Analysts Question Chinese Banks’ Efforts to Raise Funds

New York TimesBy NEIL GOUGH | New York Times – 10 hours ago

HONG KONG — Chinese banks are among the biggest and most profitable financial institutions in the world. But the state-backed banks are also in need of capital, after an aggressive lending spree that was encouraged by Beijing.

Within the past year, seven of the biggest Chinese banks have tapped the markets for 323.8 billion renminbi, or about $51 billion, in new funds, according to Citigroup. Several financial firms are expected to raise an additional 111.9 billion renminbi in the next few months, with one of the biggest Chinese lenders, the Bank of Communications, planning to raise 56.8 billion renminbi.

Banks around the world have been tapping investors for new funds, as they have struggled with slumping share prices and waning profits. But Chinese banks have said that their profits are strong and their balance sheets are solid, raising questions among some analysts about the banks’ persistent capital needs.

The concerns increased after rare and blunt criticism by Prime Minister Wen Jiabao of China . In early April, he accused banks of reaping easy profits and called for a breakup of the “monopoly” held by the biggest mainland Chinese lenders.

“Frankly, our banks make profits far too easily,” Mr. Wen said, according to China National Radio. “Why? Because a small number of major banks occupy a monopoly position, meaning one can only go to them for loans and capital.

“We have to break up their monopoly,” he added.

The uncertainty introduced by Mr. Wen means mainland banks may find it harder to raise capital, especially if investors are worried that the banks might lose their dominant position. But the irony is that this “monopoly” has served none better than the Chinese state.

Before they started going public about a decade ago, all of the major banks in mainland China were, in effect, lenders for government policies. Now, despite partial overhauls in the broader financial system, the banks remain integral to the Chinese model of state- directed capitalism, in which government-supported companies and projects enjoy preferential access to bank loans at what many analysts say are artificially low interest rates.

The current wave of bank capital raising is partly the legacy of an unprecedented, multiyear lending boom. Beijing responded to the 2008 financial crisis with a stimulus plan of 4 trillion renminbi. The initiative relied heavily on infrastructure spending and was primarily financed with loans from the state- controlled banking industry. Local governments chipped in with additional spending of their own, which likewise depended heavily on projects financed by banks.

This lending spree has proved to be extremely profitable for the banks, as Mr. Wen observed. The country’s four biggest lenders by assets — Industrial & Commercial Bank of China, the Bank of China, China Construction Bank and Agricultural Bank of China — reported combined profits of 623 billion renminbi for 2011, up about 25 percent from 2010.

The least profitable among the Big Four, Agricultural Bank of China, made 121.9 billion renminbi last year. That is just shy of the $19 billion that JPMorgan Chase, the most profitable American bank, made last year.

This week, the Big Four banks are expected to report that first-quarter profit rose 10 percent to 26 percent, according to Simon Ho and Paddy Ran at Citigroup in Hong Kong.

But along with the profits, the banks’ balance sheets have ballooned. Last month, the Big Four reported a combined 14 percent increase in total assets, to 51.3 trillion renminbi. That is about the size of the combined gross domestic product of Britain, France and Germany.

So far, the banks appear to have emerged unscathed. The Big Four all showed declining levels of nonperforming loans last year. On average, these loans at the four banks fell last year to 1.15 percent of total lending, down from 1.34 percent in 2010.

But analysts say the worry is that, over time, the enormous infrastructure, real estate and other projects that were the products of China’s stimulus-driven lending binge will fail to turn profits. Borrowers, including local governments, would then fall behind on their interest payments and could ultimately default on their loans. Much concern has centered on local governments, which had 10.7 trillion renminbi in debt at the end of 2010, according to official estimates.

Analysts say a wave of souring loans will have a magnified effect on the Chinese banking industry, given its historically weak capital position.

“For the first time, a large number of Chinese banks are beginning to face cash pressures,” Charlene Chu, a banking analyst at Fitch Ratings in Beijing, wrote in a research report. “It is because of this cash constraint that the forthcoming wave of asset quality issues has the potential to become uglier and more destabilizing than in previous episodes of loan portfolio deterioration.”

The potential risks on the banks’ loan books can be unpredictable.

For example, the ambitious Chinese plans to construct a nationwide high-speed rail network have been praised by politicians inside and outside of China as the kind of aggressive stimulus spending that yields instant and tangible economic benefits. But a collision between two trains on a high-speed rail line in eastern China last July, which killed 40 people and injured 191, has prompted a rethinking in Beijing. Now, analysts question whether the Ministry of Railways can continue servicing about 2 trillion renminbi in debt that it amassed before the accident.

The systemic risks that a bad-debt bubble may burst are not lost on Chinese banking regulators, who are requiring banks to bolster their reserves . Under a new set of rules, the biggest mainland lenders will need to increase their capital adequacy levels to 11.5 percent of risk-weighted assets by the end of 2013. Their core Tier 1 capital ratio, a measure of a bank’s ability to absorb financial shocks, will need to be at least 9.5 percent. These requirements are far more rigorous than the rules that apply to American and European banks.

But increasing regulatory capital reserves may not be enough, because that focuses on only the loans that banks keep on the books. In late 2010, financial regulators in China started cracking down on the growth of new loans in order to fight inflation. Seeking to comply with regulators, but also to continue chasing profits, banks responded by pursuing newer and more creative forms of off-balance-sheet lending. Joyce Poon, a research director at GaveKal, a research firm in Hong Kong, has estimated that outstanding off-balance-sheet lending rose to about 12 trillion renminbi by the first half of 2011, having doubled since the end of 2009.

“China’s conservative turn in financial regulation, while understandable given the global excesses that led to the 2008 financial crisis, meant that financial institutions’ search for profits increasingly led them into regulatory gray areas,” Ms. Poon wrote in a research report.

The leading mainland banks have another reason for raising capital. They need to maintain big dividends for their biggest shareholder, the state.

The firms’ recapitalization programs are “largely due to massively excess dividends the banks have paid in recent years,” said Nicholas R. Lardy, an expert on the Chinese financial system and a fellow at the Peterson Institute for International Economics in Washington.

The problem is that paying out high dividends reduces their base capital. Thus, banks need to continue tapping the markets for fresh funds, often diluting minority shareholders by issuing new shares. The Chinese Finance Ministry, the banks’ ultimate controlling shareholder, always buys in, keeping its stakes topped up.

The amount of cash that is churned in the process is staggering. In 2010, the five biggest mainland banks — the Big Four plus Bank of Communications — paid about 144 billion renminbi in dividends and raised about 199 billion renminbi on the capital markets, according to GaveKal.

“This is the nonsense of it,” said Fraser Howie, a managing director at the brokerage firm CLSA Asia-Pacific Markets, who is based in Singapore and a co-author of “Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise.”

“There’s an awful lot of money just going round and round from one pocket to another, giving the appearance of strength when it’s really not there.”