Founder of Antler Capital

Stanley Tsai, CFA

Credit

ICBC <a href="https://www.smartkarma.com/entities/ind-comm-bk-of-china-h" target="_blank" data-smartkarma-citation="entities:1119:1" rel="noopener">(1398 HK</a> | <a href="https://www.smartkarma.com/entities/ind-comm-bk-of-china-a" target="_blank" data-smartkarma-citation="entities:494:1" rel="noopener">601398 CH)</a> 
The market has been much more generous to ICBC's USD preferred shareholders than to its H-shareholders. ICBCAS 3.58 PERP has had a strong run since it was printed in September 2020, interrupted only momentarily by the Huarong <a href="https://www.smartkarma.com/entities/china-huarong-asset-management" target="_blank" data-smartkarma-citation="entities:968:1" rel="noopener">(2799 HK)</a> scare. The prefs are trading at 103 for a dismal yield of 2.9%. In our view, the AT-1 instrument is overvalued and due for a correction.
ICBCAS 3.58 PERP is rated 'Ba1', but trades like an investment-grade bond. On a yield-to-call basis, the prefs are trading at a 200bp spread to 5-year US treasuries. The pickup over the bank's USD senior unsecured issues is 150bp, which is a very modest premium for a six-notch rating difference from 'A1' to 'Ba1'.  
The yield differential between ICBC-H <a href="https://www.smartkarma.com/entities/ind-comm-bk-of-china-h" target="_blank" data-smartkarma-citation="entities:1119:1" rel="noopener">(1398 HK)</a> and ICBCAS 3.58 PERP has widened to a recent high. The H-share / pref yield gap shows strong mean-reversion tendencies. At 425bp, we believe the spread has the potential to tighten over the coming weeks.
Supply-demand imbalance is the key driver of current price dislocations. We believe the prefs' scarcity value will gradually decline as the next round of AT-1 / senior bail-in instruments issued by the Big Four banks flood the primary market. That said, there is little we can do to change investors' perception of the Chinese G-SIBs as safe havens regardless of subordination.
We are short ICBCAS 3.58 PERP on the expectation that pending new AT-1 issues will dilute its price premium. For the long H-share / short pref trade to be worthwhile, we will probably have to wait till ICBC-H crosses below HKD4.50. Liquidity for the prefs should be plenty to facilitate these trades. The key risk is for the market to turn decidedly bearish on Chinese non-financial credits and default to bank papers for shelter.
Related Insight
<ul>
<li>
<a href="https://www.smartkarma.com/insights/icbc-the-bond-identity-a-zero-growth-dividend-discount-story" target="_blank" data-smartkarma-citation="insights:51463" rel="noopener">ICBC: The Bond Identity | A Zero-Growth Dividend Discount Story</a> </li>
</ul>
(Attachment: Financial Summary)

ICBC (1398 HK | 601398 CH) 
The market has been much more generous to ICBC's USD preferred shareholders than to its H-shareholders. ICBCAS 3.58 PERP has had a strong run since it was printed in September 2020, interrupted only momentarily by the Huarong (2799 HK) scare. The prefs are trading at 103 for a dismal yield of 2.9%. In our view, the AT-1 instrument is overvalued and due for a correction.
ICBCAS 3.58 PERP is rated 'Ba1', but trades like an investment-grade bond. On a yield-to-call basis, the prefs are trading at a 200bp spread to 5-year US treasuries. The pickup over the bank's USD senior unsecured issues is 150bp, which is a very modest premium for a six-notch rating difference from 'A1' to 'Ba1'.  
The yield differential between ICBC-H (1398 HK) and ICBCAS 3.58 PERP has widened to a recent high. The H-share / pref yield gap shows strong mean-reversion tendencies. At 425bp, we believe the spread has the potential to tighten over the coming weeks.
Supply-demand imbalance is the key driver of current price dislocations. We believe the prefs' scarcity value will gradually decline as the next round of AT-1 / senior bail-in instruments issued by the Big Four banks flood the primary market. That said, there is little we can do to change investors' perception of the Chinese G-SIBs as safe havens regardless of subordination.
We are short ICBCAS 3.58 PERP on the expectation that pending new AT-1 issues will dilute its price premium. For the long H-share / short pref trade to be worthwhile, we will probably have to wait till ICBC-H crosses below HKD4.50. Liquidity for the prefs should be plenty to facilitate these trades. The key risk is for the market to turn decidedly bearish on Chinese non-financial credits and default to bank papers for shelter.
Related Insight


