As the year 2025 begins, a notable development in the Chinese banking sector has emerged with the successful triggering of compulsory redemption for convertible bonds by two banksThis move not only facilitated the conversion of these bonds into equity shares but also paved a new avenue for bolstering the banks' core tier one capitalThis situation is significant considering the ongoing emphasis from regulatory authorities on supporting banks in replenishing their capital to enhance the banking system's stability and its capacity to withstand risks.

The backdrop to this occurrence is marked by a substantial 40% increase in the A-share banking sector throughout 2024, which created a favorable climate for converting convertible bonds into stocksAs a result, the two banks involved – Chengdu Bank and Suzhou Bank – have successfully executed this redemption, collectively surpassing a scale of over 10 billion yuanSince the beginning of 2023, these banks have been among the few that completed compulsory redemption and conversion of convertible bonds, thus reflecting a notable trend in the financial markets.

Out of the 12 currently active convertible bonds, six have a conversion rate that remains below 10%. The upward surge in banking stock prices suggests a possibility for additional convertible bonds to be triggered for compulsory redemption in 2025. However, experts indicate that cultivating long-term investment confidence in the underlying stocks is crucial for investors looking for successful conversions.

The case of compulsory redemption in Chengdu Bank highlights the rarity of such occurrences among publicly listed banksAnnounced on February 6, this bank saw its convertible bonds – known as Chengyin Convertible Bonds – enact compulsory redemption and thereby resulted in their official delisting from the Shanghai Stock Exchange.

According to public information, these bonds were initially issued on March 3, 2022, with a six-year maturity, and the successful compulsory redemption allows for an early completion of the original 8 billion yuan in convertible bonds scheduled for redemption by March 2, 2028. Following this compulsory redemption, Chengdu Bank effectively converted 7.995 billion yuan, achieving an impressive conversion rate of 99.94%, which will subsequently be utilized for supplementing the core tier one capital as stipulated by regulatory requirements.

Simultaneously, starting March 4, 2025, Suzhou Bank's convertible bonds will cease trading, marking the beginning of a termination of stock conversion from March 7 onwards

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These bonds were initially issued on April 12, 2021, with a total issuance of 5 billion yuan and a six-year duration.

The fact that only a limited number of banks have managed to execute successful compulsory redemptions since 2023, specifically Jiangsu Bank, Chengdu Bank, and Suzhou Bank, indicates a larger trend within the banking sectorOther banks with convertible bonds such as Zhang Bank, Sunong Bank, Wuxi Bank, Jiangyin Bank, and Huatai Bank, have opted for redemption upon maturity, thus failing to fulfill the complete debt-to-equity conversion.

The strong stock performance of Chengdu Bank and Suzhou Bank correlates with their ability to execute compulsory redemptionsOn December 17, 2024, Chengdu Bank announced that since November 7, it had recorded 15 trading days where the closing prices were at least 1.3 times higher than the current conversion price of their convertible bonds, which triggered the conditional redemption clauseOn January 21, 2025, Suzhou Bank likewise reported that from December 12, 2024, to January 21, 2025, their stock price met the conditional redemption trigger based on the conversion price, prompting the bank to decide on early redemption.

Shiao Ke, head of the banking team at the Bank of China Research Institute, emphasizes that apart from the stocks’ price performance, long-term trends reflected in operational quality substantially strengthen investor confidenceHe observes that Suzhou Bank’s stock price had consistently increased in 2024 and was buoyed by the ongoing growth of the regional economy, alongside improvements in operating efficiency and expedited business expansion, which cultivated a robust trend favorable for stock price appreciation and enhanced recognition of convertible bonds among investors.

Similarly, Cao Yuanyuan, deputy general manager at Dongfang Jincheng’s R&D department, concurred that the success of recent compulsory redemptions of convertible bonds stems from a multitude of favorable factors

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He cites Suzhou Bank's robust business performance and significant profit growth coupled with a high dividend yield as key attractions for institutional investors, reinforcing the stock priceAdditionally, the recent reduction of the conversion price from 8.34 yuan to 6.19 yuan due to ongoing cash dividend distributions set favorable conditions for triggering compulsory redemptions.

Experts recommend that careful structuring of convertible bond terms is essential for a thriving landscapeEstablishing sensible conversion prices and redemption terms can better balance the interests of issuers and investors while adapting to market fluctuations, thus enhancing the potential for triggering compulsory redemptionsThe timing of market interventions also plays a crucial role; for example, the strategic timing of Suzhou Bank's conversion actions post-Chinese New Year align well with market liquidity and investor sentiment, increasing the probability of successful conversions.

Moreover, an active dividend policy can elevate the allure of convertible bonds for institutional investorsThis sector is encouraged to seize the current influx of mid-to-long-term capital investments, focusing on value management for publicly listed banks to enhance the attractiveness of banking stocks and convertible bonds.

While convertible bonds present a promising avenue for supplementing core tier one capital—coupled with their advantageous features of low interest rates and deferring equity dilution—actual conversion remains challenging amidst fluctuating market performancesComprehensive data indicates that six particular convertible bonds, including those from Pudong Development Bank, Qingnong Bank, and Xinyu Bank, are currently reflecting conversion rates below 10%. Investors are closely monitoring the potential for conversion as recent market trends have sparked concern regarding the sustainability of rebounds in bank stocks.

Chongqing Bank, for example, clarified its status, noting its 13 billion yuan in A-share convertible bonds is currently within its conversion period and has experienced some conversions

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The profound ramifications of a lack of stock price momentum—whereby several banks remain in a state of underperformance—are evident as many are trading below their conversion prices, further damping interest among potential converting investors.

Shiao Ke points out that the current rise in indices has not resulted in accelerated conversion rates, likely due to certain banks still facing challenges where their stock prices remain beneath conversion prices, thereby reducing investor motivation to opt for conversion amidst declining stock valuationsAlso, since the majority of convertible bond investors are institutional with a more conservative approach, many prefer to retain bonds for interest rather than gamble on the volatility post-conversion.

Cao Yuanyuan observed that triggering redemption is contingent upon two factors: one, the underlying stock price reaching a triggering point, usually 130% of the conversion price; and two, the sustained momentum of the stock price above this threshold across requisite trading daysLong-term metrics show that various banks have issued convertible bonds between 2020 and 2022, and ongoing economic pressures have dampened stock prices substantially leading to slow recovery despite the positive performance across the broader banking index.

The question remains: can the path of strong stock performances triggering redemption be replicated? Xu Wenchao, director of Fitch Ratings for Asia Pacific financial institutions, warns of the multitude of constraints faced by banks, projecting a continued underperformance in the entire banking sector throughout 2025. Factors such as insufficient overall loan demand and repeated interest rate cuts continue to keep revenue growth rates at low levelsConsequently, investor confidence in banks’ profitability and growth prospects remains shaky amid growing disparities in revenue growth and asset quality between institutions based in prosperous and weaker economic regions.

However, any positive indicators for bank valuation recovery observed in 2024 are anticipated to carry weight into 2025. The aforementioned factors such as a low interest rate environment, the introduction of effective debt management policies, and advocacy for mid-to-long-term investments will likely underpin the stability of banks moving forward

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