Hong Kong banks' Basel III Tier 2 debt ratings to dip two notches lower

Here's what to blame.

In a report, Fitch Ratings says that it expects to rate most Hong Kong banks' Basel III Tier 2 debt two notches down from their anchor ratings, reflecting poor recoveries as a result of contractual write-down clauses at the point of non-viability. 

The notching may be limited to one level if Fitch considers it sufficiently likely that initially incurred losses can be recovered during the lifetime of the instruments.

Fitch believes the non-performance risk of a pure non-viability trigger (at the discretion of the Hong Kong Monetary Authority) in Tier 2 notes is adequately reflected in the anchor rating and no notching is required.

Where structural features, such as management discretion over coupon payments, or the inclusion of easily activated triggers, are present and which are more common in Basel III Tier 1 instruments, notching for non-performance of up to three notches may be applied.

The anchor rating is either an issuer's Viability Rating (VR) or a support-driven Issuer Default Rating if Fitch expects parental support to be made available to regulatory capital securities.

However, as Fitch views that state support for Tier 1 securities is unlikely, the anchor rating for Tier 1 securities would typically be the parent bank's VR for a number of Chinese-owned subsidiaries with strong integration with their parents.

Fitch does not see Hong Kong banks aggressively issuing Basel III-compliant supplementary capital, due to their solid capitalisation. The Fitch Core Capital ratio of the 10 Hong Kong banks rated by the agency was on average 14.2% at end-2012.

New issuance will mainly be to replace existing subordinated instruments and Fitch believes Hong Kong banks may consider including write-up features rather than partial write-downs or equity conversion.