Banks are increasingly issuing bonds to replenish their capital. On June 24th, Zhejiang Lin'an Rural Commercial Bank issued 600 million yuan in Tier 2 capital bonds. A week prior, Guangfa Bank and Hangzhou Bank also issued perpetual bonds worth 20 billion yuan and 10 billion yuan respectively. According to data from Choice, just in June alone, 13 companies have issued Tier 2 capital bonds and perpetual bonds (collectively referred to as "Tier 2 perpetual bonds"), with a total scale exceeding 150 billion yuan.

Looking at a longer timeline, the pace of "Tier 2 perpetual bonds" issuance by commercial banks has significantly accelerated this year. As of June 24th, the issuance scale of commercial banks' "Tier 2 perpetual bonds" has approached 800 billion yuan, a year-on-year increase of over 127%. Behind this, on one hand, there is a strong demand for banks to replenish their capital due to regulatory requirements and market changes; on the other hand, factors such as the peak of redemption of existing Tier 2 capital bonds are also driving this trend.

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Industry analysts believe that considering the current strong demand for capital replenishment by commercial banks, the scale of "Tier 2 perpetual bonds" by commercial banks may continue to expand in the future.

Scale up, interest rates down

As an important external channel for banks to supplement their capital, the issuance and net financing scale of Tier 2 capital bonds have remained high in recent years. According to data organized by Choice, as of June 24th, nearly 40 banks have issued "Tier 2 perpetual bonds" this year, with an issuance scale of about 777.6 billion yuan, a 127% increase from 342 billion yuan in the same period last year. Among them, the issuance scale of Tier 2 capital bonds was 471.6 billion yuan, a 61% increase year-on-year; the issuance scale of perpetual bonds was 306 billion yuan, a 544% increase year-on-year.

Net financing has also continued to be high. According to Choice data, as of June 24th, the net financing amounts for banks' Tier 2 perpetual bonds from January to June were 1.85 billion yuan, 13 billion yuan, -7.23 billion yuan, 14.12 billion yuan, 8.42 billion yuan, and 7.23 billion yuan, respectively, totaling 37.39 billion yuan, higher than the same period last year.

More banks are on the way to issuing "Tier 2 perpetual bonds." According to incomplete statistics by the reporter, as of the time of writing, at least nine banks have been approved for new issuance quotas this year, involving a scale of over 200 billion yuan.

While the issuance and net financing scales continue to rise, the interest rates for banks issuing Tier 2 perpetual bonds are gradually decreasing. A report from China Bond Rating shows that the average issuance interest rate for Tier 2 bonds has dropped from 4.98% in 2019 to 4.32% in 2023, a decrease of 66 basis points. During the same period, the yield of 5-year government bonds decreased by only 49 basis points. According to calculations by the fixed income team at Huaxiang Securities, from January 1, 2024, to June 14, the yield of bank capital bonds has significantly decreased by 57 to 154 basis points, and the credit spread has narrowed by 17 to 120 basis points.

Most newly issued "Tier 2 perpetual bonds" have fallen into the range below 3%. According to Choice data, among the 49 "Tier 2 perpetual bonds" issued by commercial banks this year, 39 have an issuance coupon rate of 2.3% to 3%, accounting for nearly 80%.

The decrease in interest rates has also affected the supply structure to some extent. This year, joint-stock banks and city and rural commercial banks have seized the opportunity of low interest rates, with capital bond issuance and net financing far exceeding the same period in previous years. According to Huaxiang Securities' calculations, in 2022 and 2023, state-owned banks were the main suppliers of capital bonds, with an issuance share of over 75%. This year, as interest rates have fallen to low levels, joint-stock banks and city and rural commercial banks have taken the opportunity to issue a large number of capital bonds, with a combined issuance share of 37.5%, and the issuance cost has set new lows on multiple occasions. Specifically, since 2024, joint-stock banks have issued 194 billion yuan in capital bonds, with net financing of 84 billion yuan, compared to a net increase of only 20 billion yuan in the same period of 2023; city and rural commercial banks have issued 81.6 billion yuan in capital bonds, with net financing of 46.6 billion yuan, an increase of 33.9 billion yuan year-on-year.Why Banks Frequently "Replenish Blood"

It is generally believed in the industry that the issuance of perpetual bonds has a seasonal pattern, with banks tending to issue them in the second half of the year, especially in the third quarter. Why have many banks started to frequently issue "perpetual bonds" to replenish their capital in the first half of the year? Industry insiders believe this is related to factors such as high capital pressure and facing a peak period of redemption maturity.

