Great China Bank Sale
Fannie Mae and Freddie Mac, meet ICBC. China's largest bank joins the ranks of publicly listed companies next week when it unveils what may be the world's largest-ever IPO in Hong Kong and Shanghai. But as with America's mortgage behemoths, investors are betting as much on implicit government support as on ICBC itself.
Headquartered in Beijing, the Industrial Commercial Bank of China Ltd. is China's largest commercial bank by total assets, loans and deposits. With more than 18,000 branches and $21.7 billion in 2005 operating income, it holds 15.4% of total loans in all Chinese banking institutions, according to its offering prospectus. For foreign investors hoping to profit from China's rapid economic growth, ICBC shares may seem just the ticket.
We hope this isn't lemmings jumping off a cliff. At around this time last year, China Construction Bank Corp., the nation's third-largest lender by assets, raised $9.2 billion. This year, Bank of China Ltd., the country's second-largest by assets, raised $11.2 billion in an IPO. Even mid-tier China Merchants Bank received so much demand for its shares that its underwriters exercised a 10% overallotment option.
Amid this excitement, it's easy to forget how and why the Great China Bank Sale started. In the mid-1990s, Beijing's policy makers realized that government-directed lending wasn't compatible with a rapidly expanding capitalist economy. So they created policy banks to lend on behalf of the public sector, leaving state-owned lenders free to dole out cash along commercial lines.
The problem was, the proper economic incentives weren't in place. Why lend on a commercial basis if your local provincial bureaucrat needs some cash? The money soon disappeared -- into pockets and bad projects -- and China's banks were back in the red. So China used its foreign-exchange reserves to recapitalize its banks, creating asset-management companies to take on tricky bad loans.
Since 1998, Beijing has injected $95 billion into the "big four banks," and carved out $305 billion of bad loans, according to Fitch Ratings. ICBC itself received a $15 billion state capital injection last year, plus a government-financed nonperforming-loan carveout of $85 billion. Foreign banks added an additional $20 billion; Goldman Sachs, Allianz Capital and American Express own 10% of ICBC's equity.
With all this money floating around, why worry? Well, bailing out banks -- or the implicit guarantee of doing so -- implants perverse economic incentives. Investors will be betting that public-company standards will help transform ICBC's lending practices, but there's no guarantee that the companies it is lending to have been transformed. Communist Party officials also still populate Chinese banks' boards of directors.
Like other state-owned banks, ICBC is still swimming in nonperforming loans -- which are classified according to Chinese, not international, standards. Fitch estimates a nonperforming to total loan ratio of 4.7%. If you kick in so-called "special mention" loans -- debts that haven't gone bad yet, but might -- the ratio jumps to 9.2%. ICBC also has heavy exposure to manufacturing, transportation and energy industries that are highly cyclical.
We're not here to give investment advice. But the comparison with the two U.S. "government-sponsored" mortgage giants is startling. Investors comforted by implicit American taxpayer support have had to endure several years of uncertainty and lower returns as fraud and false accounting have been uncovered at Fannie and Freddie. Perhaps that's a warning for ICBC investors.
Headquartered in Beijing, the Industrial Commercial Bank of China Ltd. is China's largest commercial bank by total assets, loans and deposits. With more than 18,000 branches and $21.7 billion in 2005 operating income, it holds 15.4% of total loans in all Chinese banking institutions, according to its offering prospectus. For foreign investors hoping to profit from China's rapid economic growth, ICBC shares may seem just the ticket.
We hope this isn't lemmings jumping off a cliff. At around this time last year, China Construction Bank Corp., the nation's third-largest lender by assets, raised $9.2 billion. This year, Bank of China Ltd., the country's second-largest by assets, raised $11.2 billion in an IPO. Even mid-tier China Merchants Bank received so much demand for its shares that its underwriters exercised a 10% overallotment option.
Amid this excitement, it's easy to forget how and why the Great China Bank Sale started. In the mid-1990s, Beijing's policy makers realized that government-directed lending wasn't compatible with a rapidly expanding capitalist economy. So they created policy banks to lend on behalf of the public sector, leaving state-owned lenders free to dole out cash along commercial lines.
The problem was, the proper economic incentives weren't in place. Why lend on a commercial basis if your local provincial bureaucrat needs some cash? The money soon disappeared -- into pockets and bad projects -- and China's banks were back in the red. So China used its foreign-exchange reserves to recapitalize its banks, creating asset-management companies to take on tricky bad loans.
Since 1998, Beijing has injected $95 billion into the "big four banks," and carved out $305 billion of bad loans, according to Fitch Ratings. ICBC itself received a $15 billion state capital injection last year, plus a government-financed nonperforming-loan carveout of $85 billion. Foreign banks added an additional $20 billion; Goldman Sachs, Allianz Capital and American Express own 10% of ICBC's equity.
With all this money floating around, why worry? Well, bailing out banks -- or the implicit guarantee of doing so -- implants perverse economic incentives. Investors will be betting that public-company standards will help transform ICBC's lending practices, but there's no guarantee that the companies it is lending to have been transformed. Communist Party officials also still populate Chinese banks' boards of directors.
Like other state-owned banks, ICBC is still swimming in nonperforming loans -- which are classified according to Chinese, not international, standards. Fitch estimates a nonperforming to total loan ratio of 4.7%. If you kick in so-called "special mention" loans -- debts that haven't gone bad yet, but might -- the ratio jumps to 9.2%. ICBC also has heavy exposure to manufacturing, transportation and energy industries that are highly cyclical.
We're not here to give investment advice. But the comparison with the two U.S. "government-sponsored" mortgage giants is startling. Investors comforted by implicit American taxpayer support have had to endure several years of uncertainty and lower returns as fraud and false accounting have been uncovered at Fannie and Freddie. Perhaps that's a warning for ICBC investors.
posted by Babson CSSA at
8:09 AM
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