ICBC: The Bond Identity | A Zero-Growth Dividend Discount Story 

(Attachment: Financial Summary)

ICBC: The Prefs Are Junk and Should Trade Like It

Equity Bottom-Up

ICBC <a href="https://www.smartkarma.com/entities/ind-comm-bk-of-china-h" target="_blank" data-smartkarma-citation="entities:1119:1" rel="noopener">(1398 HK</a> | <a href="https://www.smartkarma.com/entities/ind-comm-bk-of-china-a" target="_blank" data-smartkarma-citation="entities:494:1" rel="noopener">601398 CH)</a> 
The market rout since April has taken ICBC-H <a href="https://www.smartkarma.com/entities/ind-comm-bk-of-china-h" target="_blank" data-smartkarma-citation="entities:1119:1" rel="noopener">(1398 HK)</a> back to HKD5.00/share. The stock is now trading at historically low forward P/B and P/E multiples and offers a hefty yield of 7%. Investors are pricing the shares exactly as if the bank is a dividend stock with no perpetual growth.
A perpetual bond may just be what the bank is. The market-implied NPL ratio of over 8% is not out of the realm of possibility. We forecast cumulative loan write-offs of CNY1 trillion (USD155 billion) over the next five years. It doesn't take another global crisis for us to get there. Asset quality concerns will continue to weigh heavily on the stock and the lack of catalysts will limit re-rating potential, in our view.
A multi-year ROE compression story is taking shape. Even the most bullish forecasts see the bank's ROE trending lower as impairment charges eat into interest and fee income. A strong provision level helps to an extent. But we expect the bank to burn down its reserve cover considerably in 2021E to 2025E just to maintain its dividends. 
Asset quality will likely get worse, but the mortgage book provides a glimmer of hope. ICBC continues to be a major funding source of China's capital-intensive recovery. The bank's infrastructure book has grown by CNY1.6 trillion (USD247 billion) since 2016. Indirect exposures to local government finances have also been on the rise. On a more positive note, the mortgage book has been a star. Even if NPLs tick up moderately as the portfolio seasons, homeowners are paying most of the bank's shareholder dividends.
We are underweight ICBC-H against MSCI China <a href="https://www.smartkarma.com/entities/msci-china-index" target="_blank" data-smartkarma-citation="entities:22895:1" rel="noopener">(MXCN INDEX)</a> and would look to build a net short position if the stock edges past HKD6.00/share. The bank's dividend capacity puts a floor on the stock, but offers limited room for capital appreciation. The key risks to our call are macro-related. Rising tides lift all boats and any unexpected form of monetary easing by the PBOC will drive the shares higher.
(Attachment: Financial Summary)

ICBC (1398 HK | 601398 CH) 
The market rout since April has taken ICBC-H (1398 HK) back to HKD5.00/share. The stock is now trading at historically low forward P/B and P/E multiples and offers a hefty yield of 7%. Investors are pricing the shares exactly as if the bank is a dividend stock with no perpetual growth.
A perpetual bond may just be what the bank is. The market-implied NPL ratio of over 8% is not out of the realm of possibility. We forecast cumulative loan write-offs of CNY1 trillion (USD155 billion) over the next five years. It doesn't take another global crisis for us to get there. Asset quality concerns will continue to weigh heavily on the stock and the lack of catalysts will limit re-rating potential, in our view.
A multi-year ROE compression story is taking shape. Even the most bullish forecasts see the bank's ROE trending lower as impairment charges eat into interest and fee income. A strong provision level helps to an extent. But we expect the bank to burn down its reserve cover considerably in 2021E to 2025E just to maintain its dividends. 
Asset quality will likely get worse, but the mortgage book provides a glimmer of hope. ICBC continues to be a major funding source of China's capital-intensive recovery. The bank's infrastructure book has grown by CNY1.6 trillion (USD247 billion) since 2016. Indirect exposures to local government finances have also been on the rise. On a more positive note, the mortgage book has been a star. Even if NPLs tick up moderately as the portfolio seasons, homeowners are paying most of the bank's shareholder dividends.
We are underweight ICBC-H against MSCI China (MXCN INDEX) and would look to build a net short position if the stock edges past HKD6.00/share. The bank's dividend capacity puts a floor on the stock, but offers limited room for capital appreciation. The key risks to our call are macro-related. Rising tides lift all boats and any unexpected form of monetary easing by the PBOC will drive the shares higher.
(Attachment: Financial Summary)

