USD500 million in debt securities rated
Hong Kong, November 10, 2016 -- Moody's Investors Service has today assigned a definitive Aa3 long-term
rating to the secured notes issued by Bank of China Limited (BOC),
London Branch (counterparty risk assessment A1(cr), foreign currency
senior unsecured rating A1 with a negative outlook).
The notes are issued under BOC's medium term note program, and are
secured by a pledge by BOC over a portfolio of PRC domestic climate-aligned
bonds issued by Chinese institutions and traded on the China Interbank
Bond Market.
The complete rating action is as follows:
Issuer: Bank of China Limited, London Branch
....U.S.$500,000,000
1.875 per cent. Notes due 2019, Definitive Rating
Assigned Aa3
The rating that Moody's has assigned addresses the expected loss posed
to investors. Moody's ratings address only the credit risks associated
with the transaction. Other non-credit risks have not been
addressed, but may have a significant impact on yield to investors.
RATINGS RATIONALE
When assigning the ratings, Moody's considered, among other
things, the following key strengths of the transaction:
1. The credit strength of the issuer, which has a counterparty
risk assessment of A1(cr).
2. The benefit to secured notes from (1) the issuer's promise to
pay interest and principal on the notes; and (2) following the default
of the issuer, the economic benefit of the collateral pool.
3. The amount of the collateral pool, with an initial par
amount of RMB6.79 billion, equal to 200% of the issued
notes based on an assumed USD/RMB exchange rate of 6.79,
and the requirement that the aggregate RMB par amount of the newly added
bonds needs to be at least equal to the aggregate RMB par amount of the
bonds repaid, repurchased or removed during portfolio substitution.
In addition, Moody's considered the following weaknesses:
1. The concentration and the credit quality of the assets backing
the secured notes.
The pledged collateral pool comprises a portfolio of pledged bonds that
are issued by Chinese institutions and meet certain eligibility criteria
and concentration limits, including criteria on the minimum credit
quality of the bond issuers, and limits on the exposure of individual
issuers and the weighted average remaining term of the pool.
The initial collateral pool primarily consists of bonds issued by two
issuers. Issuers of PRC domestic climate-aligned bonds are
often government-related entities or entities that receive support
from the Chinese government. The credit quality of the initial
and future pledged bond issuers can be highly correlated to each other
and to the credit quality of BOC.
The pledged bonds may change from time to time when the existing pledged
bonds are repaid or repurchased, or when the issuer substitutes
the bonds. The issuer is required to replace bonds that are repaid,
repurchased or become ineligible due to the deterioration of credit quality
with new bonds, so that the eligibility criteria and concentration
limits are satisfied. The issuer also has the right to substitute
bonds in the collateral pool, subject to certain conditions.
Moody's modeled a stressed level of collateral credit losses of 36.85%
- a relatively high number - because the portfolio is highly
concentrated, the credit quality of the issuer and that of the collateral
pool can be highly correlated, and the characteristics of the collateral
pool can change within a relative short period of time.
2. Legal uncertainties around the enforcement of the collateral
pool.
The transaction differs from covered bond transactions in other jurisdictions.
This transaction does not benefit from covered bond legislation,
or from the true sale of a collateral pool to a separate entity to support
the segregation of assets from the issuer's bankruptcy estate.
As the collateral pool is pledged to the transaction, certain preferred
creditors may receive sales proceeds of the collateral pool ahead of the
creditors of the subject secured notes.
In addition, the enforcement of security under the transaction can
be suspended in case the bankruptcy or reorganization process of the issuer
has begun, or if a receiver is appointed to take over the issuer
and the receiver applies for a suspension order from the courts.
The suspension of security enforcement will result in the present-value
loss of the value of the collateral pool associated with the delay in
receiving the sales proceeds of the collateral pool.
Under PRC law, the interest on the secured notes will cease to accrue
upon the commencement of the bankruptcy proceeding of the issuer.
Hence, the suspension of security enforcement could result in a
loss of notes interest to noteholders. Such loss may not be covered
by the collateral pool because noteholders will only have a claim on the
interest accrued up to the commencement of the bankruptcy proceedings
of the issuer.
