Global Economics

Chinese Bank Stocks: What, Me Worry?


Nothing much seems to faze global investors when it comes to China bank stocks. Chinese financial regulators concede that loan fraud and employee embezzlement still bedevil mainland lenders. And not many would disagree that if China's hyperactive economy overheats and then sharply contracts, the number of bad loans would soar. That's pretty much what happened in the late '90s when it took a massive mop-up operation of capital injections and other financial assistance by Beijing to prevent outright bank failures.

Yet none of this seems to matter much now, at least judging by the ravenous demand for Chinese bank shares this year. Two big mainland state-owned banks, China Construction Bank and Bank of China, had little trouble selling a combined $22 billion-plus worth of share offerings over the past year in listings in Hong Kong and Shanghai (see BusinessWeek.com, 5/31/06, "A Golden Age for Chinese Banks").

HUGE NEGATIVES. Now a new torrent of bank shares is about to hit the market. China Merchants Bank, the nation's sixth biggest lender, is expected to raise $2.4 billion in a Hong Kong offering in early September that will be distributed by JPMorgan Chase (JPM), UBS (UBS), and China International Capital. Next up: The mainland's biggest lender, Industrial & Commercial Bank of China (ICBC), will attempt to rake in $19 billion in a dual listing of shares in Hong Kong and Shanghai in October that is likely to be the biggest initial public offering in history.

So are investors misguided for diving into Chinese bank shares despite their mixed record in managing their loan books, and spotty corporate governance? Not necessarily. In an economy that grew 10%-plus during the first half of 2006, the huge negatives don't really mean all that much.

If you want a China play with broad exposure to the mainland economy, it's hard to pass up big banks that lend to so many different industries and will benefit from the country's prospering and growing middle class. "The financial sector is really one sector that you need to invest in" to capitalize on the China growth story, says Tat Auyeung, a fund manager at Apex Capital Management in Hong Kong.

GROWTH BETS. "There is certainly positive sentiment from some global fund managers," figures Jing Ulrich, managing director and chairman of China Equities at JP Morgan Securities (Asia Pacific) in Hong Kong. Ulrich notes the bank shares are a "proxy play on the (China) growth story" and that the market for "consumer banking, mortgages, credit cards, and any consumer loans is still underpenetrated" on the mainland. That means plenty of growth opportunity for the better-managed Chinese banks in the years ahead.

It's not just global investors who are rushing to get a piece of the action. Big international banks such as HSBC (HBC), Bank of America (BAC), UBS, Royal Bank of Scotland, Standard Chartered (SCBFF), and others have plowed more than $20 billion into strategic equity stakes in Chinese banks in recent years. All are betting China's rapid wealth generation means a secure future for domestic and foreign financial service players well positioned in big urban mainland markets such as Beijing, Shanghai, and Shenzhen.

Consider, too, that China's banking industry experienced more than 15% annualized growth in deposits from 2000 to 2005 and is tracking a similar pace in 2006. Even the campaign by Chinese President Hu Jintao's government to rein in bank lending and manage a soft landing for the economy isn't likely to have a big and lasting impact on bank earnings given the mainland's long-term growth prospects, analysts contend.

ACQUISITIONS BANKROLL. Two modest interest rate hikes this year totaling a little more than 50 basis points on one-year loan rates haven't hurt at all. China Merchants Bank, a leader in the market for dual-currency credit cards, is expected to turn in profit growth of 40%-plus to nearly $700 million in 2006. Its stock is up 25% this year on the Shanghai Stock Exchange.

Chinese banks are raising so much money in initial and secondary offerings that they will not only be able to strengthen capital bases but also bankroll acquisitions. The money being raised by China Construction Bank, Bank of China, China Merchants Bank, and ICBC later this year will bolster the balance sheets of mainland lenders and "put them in line with other banks in Asia," says May Yan, vice-president and senior credit officer with Moody's Asia Pacific in Hong Kong.

The capital infusion will help these banks pursue their international ambitions as well. China Construction Bank, whose share price has appreciated more than 40% since its IPO last October, announced on Aug. 24 that it will spend $1.24 billion to buy the Hong Kong consumer banking operations of Bank of America. (BofA is a strategic investor in China Construction Bank and holds an 8.5% stake.)

LOOKING AHEAD. The same likely will hold true for ICBC, China's biggest and arguably strongest bank with 21,000 domestic and 100 overseas branches. Thanks to a $15 billion government capital infusion a few years back, plus sales of non-performing loans to state-run asset management companies on preferential terms, its balance sheet is already in pretty good shape, according to Standard & Poor's.

A big chunk of the $19 billion or so ICBC is expected to raise in its mega-IPO in October will finance acquisitions of other Asia banks. "As the largest bank in China, they have the ambitions to go international," says Moody's Yan. In the final analysis, China's better-run banks have a golden opportunity to tap the global capital markets and position themselves for growth at home and abroad. And for now at least, investors are willing to avert their eyes from the less than glorious past of Chinese banking.


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