ICBC: The Bond Identity | A Zero-Growth Dividend Discount Story

Pan-Asia Catalysts/Events, Quiddity Advisors

David Blennerhassett

Pan-Asia Catalysts/Events

Quiddity Advisors

Event-Driven

Last Week in Event SPACE:  Swire, Hitachi Metal, Jardine, Softbank, Bingo, Japan Asia, Mainstream

Independent Asian Credit Research, Bondcritic

Warut Promboon

Independent Asian Credit Research

Asian Fixed Income/Frontier Market Research

Bondcritic

Bondcritic, established in 2009, is designed to be an independent credit research voice that helps investors gain insights and unbiased analyses on Asian fixed income market. Our mission is to discover deep-value Asian high-yield and distressed bonds with a bottom-up approach, together with the help of our proprietary ESG (Environmental, Social Development, and Governance) model. At the same time, we focus on bringing investment cases of unrated and unloved issuers to the general public.

Here, we have wrapped-up the recent fear on the Chinese debt bubble with our new periodical called “The Chinese Credit Chronicle (CCC)”. China is a bicycle economy which will fall down when the economy stops growing at a certain rate, in our view. We believe the minimum real GDP growth rate is c.5%. China’s real GDP growth was 2.3% in 2020, according to China’s National Bureau of Statistics. The 2.3% GDP growth achieved with the effective control of COVID-19 and without much government stimulus remains impressive, in our view, only if we believe this GDP growth is authentic.
Now comes the core of the problem. We have seen leverage in China being extended because of cheap funding costs rather than borrowers’ repayment capability.  Not to mention a shadow banking sector which the China Banking and Insurance Regulatory Commission (CBIRC) once estimated at RMB84.8trn in 2019 or 29% of total banking assets in 2019, leverage was injected officially into ineffective and poorly-managed borrowers such as local government financing vehicles (LGFV). In addition, with China’s urbanization, the demand for residential and commercial properties has risen in tandem with leverage of the Chinese property sector, hence concentrating the leverage in the sector.
Many market participants in China seem to have gambled that China’s growth music will continue playing and when loan growth continues, non-performing loans may not be a big problem. We believe the music has stopped and the Chinese government seems to have agreed with us.
Here, we have raised three anecdotes on the Chinese debt bubble and how we see the situation going this year: China Evergrande (<a href="https://www.smartkarma.com/entities/china-evergrande-group" target="_blank" data-smartkarma-citation="entities:479:1" rel="noopener">Evergrande Real Estate Group (3333 HK)</a> , <a href="https://www.smartkarma.com/entities/hna-group-co-ltd" target="_blank" data-smartkarma-citation="entities:25987:1" rel="noopener">HNA Group (HNAGRZ CH)</a> , and <a href="https://www.smartkarma.com/entities/china-huarong-asset-management" target="_blank" data-smartkarma-citation="entities:968:1" rel="noopener">China Huarong Asset Management (2799 HK)</a> .

