Mainland bank jitters may be only a taste of things to come
Tom Holland 26 January 2010
The reason why is a mystery, but news that Chinese banks need to raise capital never fails to take investors by surprise.
It took them by surprise back in November when the China Banking Regulatory Commission ordered the country’s big state banks to shore up their capital bases or face restrictions on their business. The result was a steep sell-off in the Hong Kong listed H shares of mainland banks.
And it took them by surprise last Friday, when the Bank of China announced that in addition to a proposed 40 billion yuan (HK$45.52 billion) convertible bond issue, it will ask shareholders’ permission for a new stock offering worth up to 20 per cent of its existing equity base.
Given that the Chinese government owns 75 per cent of Bank of China, the bank is unlikely to have much difficulty getting permission to go ahead. Based on last Friday’s closing prices, that would imply an A-share issue of 148 billion yuan and an H-share issue worth HK$59 billion.
Together with the convertible issue, that would mean a combined capital call of HK$273 billion. To put that amount into perspective, it is approaching twice the global size of HSBC Holdings’ monster HK$140 billion rights issue in April last year and is more than 3.5 times the size of Bank of China’s initial public offering in 2006.
The result of Friday’s announcement - you guessed it - was a steep sell-off. In yesterday’s trading, Bank of China’s H shares tumbled 2.1 per cent, with the shares of other capital-short mainland banks also sliding. China Merchants Bank dropped 2.2 per cent, while Bank of Communications fell 2.5 per cent.
The latest falls compound a drastic reversal of sentiment towards mainland banks over the past couple of months. For much of last year, Chinese bank shares were the darlings of international investors, who swallowed whole their brokers’ stories about a solid banking sector untouched by the financial crisis and enjoying handsome interest margins and rapid asset growth, thanks to the Beijing government’s economic stimulus programme. As a result, Bank of China’s H shares soared 168 per cent between January and November (see the first chart).
Then, following the CBRC’s warning, investors suddenly woke up to the realisation that rapid loan growth means an equally rapid erosion of a bank’s capital base, which is measured as the ratio of capital to assets. Over the 12 months to September, Bank of China’s loan book expanded by 44 per cent, beating its tier-1 capital adequacy ratio down from 11 per cent to just over 9 per cent at end-September (see the second chart).
That might not sound too bad by international standards. But when you consider the CBRC’s effective requirement that tier-1 capital must be at least 7 per cent of assets and that most of that capital must consist of equity and retained earnings, and then factor in forecast loan growth of 18 per cent this year (and a great deal more if banks exceed their quotas like they did last year), then Bank of China’s capital base looks a lot less solid.
Even so, the market was still taken by surprise by last Friday’s announcement. Beforehand, most analysts had expected a Bank of China capital call of about 65 billion yuan, so the scale of the proposed capital raising came as a nasty shock.
Yet even now many analysts may be failing to appreciate the full extent of the dilution investors are facing. Yesterday, for example, UOB Kay Hian told clients that Bank of China is unlikely to utilise its mandate in full, raising only 100 billion yuan in new capital.
That forecast may be too modest, however. Much of last year’s 9.6 trillion yuan increase in mainland bank lending was extended to local government investment companies to fund infrastructure projects under Beijing’s stimulus programme. According to Victor Shi, a professor of political science at Northwestern University in the United States, at the end of last year loans outstanding to such investment companies amounted to 11.4 trillion yuan. Given ongoing financing requirements already agreed, by the end of next year that amount will have climbed to 24.2 billion yuan.
Based on the quality of the projects, Shi estimates that between 30 and 40 per cent of those loans will turn bad. Based on previous recovery rates, that could imply losses for the mainland’s banks of about five trillion yuan.
The result, says Shi, will be repeated rounds of capital raising over the next few years, with repeated dilution of minority shareholders’ investments.
If he is right, Bank of China’s HK$273 billion capital request may only be the start of a long round of capital raising. And the recent fall in mainland banks’ share prices may only be a taste of things to come.
