OREANDA-NEWS. Fitch Ratings has today affirmed the Long-Term Foreign-Currency Issuer Default Ratings (IDRs) of four Chinese mid-tier commercial banks with Stable Outlooks. At the same time, the Viability Ratings (VRs) of all four banks were also affirmed. A full list of rating actions is at the end of this rating action commentary.

The four banks are:

- China Merchants Bank

- China CITIC Bank

- China Everbright Bank

- Shanghai Pudong Development Bank (SPDB)

KEY RATING DRIVERS

IDRS, SUPPORT RATINGS AND SUPPORT RATING FLOORS

All of the IDRs are based on state support, and are at the banks' Support Rating Floors (SRFs), reflecting continued expectations that extraordinary support from the central government would be forthcoming in the event of stress.

China Merchants Bank, China CITIC Bank and China Everbright Bank have Support Ratings (SRs) of '2' and SRFs of 'BBB', indicating a high probability of state support, if needed. This is based on a combination of factors, including their relative size and domestic significance (for China Merchants Bank and China CITIC Bank), ownership by state-owned conglomerates (all three), direct central government ownership (for China Everbright Bank), and a history of past government support (for China Everbright Bank). Fitch does not expect the corporate restructuring at the parents of China CITIC Bank and China Everbright Bank to affect the state's propensity to support these two banks, as both parent groups remained majority-state-owned financial conglomerates.

SPDB has an SR of '2' and SRF of 'BBB-', based on its close integration and perceived support from the Shanghai government. The strengthening of the bank's role in the development of Shanghai as a major financial centre, and SPDB's enhanced systemic importance following the acquisition of Shanghai Trust (by way of capital injection from Shanghai International Group, which is wholly owned by the Shanghai government) should further increase SPDB's regional significance, and warrant a higher propensity for state support relative to other mid-tier banks not covered in this review. The one-notch difference between the IDRs of SPDB and the other three mid-tier banks with SRs of '2' reflects their different ownership structures (all three) and the level of interconnectivity with other financial affiliates within their parent groups (for China CITIC Bank and China Everbright Bank).

VIABILITY RATINGS

The VRs of China's four mid-tier banks range from 'bb-' to 'b+', reflecting varying degrees of intrinsic strength, which are affected by the extent of off-balance sheet activity; the level and pace of credit growth in the financial system; issues with transparency and corporate governance; an evolving regulatory framework; and nascent legal system.

System-wide provision buffers have fallen, and the average provision coverage ratio for joint stock banks declined to 179% at end-March 2016 from 218% at end-2014 and is approaching the regulatory minimum of 150%, even though the banks have made new provisions and disposed of NPLs at the same time. The need to comply with higher capital requirements at a time of weakening profitability has put pressure on the capital of the four mid-tier banks.

Fitch's analysis of Chinese banks' asset quality places greater emphasis on loss-absorption capacity (which includes factors such as capitalisation, loan-loss reserve coverage, and profitability) than data on loan classification. Fitch estimates the four mid-tier banks had loss-absorption buffers of around 4%-6% of credit based on end-2015 data, compared with an average of 7.9% for state banks. This shows the four mid-tier banks can withstand less deterioration in their buffers relative to the state banks before some form of remedial action would be likely to be required to restore capital to a sustainable level. However, recognition of asset impairment is likely to be a protracted process given that authorities often encourage support for troubled counterparties. In the meantime, delinquencies will continue to manifest in eroding liquidity and cash buffers, as inflows from distressed borrowers remain weak and more resources are directed at forbearance and support.

The raising (or planned raising) of additional capital in 2016 at some mid-tier banks should help increase their risk buffers, provided there is no acceleration in growth. Fitch took into account situations where capital had been raised by banks to offset rapid growth and maintain loss-absorption capacity at levels in line with similarly rated peers.

