As bad debt piles up and assets bases grow, Chinese banks are keen to tap equity markets to top up on capital. But why are some doing better than others in the IPO market? Stefania Palma investigates.

China Zheshang Bank embedded

Chinese banks’ rush to join the equity market is showing no sign of slowing. Chinese joint-stock commercial bank China Bohai Bank and city commercial banks Bank of Shanghai and Shanghai Rural Commercial Bank (SRCB) are just three of the lenders looking to launch an initial public offering (IPO).

In March this year, China Zheshang Bank printed a $1.69bn Hong Kong IPO. This was significant to the development of China’s banking sector because the lender is a joint-stock commercial bank. These banks are regarded as systemically important financial institutions and rank immediately below China’s 'big four' (Industrial and Commercial Bank of China, Bank of China, China Construction Bank and Agricultural Bank of China). 

China Zheshang Bank’s deal was also significant because, unlike Chinese banks’ IPOs at the end of 2015, its pricing was solid (at HK$3.96), making it the ninth most valuable Chinese bank to be listed in Hong Kong, according to magazine FinanceAsia

Today, only three Chinese joint-stock commercial banks have yet to go public: Guangdong Development Bank, Evergrowing Bank and China Bohai Bank.

Under strain

City commercial banks, meanwhile, are doing less well. Formerly urban co-operative banks, these lenders have strong ties to local governments, lend mostly to city clients – often state-owned enterprises – and have lower capital requirements compared with joint-stock commercial banks. 

Chinese banks’ IPO deals (2015 and 2016)

A limited geographical focus means these banks have come under pressure now that China’s economy is slowing and the country's corporate debt is one of the highest in the world at 170% of gross domestic product. “[Because] they often focus on corporate clients concentrated in their home city, their asset growth outpaces the industry average and they tend to have relatively high adjusted loan-to-deposit ratios,” says a note from rating agency Moody’s.

According to the China Banking Regulatory Commission, city commercial banks’ assets grew by 25% in 2015, compared with 18% for joint-stock commercial banks and 15% at the big five banks (including Bank of Communications).

“When compared with the big five state-owned commercial banks in China, or the country’s joint-stock commercial banks, city commercial banks on average face greater credit challenges,” says Amanda Du, a senior analyst at Moody’s.

Fellow Moody’s analyst Yulia Wan adds: “Most city commercial banks will see their profitability levels weaken as a result of narrower net interest margins in a liberalised interest rate environment, and growing credit costs in a moderating economy.” And if city commercial banks maintain their loan growth rates at the current level of more than 20%, their capital ratios might also come under pressure, she adds.

Tricky terrain

This is a tricky scenario considering the increase in non-performing loans (NPLs) in China. According to PricewaterhouseCoopers, if Western calculations of NPLs were applied to China, the banking sector’s NPL ratio would be 3% to 5%, rather than the official 1.75%. Western banks consider a loan to be 'non-performing' if the debt is overdue by more than 90 days. In China, banks can avoid classifying the same loan as non-performing if they do not expect to suffer a loss when a company defaults; for example, when the company has prime real estate the bank can acquire upon default. 

“Asset quality is deteriorating with increasing NPLs and rising credit costs; there is a widening gap between NPLs and 90-plus-day delinquencies as greater numbers of 90-plus-day delinquencies are not recognised as NPLs,” says Moody’s, which assigned a negative outlook to China’s banking sector in March 2016.

Nonetheless, Moody’s still believes city commercial banks will maintain their liquidity profiles over the next 12 to 18 months, partly because China’s accommodative monetary policy will sustain liquidity in the banking sector.

To counter bad debt piling up and a period of rapid asset growth, city commercial banks are keen to tap equity markets and top up on capital.

Asset growth accelerates at Chinese banks

Three city commercial banks tapped the Hong Kong market in less than two months in 2015. Bank of Qingdao, from China’s Shandong province, issued a $607bn IPO in November 2015. Bank of Jinzhou, from the north-eastern Liaoning province, and Bank of Zhengzhou, from central China’s Henan province, followed with respective IPOs of $794m and $656m in December.

But these deals’ prices – all of which were at or near the bottom end of their price ranges – reflected poor investor appetite and growing worries over city lenders in an economy that is slowing and where corporate balance sheets are under strain.

An IPO breakthrough

City commercial lender Bank of Shanghai received approval from the China Securities Regulatory Commission in December 2015 to launch an IPO. “[We] made a concrete breakthrough in the IPO process,” says Bank of Shanghai chairman Jin Yu. Fellow Shanghai city bank Shanghai Pudong Development Bank (SPDB) has already gone public. 

Shanghai Rural Commercial Bank (SRCB) plans to be publicly listed within three years. “After [the SPDB and Bank of Shanghai IPOs], the local government is keen for us to list,” says Xu Li, president of SRCB. “Depending on market conditions, we are considering Shanghai or Hong Kong [for the IPO]. As one of the three banks headquartered in Shanghai, Shanghai is the top choice.” 

Bank of Shanghai and SRCB stand out as some of the strongest city commercial banks in China thanks to them being based in a prosperous city such as Shanghai. Their NPL ratios in 2015 stood at 1.19% and 1.38%, respectively. Although SRCB’s NPL ratio increased slightly year on year, considering the cyclical pressure on loans in China’s banking industry imposed by economic slowdown, Mr Xu says this is still manageable. 

“For our IPO, our big selling point is that we are in Shanghai and our customers are mainly local enterprises,” adds Mr Xu. It is worth noting, however, that city commercial lenders in poorer regions such as north-eastern or western China are less fortunate.

In preparation for its IPO, SRCB is keen to increase its asset base. Total assets grew 21% year on year in 2015 to Rmb587bn ($89bn). “We have to increase our asset base particularly through individual and corporate loans. [But] we especially want to grow loans to individuals,” says Mr Xu (see article on retail banking in China, page XX). SRCB's total loans also grew year on year in 2015, by 14.2%, to reach Rmb298.6bn.

This expansion, however, will be coupled with a more cautious choice of clients, according to Mr Xu. “In the future [we will] reduce exposure to high-risk segments. We cannot focus too much on real estate companies, for example. About 60% of our clients are in the manufacturing industry,” he says. 

Bank of Shanghai and SRCB did not provide further details on their upcoming IPOs.

Bohai's big move

In Tianjin, joint-stock commercial lender China Bohai Bank is keen to launch an IPO in the next two years to have a more comfortable capital adequacy ratio. In China, systemically important institutions (essentially the 'big four' and joint-stock commercial banks) have a capital adequacy ratio requirement of 11.5%. China Bohai Bank’s capital adequacy ratio in 2015 sat at 11.61%, but the figure was below the requirement, at 11.09%, only a year earlier.

China Bohai Bank would like to raise Rmb15bn in capital overall, according to chairman Li Fuan, though the bank has not specified whether this will all be raised through an IPO.

China Bohai Bank was not able to raise capital previously because it wanted to change its shareholder structure before the IPO. This includes eliminating individual shareholders, who are harder to monitor, so much so that there have been cases of 15-year-olds being shareholders in other Chinese banks. The Tianjin government has been negotiating a buy-back share price for individual shareholders. Mr Li says the issue could be solved by the end of 2016. “The shareholding structure will be very good, clearly structured and it will be easy for us to be a public company after we clarify these issues,” he adds.

China Bohai Bank might opt to issue in Hong Kong for its IPO because the regulatory framework is structured clearly and the IPO timetable is more certain, according to Mr Li. “In mainland China you tend to wait more and it is less efficient,” he adds.

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