China’s Small Lenders Are Filling Up on Riskiest Bank Debt

China’s cash-strapped small lenders are expanding their pile of the riskiest kind of bank debt to shore up their capital levels, bracing against an economic slowdown and rising loan defaults.

A total of 19 banks have sold 339.6 billion yuan ($48.5 billion) perpetual bonds, high-yielding subordinated bonds with no maturity dates, as of July 10 this year, according to data compiled by Bloomberg. Smaller lenders including Chongqing Three Gorges Bank Co., Bank of Rizhao Co., and Huarong Xiangjiang Bank Corp. accounted for more than 70% of the issuance.

Regional and local banks are rushing to take advantage of demand amid a flood of stimulus from the central bank to cushion the economy from the fallout of the virus outbreak. The government is providing funding to shore up confidence in its smaller lenders, with a plan to allow local governments to use about 200 billion yuan from bond sales to help them replenish capital.

China’s Small Lenders Are Filling Up on Riskiest Bank Debt

It’s a turnaround from last year when a number of highly publicized small bank failures caused yields on so-called Additional Tier 1 notes to blow out. Guilin Bank Co., which is AA+ rated, this year sold debt at a yield of 4.8%, compared with 5.4% last year for similarly rated Weihai City Commercial Bank Co.

Even so, some analysts warned against the debt bonanza. “For some smaller banks with weaker risk management capability and tighter liquidity, there’s risk and uncertainty that they may not be able to make interest payments or redeem the debt,” said May Hu, a Beijing-based partner at KPMG’s restructuring services portfolio solutions groups. “Investors may suffer losses as a result.”

As China’s perpetual bond market kicked off last year, the issuance was dominated by the nation biggest lenders. Bank of China Ltd. issued the first ever such bond in January 2019 after regulators pledged support for the market, in a bid to boost lending. A total of 16 banks raised 569.6 billion yuan in such debt last year.

The issuance will allow the banks to replenish capital levels, now in danger from rising bad debt. Small banks are facing a $349 billion shortfall in capital, according to an analysis by UBS Group AG, while the nation’s financial regulator puts that figure at only $50 billion.

Smaller lenders are also tapping other channels to replenish capital. Xiamen Bank Co. on Thursday won the green light from China Securities Regulatory Commission to carry out an initial public offering, which would make it the first bank to sell new shares in China this year.

Adding to confidence is a pick up in economic growth as China appears to have brought the virus outbreak under control. Gross domestic product expanded 3.2% in the three months to June from a year ago, reversing a 6.8% decline in the first quarter. Output in the first half was still down 1.6% from the same period in 2019.

©2020 Bloomberg L.P.

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