Here, we have wrapped-up the recent fear on the Chinese debt bubble with our new periodical called “The Chinese Credit Chronicle (CCC)”. China is a bicycle economy which will fall down when the economy stops growing at a certain rate, in our view. We believe the minimum real GDP growth rate is c.5%. China’s real GDP growth was 2.3% in 2020, according to China’s National Bureau of Statistics. The 2.3% GDP growth achieved with the effective control of COVID-19 and without much government stimulus remains impressive, in our view, only if we believe this GDP growth is authentic.
Now comes the core of the problem. We have seen leverage in China being extended because of cheap funding costs rather than borrowers’ repayment capability.  Not to mention a shadow banking sector which the China Banking and Insurance Regulatory Commission (CBIRC) once estimated at RMB84.8trn in 2019 or 29% of total banking assets in 2019, leverage was injected officially into ineffective and poorly-managed borrowers such as local government financing vehicles (LGFV). In addition, with China’s urbanization, the demand for residential and commercial properties has risen in tandem with leverage of the Chinese property sector, hence concentrating the leverage in the sector.
Many market participants in China seem to have gambled that China’s growth music will continue playing and when loan growth continues, non-performing loans may not be a big problem. We believe the music has stopped and the Chinese government seems to have agreed with us.
Here, we have raised three anecdotes on the Chinese debt bubble and how we see the situation going this year: China Evergrande (Evergrande Real Estate Group (3333 HK) , HNA Group (HNAGRZ CH) , and China Huarong Asset Management (2799 HK) .

The Chinese Credit Chronicle: The CCC Danger

Silver Point

Thomas J. Monaco

Silver Point is a boutique research firm that focuses on the broader financial services sector, with a particular focus on troubled institutions globally. 

Asia Ex Japan

China Huarong Asset Management / Equity Bottom-Up

*Already On Edge:  Again in mainland China, there have been rumblings of another credit default over the past several days. The CBIRC disclosed that China Huarong Asset Management (2799.HK) [Huarong] is actively working with its auditor to complete its annual report. The issue appears to be Huarong’s legacy exposure associated with the misdeeds of its former Chairman, which still need to be addressed post-removal in 2018; and *Another Audit Delay: Huarong is delaying its 2020 earnings results beyond the April 30, 2021 deadline, which, in our view, only exacerbates concerns over a potential Huarong default. Ironic, given that Huarong was supposed to help mainland China clean up its bad debt mess. This further delay will not help bond liquidity which already appears to have disappeared. Contagion risk remains a real threat as bondholders likely sell other holdings.

*Already On Edge:  Again in mainland China, there have been rumblings of another credit default over the past several days. The CBIRC disclosed that China Huarong Asset Management (2799.HK) [Huarong] is actively working with its auditor to complete its annual report. The issue appears to be Huarong’s legacy exposure associated with the misdeeds of its former Chairman, which still need to be addressed post-removal in 2018; and *Another Audit Delay: Huarong is delaying its 2020 earnings results beyond the April 30, 2021 deadline, which, in our view, only exacerbates concerns over a potential Huarong default. Ironic, given that Huarong was supposed to help mainland China clean up its bad debt mess. This further delay will not help bond liquidity which already appears to have disappeared. Contagion risk remains a real threat as bondholders likely sell other holdings.

China Huarong Asset Management  - This Can’t Be Good

China

China Huarong Asset Management Co Ltd. provides a variety of financial services. The Company offers asset management, banking, securities services, financial leasing, trust services, and investment services. China Huarong Asset Management maintains branch locations throughout China.

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China Huarong Asset Management (2799 HK)

ICBC: The Prefs Are Junk and Should Trade Like It

The prefs have had a strong run and are trading at 103 for a yield-to-call of only 2.9%. The AT-1 is significantly overvalued relative to 5-year US...

Stanley Tsai, CFA

ICBC: The Bond Identity | A Zero-Growth Dividend Discount Story

ICBC-H offers a hefty yield of 7% and is trading precisely as a zero-growth dividend-paying stock. But we are not buyers just yet and there is a...

Stanley Tsai, CFA

Last Week in Event SPACE: Swire, Hitachi Metal, Jardine, Softbank, Bingo, Japan Asia, Mainstream

The weekend is here! Pour yourself a coffee, grab a comfortable seat, and sift through a brief summary of insights on various events discussed...

David Blennerhassett

The Chinese Credit Chronicle: The CCC Danger

Here is our first Chinese Credit Chronicle (CCC) to track the debt bubble in China. China Huarong could be the first domino to fall.

Bondcritic

China Huarong Asset Management - This Can’t Be Good

CHINA HUARONG ASSET MANAGEMENT: Huarong is delaying its 2020 earnings results beyond the April 30, 2021 deadline, which, in our view, only...

Thomas J. Monaco

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