RATING SENSITIVITIES

IDRS, SUPPORT RATINGS AND SUPPORT RATING FLOORS

The banking system's continued rapid growth, combined with the rise in nonbank credit extension, means that the potential claims on the state are increasing. Pressures will build on the banks' IDRs if Fitch perceives the state's ability to support the banking sector is undermined by the growing size of the financial system. Authorities in China have not yet provided any clear guidance on the classification of domestic systemically important banks - such guidance could lead to changes in the SRs, SRFs and, in turn, the IDRs of the banks. Over the near term, Fitch expects the state's propensity to support the banking sector remains high (and extremely high for systemically important banks).

Significant changes to the sector's liability structure resulting in the banks becoming more reliant on wholesale and/or offshore funding (that is, when the system loan-to-deposit ratio reaches over 100%), may affect the willingness of the state to support the entire financial system - especially less systemically important banks - in the longer term, including resolving the rising stock of problem assets. Reduction in the state's ownership in the four mid-tier banks, either directly or indirectly through state-owned-enterprises, may affect the propensity of the state to support these banks if the reduction is significant and results in materially lower state influence.

VIABILITY RATINGS

Downgrades of the mid-tier banks' VRs could be triggered if (absent adequate external or internal capital being raised) excessive growth, particularly in areas such as wealth-management product (WMP) issuances, investments in receivables, non-loan credit, renders capital more vulnerable to deterioration.

There has been notable growth in WMPs by the four mid-tier banks over 2015, especially China Merchants Bank, which is building a leading asset management business on the back of its retail banking franchise. China Merchants Bank's outstanding WMPs more than doubled in 2015 and grew to around 33% of total assets at end-2015. This is second highest among our rated Chinese banks after China Everbright Bank (with outstanding WMPs equivalent to around 39% of assets). The magnitude of growth in China Merchants Bank's WMP issuance and investment in "non-standard" assets over the past year indicates that the bank's risk appetite is increasing, and this can become a key source of credit and liquidity risk, if such growth is not managed prudently and accompanied by a build-up of additional buffers.

Similarly, downgrades to VRs are possible if concentrations in exposures increase relative to peers, if the deterioration in asset quality begins to undermine solvency, or if severe deposit migration and/or reliance on WMPs leads to greater funding and liquidity strains. The sector benefits from a degree of ordinary support from Chinese authorities, most notably in the form of market liquidity injections and aid for financially troubled borrowers, but major disruptions in the issuance of WMPs, quasi-substitutes for time deposits, or interbank market distress could lead to VR downgrades for those entities highly exposed to, or that experience a material increase in, these activities.

VR upgrades for China's mid-tier banks are possible if Fitch considers the operating environment to have stabilised, if not improved. This would likely be evidenced by the pace of credit (both loan and non-loan) growth further slowing to a more sustainable level, stronger regulation contributing to less off-balance-sheet activity (or being less of a concern, including due to greater transparency around such activity), greater confidence that reported asset-quality ratios will hold, or the banks improving their loss-absorption capacities and/or strengthening their deposit funding and liquidity. Further development in the country's financial markets would also help reduce the financing and asset-quality burdens currently placed on the banking system, as well as support eventual deleveraging of the economy.

The full list of rating actions is as follows:

China Merchants Bank

-Long-Term Foreign-Currency IDR affirmed at 'BBB'; Stable Outlook

-Support Rating affirmed at '2'

-Support Rating Floor affirmed at 'BBB'

-Viability Rating affirmed at 'bb-'

China CITIC Bank

-Long-Term Foreign-Currency IDR affirmed at 'BBB'; Stable Outlook

-Support Rating affirmed at '2'

-Support Rating Floor affirmed at 'BBB'

-Viability Rating affirmed at 'b+'

China Everbright Bank

-Long-Term Foreign-Currency IDR affirmed at 'BBB'; Stable Outlook

-Support Rating affirmed at '2'

-Support Rating Floor affirmed at 'BBB'

-Viability Rating affirmed at 'b+'

Shanghai Pudong Development Bank

-Long-Term Foreign-Currency IDR affirmed at 'BBB-'; Stable Outlook

-Support Rating affirmed at '2'

-Support Rating Floor affirmed at 'BBB-'

-Viability Rating affirmed at 'b+'