China's state-owned banks may be offering the world some of its biggest and
hottest initial public offerings, but investing in them can be a leap of faith.
Even analysts at rating agencies, whose job it is to determine the banks'
stability and credit-worthiness, say they have only a weak grip on what's really
happening inside these black boxes.
"We come out of a ratings meeting with executives who talk about reform, but
then we read the paper and see stories about scandals," said David Marshall,
head of Asian financial institutions for Fitch Ratings.
But as China's major banks go public, data on their operations is gradually
becoming more accessible. Though it only scratches the surface, it's enough to
give a sense of their potential weaknesses.
At a conference in Hong Kong on Friday, Fitch's Marshall offered an
insightful reading of some numbers on China Construction Bank, which had an $8
billion IPO last October.
Shares in CCB, China's third-largest lender by assets, closed at HK$3.55 on
Friday. The stock debuted at HK$2.35.
Marshall's assessment of CCB: despite its listing on the Hong Kong Stock
Exchange alongside sophisticated international banks like HSBC, the CCB still
basically functions to collect money from China's vast population and pump it
into state-owned enterprises.
According to the bank's listing prospectus, it has more than 14,000 branches
and 146 million active accounts. "Active" in this case means that an account
holds more than 100 yuan, or about $12. "Inactive" accounts bring the bank's
total to more than 300 million, says Marshall. CCB has total deposits about $476
billion. That means the average account size is about $1,500, but the majority
are much smaller.
What's most telling, though, is how the bank distributes its funds. Its loans
are as large and concentrated as its deposits are small and fragmented. The
average corporate loan size is over 25 million yuan, or more than $3 million.
Nearly half of corporate loans are over 100 million yuan, or $12 million.
That's far greater than at most Western banks, which make a large portion of
their loans to small and medium-sized companies, according to Marshall.
"These banks haven't moved far from their old business model of shoveling
money to state-owned enterprises," he said in an interview with MarketWatch.
"That business model isn't sustainable in the long-term. It's not going to
achieve good profit margin. Banks need a more diversified portfolio."
Another eye-opening statistic for investors: CCB has more than 300,000
employees. which has several times CCB's assets. In a market-based
economy, a company can trim staff if it runs into tough times. But in an economy
that's still nominally socialist, China's state-owned companies play a welfare
role.
If China's economy turns downward, investors in its state-owned firms could
be funding a nationwide social safety net. And investors won't have much say in
the matter, because the government usually keeps a majority stake when its firms
go public.
Yet another source of concern, say analysts, is the disconnect between the
banks' head offices and local branches. Their networks are so far-flung that
reform-oriented big-city executives often have little knowledge of, or control
over, what goes on there. It's at the local level that most corruption takes
place, and where bad loans get covered up.
Finally, Marshall worries that China's listed banks haven't made enough
progress in the field of risk analysis. He cites the CCB's own data showing that
it has only 12 people evaluating new loans at its head office, and more
generally suffers from a low ratio of risk experts to the total number of loans
being made.
Many analysts suggest that investors look at less-hyped Chinese bank plays,
such as China Merchants Bank. Though smaller, it's widely reputed to be better
run, and controls a large chunk of the country's nascent credit card market. CMB
is planning a roughly $2 billion IPO in Hong Kong in September.
As long as China's economy keeps booming, none of the banking industry's
problems are likely to become critical. But when the growth spurt ends, banks
could be in for some serious pain. When that happens, investors' IPO fever could
turn out to have been the start of a much more serious malady.