3. Set-off risk.
When the issuer becomes bankrupt, the issuers of the pledged bonds
may exercise their set-off rights to reduce the amount of debt
they owe to the issuer, including pledged bonds in the collateral
pool, by the amount of their deposits at the issuer. The
pledged bonds in the transaction are held by a central clearing house,
China Central Depository and Clearing Co., Ltd. (CCDC).
This could create practical difficulties for the bond issuers to exercise
their set-off rights on such bonds, which could in turn create
an incentive for the bond issuers to exercise their set-off rights
on other debt, such as loans.
4. Commingling risk.
The cash collected from the pledged bonds before the secured notes become
due and payable can become subject to commingling risk because it is not
clear under PRC law whether such cash will be part of the pledged assets.
To limit the exposure on such cash, the issuer is required to replace
the collected cash with new bonds within 60 business days.
5. Currency risk.
The collateral pool is denominated in RMB while the secured notes are
denominated in USD. There is no hedge in the transaction to mitigate
this currency mismatch. In case of a depreciation of RMB against
USD, there is no obligation for the issuer to add new pledged bonds
if the USD equivalent of the par value of the collateral pool diminishes,
unless the USD equivalent of the full-price value published by
CCDC of the collateral pool falls below certain level. If BOC is
in default, it is expected that RMB will depreciate and cause a
substantial reduction in the value of the collateral pool. Moody's
has applied a significant haircut to the value of the collateral pool
to account for the currency risk.
6. Refinancing risk.
To avoid suspension of security enforcement, the transaction contemplates
to sell the collateral pool soon after the occurrence of an enforcement
event, which is the non-payment of the secured notes at its
maturity or the acceleration of the notes following an event of default.
The liquidation value of the collateral pool can be subject to a substantial
reduction under a fire sale scenario. Although the present-value
loss arising from the suspension of security enforcement will not materialize
in case the fire sale is successful, the suspension of security
enforcement could prevent a successful fire sale.
7. No liquidity reserve.
The transaction does not have a liquidity reserve or other liquidity arrangements.
If the issuer defaults and the collateral pool cannot be sold in a timely
manner, there will be no liquidity to support the continued payment
of the secured notes.
Moody's analysis focused, among other factors, on the following
considerations:
1. The credit strength of the issuer;
2. The rights of the creditors under the secured notes on the collateral
pool, and the uncertainties of such rights under the PRC laws;
3. The potential reduction in the value of the collateral pool
because of various factors, including currency, credit,
set-off, commingling, present-value and refinancing
losses.
4. The characteristics of the collateral pool, including
the over-collateralization of 100% based on par value of
the collateral pool and an assumed USD/RMB exchange rate of 6.79;
and
5. The legal and structural integrity of the transaction.
The rating of the secured notes will be highly linked to the long-term
counterparty risk assessment of BOC because of the weak asset ring-fencing
protection when compared with traditional covered bonds, and in
view of the various risks in the transaction as explained in the preceding
paragraphs.
The rating of the secured notes is in line with the Aa3 rating level of
China's foreign currency and local currency country ceilings.
As of the closing date, the total aggregate par value of the collateral
pool is RMB6.79 billion. The pool consists of 11 PRC domestic
climate-aligned bonds, issued by 6 issuers. The top
two issuers, China Railway Corporation and Shanghai Pudong Development
Bank Co., Ltd., contribute 57.9%
and 39.8% to the par value of the initial collateral pool
respectively. The bonds pay annual fixed rate interest, and
bullet principal at maturity. The remaining terms of the bonds
range from 2 years to 8 years, and the weighted average is about
3 years.
BOC is headquartered in Beijing. It reported assets of RMB17.9
trillion at 30 September 2016.
The Hong Kong and Shanghai Banking Corporation Limited is the trustee,
security trustee and paying agent for this transaction.
CCDC is the asset monitor agent and enforcement agent for this transaction.
KEY RATING ASSUMPTIONS/FACTORS
Moody's determines the rating of the secured notes using a two-step
process: an expected loss analysis and a timely payment indicator
(TPI) framework analysis. In addition, Moody's has considered
the impact of the aforementioned uncertainties of various risks in its
analysis.