From a direct cause perspective, in the first half of this year, the concentration of redemptions and maturities of "perpetual bonds" was relatively large. To maintain a certain level of capital adequacy ratio, banks need to continue issuing bonds, which has objectively driven a surge in the issuance scale of "perpetual bonds."

According to Choice data, in 2024, there are 42 tranches of subordinated debt maturing, with a total scale of 256.7 billion yuan, higher than the same period last year.

Although perpetual bonds are theoretically bonds that can exist indefinitely, they are usually issued in the form of "5+N," with a clause that allows for the option to exercise redemption rights in the fifth year. According to Choice data, in 2024, there are 19 tranches of perpetual bonds that can be redeemed, involving a scale of 489.6 billion yuan. In contrast, there were no redeemable perpetual bonds last year.

Overall, the scale of redemptions of banks' "perpetual bonds" in 2024 is expected to be about 746.3 billion yuan, far exceeding the 6.2 billion yuan in 2023. Additionally, according to a report from the China Bond Credit Rating Financial Industry Research Team in early June, the redemption scale of "perpetual bonds" (including subordinated debt and perpetual bonds) in 2024 and 2025 will reach 2.34 trillion yuan, exceeding one-third of the existing scale.

Furthermore, the deeper reason behind the banks' frequent "blood replenishment" is the capital pressure they face. "The paths for commercial banks to supplement capital can be divided into endogenous and exogenous. Endogenous growth mainly relies on methods such as increasing retained earnings by banks, but it is difficult under the situation where the net interest margin continues to narrow," said Li Qinghe, an analyst at Huafu Securities.

The reporter noticed that the net interest margin of banks has dropped to a historical low. After the net interest margin of commercial banks fell below 1.7% for the first time at the end of the fourth quarter last year, according to the latest data disclosed by the National Financial Regulatory Administration, the net interest margin of commercial banks further decreased to 1.54% in the first quarter of this year.

Li Qinghe believes that, given the above situation, banks are more reliant on exogenous financing. At present, Chinese commercial banks mainly rely on issuing perpetual bonds and subordinated debt, such as these subordinated instruments, to supplement their capital.

It is worth noting that regulatory requirements also force some banks to accelerate the capital replenishment process. Under the new capital management regulations, many banks have approached the "red line." The "Commercial Bank Capital Management Measures," which came into effect on January 1 of this year, stipulate that the core tier-one capital adequacy ratio of commercial banks must not be lower than 5%, the tier-one capital adequacy ratio must not be lower than 6%, and the capital adequacy ratio must not be lower than 8%.Additionally, commercial banks should set aside capital conservation buffers on top of the minimum capital requirements. The conservation buffer requirement is 2.5% of risk-weighted assets, which should be met by Tier 1 core capital. That is, the minimum requirements for the core Tier 1 capital adequacy ratio, Tier 1 capital adequacy ratio, and total capital adequacy ratio (including the conservation buffer) for commercial banks are 7.5%, 8.5%, and 10.5%, respectively.

Looking at the data disclosed by listed banks for the first quarter of 2024, some banks have a core Tier 1 capital adequacy ratio that is close to the regulatory "red line". Among them, seven banks have a core Tier 1 capital adequacy ratio below 9%, approaching the regulatory red line of 7.5%.

In addition to the new capital management regulations, banks will also face the challenge of meeting the Total Loss-Absorbing Capacity (TLAC) regulatory requirements.

"The five major banks, including Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China, China Construction Bank, and Bank of Communications, need to meet the regulatory requirements for the TLAC risk-weighted ratio by issuing TLAC instruments to supplement capital, mainly in the form of TLAC non-capital debt and perpetual bonds issued by banks," said Tan Yiming, Chief Fixed Income Analyst at Minsheng Securities. To meet the TLAC regulatory requirements, considering the issuance of TLAC non-capital bonds and the scale of perpetual bonds issued this year, it is estimated that the TLAC capital bond gap for the five major banks at the beginning of 2027 will be about 1.8 trillion yuan.

Overall, the supply scale of perpetual bonds in the future will still be quite large. According to Yang Yewei, Chief Fixed Income Analyst at Guosheng Securities, in his research report, if banks want to maintain the capital adequacy ratio without decline while carrying out their business normally, considering the impact of profitability, asset quality, and the new capital regulations, the net financing of perpetual bonds for the whole year of 2024 may need to be 1.16 trillion yuan, and the issuance volume, combined with the maturity scale, is estimated to be about 2.3 trillion yuan.