HONG KONG, December 20, 2019. Pengyuan International has assigned a first-time global-scale long-term issuer credit rating (LTICR) of ‘A+’ to Bank of China Ltd (BOC) with a Stable Outlook.


The rating incorporates a standalone credit profile (SACP) of ‘bbb’, which reflects the bank’s strong franchise, adequate profitability, and sufficiently robust capital buffer. In addition, we are of the view that the Chinese government (‘AA’/Stable) has a very strong willingness to support BOC’s senior unsecured creditors in times of need, given the bank’s ownership structure, systemic importance to the financial system, and critical quasi-policy role.

 

These strengths are partially offset by the slowdown in the economy and high private-sector leverage, which may accelerate asset impairments in 2020-2021. This risk is exacerbated by the bank’s relatively relaxed non-performing loan (NPL) recognition practices, as can be seen from the significant migration from special-mention loans (SMLs) to NPLs in the past. In our view, the interest-rate environment is also not conducive to internal capital formation, with us forecasting sequential declines in the bank’s net interest margin (NIM) in 2020-2021 on the order of 5-10bps a year.

 

The Stable Outlook reflects our view that BOC will likely remain a systemically important bank in both a domestic and global context in the foreseeable future. As such, we believe the Chinese government will continue to have a high propensity to provide emergency funding in high-stress scenarios.

 

We would consider a downgrade if we believe the government’s willingness to support BOC shows signs of weakening – which may be reflected by a material change in ownership or public policy – or if China’s foreign-currency LTICR is downgraded.

 

We would consider an upgrade if China’s foreign-currency LTICR is upgraded, although we believe that there is a relatively low likelihood of that happening in 2020, in view of the macro headwinds domestically and abroad.

 

Rating Rationale


Credit Strengths

Strong Franchise. BOC has a strong franchisee, given its position as the world's Top-10 largest and China’s fourth-largest bank and its designation as a global systemically important bank (G-SIB). In our opinion, there is a high certainty that BOC would be designated as a domestic systemically important bank (D-SIB) as well, when that scheme is officially rolled out in China. Furthermore, we believe the bank is uniquely positioned to facilitate capital into and out of the mainland, thanks to its well-established presence in Hong Kong and global footprint across all major financial and commercial centers.


Sufficiently Robust Capital Buffer. As one of the six state-owned mega banks, BOC has a strong track record of meeting the regulator’s capital and liquidity requirements. Our expectation is for the bank to maintain a common equity tier-1 (CET-1) ratio of around 12%, a tier-1 ratio of 13% and total capital adequacy ratio (CAR) of 16% from 2020-2021. In our opinion, this level of capitalization is sufficient to withstand the potential shocks from the economic slowdown we anticipate over this period.


Relatively Benign Liquidity Environment. Our expectation is for the liquidity environment to remain benign in 2020-2021, resulting from the central bank’s moderately accommodative monetary policy. BOC’s substantial deposit base remains a key competitive advantage, in our view. In addition, we believe BOC will maintain a strong ability to raise wholesale funding as required, although its equity financing capability is somewhat impaired by its current low valuation. However, we note that one of the key risks may lie in the real estate sector, where policymakers have turned increasingly cautious in terms of facilitating financing.


Very Strong Willingness of the Chinese Government to Provide Extraordinary Support. In our view, BOC’s long-term strategy is closely aligned with the central government’s social and economic objectives. This is evident from the bank’s contribution to efforts such as Renminbi (RMB) internationalization, micro finance, and the belt-and-road initiative. This strategic positioning and the bank’s ownership and management structure inform our view that the government has a very strong incentive to provide liquidity and capital support in times of need. BOC’s systemic importance also suggests that its potential failure may be detrimental to the stability of the domestic and global financial systems.


Credit Weaknesses

Challenging Earnings Outlook. We believe 2020-2021 will prove to be a different period in terms of internal capital formation. This may result from the combination of NIM contraction as yields fall, a pickup in NPL formation, and more stringent provisioning requirements under IFRS-9, which requires that the banks set aside reserves on a more proactive and forward-looking basis. Consequently, we anticipate that the bank’s return on average equity (ROAE) and return on average assets (ROAA) to fall below 10% and 0.8%, respectively, in the next two years. Partially mitigating this factor is the bank’s relatively prudent dividend policy at around 30% of share capital a year.


Aggressive NPL Recognition Practices. While we recognize that BOC has taken consistent efforts to clean up its loan book via write-downs and NPL sales since 2008, we are somewhat concerned about the bank’s NPL recognition and provisioning practices. In particular, we view an annual migration rate from the SML category to NPLs in the range of 20-25% to be high. This may suggest that the bank is under-provisioned and that in the post-IFRS-9 era, credit costs may see an unexpected spike in the coming years.


Total Loss-Absorption Capacity (TLAC) Requirements. We estimate that, as one of the four G-SIBs in China, BOC may need to raise as much as RMB1 trillion in TLAC-compliant instruments by 2025, according to the current regulatory schedule. In our view, this amount is material and management’s ability to comply at a reasonable cost is contingent upon a favorable market environment and the development of new forms of capital instruments in the onshore and offshore markets. We also note that, in the absence of a formal bank resolution regime, there remains significant uncertainty with regards to these instruments’ performance.


Note: Ratings mentioned in this press release are unsolicited ratings.


ANALYST CONTACTS

MEDIA CONTACT

OTHER ENQUIRIES

Stanley Tsai, CFA

+852 3615 8340

stanley.tsai@pyrating.com

media@pyrating.com

contact@pyrating.com


Cyrus Chan

+852 3615 8219

cyrus.chan@pyrating.com




Tony Tang

+852 3615 8278

tony.tang@pyrating.com




Date of Relevant Rating Committee: 5 December 2019

Additional information is available on www.pyrating.com


Related Criteria

Global Banking Rating Criteria (16 August 2019)


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