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Mainland bank jitters may be only a taste of things to come
Tom Holland
26 January 2010
The reason why is a mystery, but news that Chinese banks need to raise capital never fails to take investors by surprise.
It took them by surprise back in November when the China Banking Regulatory Commission ordered the country’s big state banks to shore up their capital bases or face restrictions on their business. The result was a steep sell-off in the Hong Kong listed H shares of mainland banks.
And it took them by surprise last Friday, when the Bank of China announced that in addition to a proposed 40 billion yuan (HK$45.52 billion) convertible bond issue, it will ask shareholders’ permission for a new stock offering worth up to 20 per cent of its existing equity base.
Given that the Chinese government owns 75 per cent of Bank of China, the bank is unlikely to have much difficulty getting permission to go ahead. Based on last Friday’s closing prices, that would imply an A-share issue of 148 billion yuan and an H-share issue worth HK$59 billion.
Together with the convertible issue, that would mean a combined capital call of HK$273 billion. To put that amount into perspective, it is approaching twice the global size of HSBC Holdings’ monster HK$140 billion rights issue in April last year and is more than 3.5 times the size of Bank of China’s initial public offering in 2006.
The result of Friday’s announcement - you guessed it - was a steep sell-off. In yesterday’s trading, Bank of China’s H shares tumbled 2.1 per cent, with the shares of other capital-short mainland banks also sliding. China Merchants Bank dropped 2.2 per cent, while Bank of Communications fell 2.5 per cent.
The latest falls compound a drastic reversal of sentiment towards mainland banks over the past couple of months. For much of last year, Chinese bank shares were the darlings of international investors, who swallowed whole their brokers’ stories about a solid banking sector untouched by the financial crisis and enjoying handsome interest margins and rapid asset growth, thanks to the Beijing government’s economic stimulus programme. As a result, Bank of China’s H shares soared 168 per cent between January and November (see the first chart).
Then, following the CBRC’s warning, investors suddenly woke up to the realisation that rapid loan growth means an equally rapid erosion of a bank’s capital base, which is measured as the ratio of capital to assets. Over the 12 months to September, Bank of China’s loan book expanded by 44 per cent, beating its tier-1 capital adequacy ratio down from 11 per cent to just over 9 per cent at end-September (see the second chart).
That might not sound too bad by international standards. But when you consider the CBRC’s effective requirement that tier-1 capital must be at least 7 per cent of assets and that most of that capital must consist of equity and retained earnings, and then factor in forecast loan growth of 18 per cent this year (and a great deal more if banks exceed their quotas like they did last year), then Bank of China’s capital base looks a lot less solid.
Even so, the market was still taken by surprise by last Friday’s announcement. Beforehand, most analysts had expected a Bank of China capital call of about 65 billion yuan, so the scale of the proposed capital raising came as a nasty shock.
Yet even now many analysts may be failing to appreciate the full extent of the dilution investors are facing. Yesterday, for example, UOB Kay Hian told clients that Bank of China is unlikely to utilise its mandate in full, raising only 100 billion yuan in new capital.
That forecast may be too modest, however. Much of last year’s 9.6 trillion yuan increase in mainland bank lending was extended to local government investment companies to fund infrastructure projects under Beijing’s stimulus programme. According to Victor Shi, a professor of political science at Northwestern University in the United States, at the end of last year loans outstanding to such investment companies amounted to 11.4 trillion yuan. Given ongoing financing requirements already agreed, by the end of next year that amount will have climbed to 24.2 billion yuan.
Based on the quality of the projects, Shi estimates that between 30 and 40 per cent of those loans will turn bad. Based on previous recovery rates, that could imply losses for the mainland’s banks of about five trillion yuan.
The result, says Shi, will be repeated rounds of capital raising over the next few years, with repeated dilution of minority shareholders’ investments.
If he is right, Bank of China’s HK$273 billion capital request may only be the start of a long round of capital raising. And the recent fall in mainland banks’ share prices may only be a taste of things to come.
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