OREANDA-NEWS. Fitch Ratings has today upgraded the Long-Term Foreign-Currency Issuer Default Rating (IDR) of Shanghai Pudong Development Bank (SPDB) to 'BBB-' from 'BB+' with Stable Outlook. Fitch also affirmed the IDRs of nine other Chinese mid-tier commercial banks. Their Outlooks are all Stable. The Viability Ratings (VRs) of all ten banks were also affirmed.

The ten banks are:
- China Merchants Bank,
- China CITIC Bank,
- China Everbright Bank,
- Shanghai Pudong Development Bank (SPDB),
- China MinSheng Banking Corporation,
- Industrial Bank Co., Ltd,
- Ping An Bank Co., Ltd,
- Hua Xia Bank,
- China Guangfa Bank Co., Ltd, and
- Bank of Beijing.

A full list of rating actions is at the end of this rating action commentary.

KEY RATING DRIVERS

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

The upgrade for SPDB's Support Rating (SR) to '2' from '3' and IDR to 'BBB-' from 'BB+' is based on closer integration and perceived support from the Shanghai government than we previously thought. 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. The one-notch difference between SPDB and the other three mid-tier banks with SRs of '2' reflects their different ownership structure (all three) and the level of interconnectivity with other financial affiliates within their parent groups (for China CITIC Bank and China Everbright Bank).

China Merchants Bank, China CITIC Bank and China Everbright Bank have 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.

The remaining six banks have SRs of '3' and SRFs of 'BB+', indicating a moderate probability of central government support if needed. Banks in this group are mostly smaller in size and have no direct central government ownership or less significant integration with major shareholders, which may include local governments. However, these factors may evolve over time, which will affect the probability of external support. In a stress scenario, Fitch believes that the ability of local governments to support banks on a timely basis may be limited, and hence support would effectively need to flow from the central government. That said, without sufficient systemic importance, whether regionally or nationally, the propensity of the state to extend support to these banks under stress is considered to be moderate.

VIABILITY RATINGS
The VRs of China's 10 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.

The continued growth in off-balance sheet activities and increases in debt receivables, of which some are used as substitutes for loans, makes it more difficult to gauge where the ultimate risks reside. This may become clearer over time given the removal of the loan-to-deposit cap, but we have so far seen little progress, while banks remain subject to informal regulatory guidance. Mid-tier banks are more reliant on the sale of wealth management products (WMPs) and derive a larger share of their funding through these products compared with the state banks. WMPs' short tenors, asset-liability mismatches, and limited disclosure about underlying assets present a significant contingent risk to issuing banks. The removal of the deposit rate ceiling, effective October 2015, has potential to intensify the margin pressures over the long run, though the near-term impact on deposit pricing is likely to be limited.

System-wide provision buffers have fallen, and the average provision coverage ratio for joint stock banks has declined to 188% at end-September 2015 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 buffers at a time when profitability is weakening has put pressure on capital for most mid-tier banks. This implies greater profitability pressures in 2016, and possibly year-on-year declines in reported earnings at some 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 currently estimates the mid-tier banks can withstand a rise in impaired credit to an average of 4.1%, compared to an average of 7.4% for state banks (6.2% system-wide), after which varying degrees of support would be required. 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.

While there was broad-based deterioration in asset-quality indicators over the past year, other parameters such as funding and liquidity, loss-absorption capacity, and franchise strength remained generally stable among the mid-tier banks. Hence, the VRs were affirmed for all mid-tier banks. The raising (or planned raising) of additional capital in 2015 and 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
Any changes to IDRs, SRs and SRFs will be tied to shifts in the perceived willingness and/or ability of the government (central/municipal) to provide extraordinary support to the banks, which also take into account their relative systemic importance and ownership.

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. 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).

However, 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 ability 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 ownership in the 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 renders capital more vulnerable to deterioration, if concentrations in exposures increase relative to peers, if asset quality weakening begins to undermine solvency, or if funding and liquidity strains become more binding. Although the sector benefits from a degree of ordinary support from Chinese authorities, most notably in the form of market liquidity injection and aid for financially troubled borrowers, major disruptions in the issuance of WMPs, quasi-substitutes for time deposits, or interbank market distress could also 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 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 on China's 10 mid-tier banks is as follows:

SPDB
-Long-Term Foreign-Currency IDR upgraded to 'BBB-' from 'BB+'; Stable Outlook
-Support Rating upgraded to '2' from '3'
-Support Rating Floor revised to 'BBB-' from 'BB+'
-Viability Rating affirmed at 'b+'

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+'

China MinSheng Banking Corporation
-Long-Term Foreign-Currency IDR affirmed at 'BB+'; Stable Outlook
-Support Rating affirmed at '3'
-Support Rating Floor affirmed at 'BB+'
-Viability Rating affirmed at 'b+'

Industrial Bank
-Long-Term Foreign-Currency IDR affirmed at 'BB+'; Stable Outlook
-Support Rating affirmed at '3'
-Support Rating Floor affirmed at 'BB+'
-Viability Rating affirmed at 'b'

Ping An Bank
-Long-Term Foreign-Currency IDR affirmed at 'BB+'; Stable Outlook
-Support Rating affirmed at '3'
-Support Rating Floor affirmed at 'BB+'
-Viability Rating affirmed at 'b'

Hua Xia Bank
-Long-Term Foreign-Currency IDR affirmed at 'BB+'; Stable Outlook
-Support Rating affirmed at '3'
-Support Rating Floor affirmed at 'BB+'
-Viability Rating affirmed at 'b'

China Guangfa Bank
-Long-term Foreign-Currency IDR affirmed at 'BB+'; Stable Outlook
-Support Rating affirmed at '3'
-Support Rating Floor affirmed at 'BB+'
-Viability Rating affirmed at 'b'

Bank of Beijing
-Long-term Foreign-Currency IDR affirmed at 'BB+'; Stable Outlook
-Support Rating affirmed at '3'
-Support Rating Floor affirmed at 'BB+'
-Viability Rating affirmed at 'bb-'.