept. 30.

Bank of China’s new securities are expected to be rated Ba2 by Moody’s Investors Service and BB- by Standard & Poor’s. That’s seven levels below the ratings companies’ issuer grades for Bank of China of A1 and A.

The lower credit score is because the securities can be converted into Bank of China’s Hong Kong-listed shares at HK$3.44 ($0.44) apiece if the lender’s common equity Tier 1 capital adequacy ratio falls to 5.125 percent or below. Shares in Bank of China rose 0.9 percent today in Hong Kong to HK$3.53.

Fair Value

Morgan Stanley’s survey, dated Oct. 5 and conducted during September, indicated respondents viewed the fair value for new additional Tier 1 securities from China’s biggest banks at about 7.16 percent. “Investors, on average, would turn overweight if yields reached 7.69 percent and underweight if yields fell to 6.29 percent,” according to the study, which didn’t reference Bank of China specifically.

“Every maiden transaction always requires some form of a price discovery,” Raymond Chia, the Singapore-based head of credit research at Schroder Investment Management Ltd. for Asia ex Japan, said. The “pricing of the new additional Tier 1s, depending on where it comes, may have an impact on Chinese high-yield bonds currently priced to maturity,” he said, adding that notes maturing in two years or less may not be affected.

Beijing-based Bank of China said in August it more than doubled the amount set aside for bad loans as profit growth cooled to the slowest pace in five quarters amid a weaker economic expansion. Its capital adequacy ratio, a measure of financial strength, was 11.8 percent, down from 12.5 percent in December.

The planned transaction may raise Bank of China’s Tier 1 ratio to 10.12 percent from 9.7 percent, according to the preliminary offering circular.

(An earlier version of this story was corrected because it inaccurately reflected the results of Morgan Stanley’s investor survey.)

(Updates with analyst comment in 10th paragraph.)
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