EXPECTED LOSS: Moody's uses its Covered Bond Model (COBOL) to determine
a rating based on the expected loss on the notes. COBOL determines
expected loss as a function of (1) the probability that the issuer will
cease making payments under the secured notes; and (2) the stressed
losses on the collateral pool assets following the payment default of
the issuer.
The collateral pool losses for this transaction comprises mainly the losses
due to currency risk and credit risk, which can be substantial in
a distressed situation where the issuer is in default. The collateral
pool losses also include the aforementioned present-value loss,
refinancing loss, and losses due to set-off and commingling
risks.
TPI FRAMEWORK: Moody's assigns a TPI, which measures the likelihood
of timely payments to the noteholders following the payment default of
the issuer. The TPI framework limits the note rating to a certain
number of notches above the rating or counterparty risk assessment of
the issuer.
The TPI assigned to this transaction is "Very Improbable", primarily
because of the potential suspension of security enforcement and the lack
of liquidity in the transaction. Moody's TPI framework does not
constrain the rating.
However, the aforementioned risks constrain the rating of the secured
notes at one notch above the counterparty risk assessment of the issuer.
FACTORS THAT WOULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATING:
Factors that may cause an upgrade of the ratings include: a raise
of the long-term counterparty risk assessment of BOC, together
with a corresponding raise in China's foreign currency and local currency
country ceilings.
Factors that may cause a downgrade of the ratings include: a lowering
of BOC's long-term counterparty risk assessment; a lowering
of China's foreign currency or local currency country ceilings; a
significant increase of concentration or a significant deterioration in
the credit quality of the collateral pool without mitigating actions taken
on the deal; and a significant depreciation of the RMB against USD.
RATING METHODOLOGY
The principal methodology used in this rating was "Moody's Approach to
Rating Covered Bonds" published in August 2015. Please see the
Rating Methodologies page on www.moodys.com for a copy of
this methodology.
REGULATORY DISCLOSURES
For further specification of Moody's key rating assumptions and sensitivity
analysis, see the sections Methodology Assumptions and Sensitivity
to Assumptions of the disclosure form.
Moody's did not use any stress scenario simulations in its analysis.
For ratings issued on a program, series or category/class of debt,
this announcement provides certain regulatory disclosures in relation
to each rating of a subsequently issued bond or note of the same series
or category/class of debt or pursuant to a program for which the ratings
are derived exclusively from existing ratings in accordance with Moody's
rating practices. For ratings issued on a support provider,
this announcement provides certain regulatory disclosures in relation
to the credit rating action on the support provider and in relation to
each particular credit rating action for securities that derive their
credit ratings from the support provider's credit rating.
For provisional ratings, this announcement provides certain regulatory
disclosures in relation to the provisional rating assigned, and
in relation to a definitive rating that may be assigned subsequent to
the final issuance of the debt, in each case where the transaction
structure and terms have not changed prior to the assignment of the definitive
rating in a manner that would have affected the rating. For further
information please see the ratings tab on the issuer/entity page for the
respective issuer on www.moodys.com.
For any affected securities or rated entities receiving direct credit
support from the primary entity(ies) of this credit rating action,
and whose ratings may change as a result of this credit rating action,
the associated regulatory disclosures will be those of the guarantor entity.
Exceptions to this approach exist for the following disclosures,
if applicable to jurisdiction: Ancillary Services, Disclosure
to rated entity, Disclosure from rated entity.
Regulatory disclosures contained in this press release apply to the credit
rating and, if applicable, the related rating outlook or rating
review.
Please see www.moodys.com for any updates on changes to
the lead rating analyst and to the Moody's legal entity that has issued
the rating.
Please see the ratings tab on the issuer/entity page on www.moodys.com
for additional regulatory disclosures for each credit rating.
The first name below is the lead rating analyst for this Credit Rating
and the last name below is the person primarily responsible for approving
this Credit Rating.
Joe Wong
Vice President - Senior Analyst
Structured Finance Group
Moody's Investors Service Hong Kong Ltd.
24/F One Pacific Place
88 Queensway
Hong Kong
China (Hong Kong S.A.R.)
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077
Jerome Cheng
Senior Vice President
Structured Finance Group
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077
Releasing Office:
Moody's Investors Service Hong Kong Ltd.
24/F One Pacific Place
88 Queensway
Hong Kong
China (Hong Kong S.A.R.)
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077
