After all, here were three big institutions, still majority owned by Beijing, that had to be bailed out just three years ago using $60 billion of the nation’s capital. Yet here they were baring their souls to the world – and being more forthright about sub-prime than many of the global investment banks that advised them on their record-breaking Hong Kong equity offerings.
Industrial and Commercial Bank of China came first. The world’s largest lender by market value said it was sitting on $1.23 billion-worth of sub-prime-related mortgage-backed securities, accounting for 4.3% of its foreign exchange investment portfolio. Then came the big fish in the pond. Bank of China trails ICBC in assets and market capitalization but it has more overseas branches in more countries, and has been buying and selling US treasuries for years. For a long time it was Beijing’s main financial conduit to the world. BOC’s exposure to sub-prime-related securities stood at $11.25 billion – then the largest exposure revealed by an Asian institution.
The exposure at China Construction Bank, the mainland’s third-largest lender, was revealed on August 27 as a relatively modest $1.06 billion – putting China’s grand total at $13.54 billion.
Investors welcomed the relatively comforting news from CCB and ICBC, bumping their shares up. Between the revelations and close of trading on September 14, CCB’s Hong Kong securities rose by 13.7%, with ICBC’s Shanghai-listed shares up just over 4%.
Of course, it helped that each institution had calmed the markets by also announcing record earnings. First-half 2007 net income at ICBC, also announced on August 22, rose 61% to Rmb41 billion ($5.4 billion), and CCB posted a 47.5% rise in first-half net profit to Rmb34.25 billion.
CCB also announced that it planned to raise up to $7.7 billion in its Shanghai initial public offering – the largest-ever mainland initial stock sale, beating ICBC’s $5.9 billion offering in October 2006.
BOC had a trickier time. It, too, announced record profits on August 22 – posting a 51% rise in first half earnings to Rmb29.5 billion. Yet the lender’s relatively high sub-prime exposure caught analysts unawares – most had predicted a figure of between $4 billion and $5 billion, and investors reacted with predictable doubt, sending BOC’s Hong Kong shares tumbling 4.1% by September 14, with its Shanghai-listed securities also down 6.6%.
Yet this might not be the end of it. China has spent the past few years buying virtually any debt issued by US government departments, and some believe China’s real sub-prime exposure is much higher. Reporting on the web-based RGE Monitor on August 27, economist Brad Setser estimated that China had about $100 billion invested in mortgage-backed securities, albeit most of it is in low-risk assets. Setser noted also, however, that it was proving "very, very hard" to work out China’s precise sub-prime exposure.
Analysts and bankers are unsure whether to believe China’s big three banks or not. Are they telling the truth, or is their sub-prime exposure much higher? It’s rare for mainland institutions to be so open about their shortcomings; but then, nor are they known for their precision and unfailing accuracy.
Anthony Lok, the Hong Kong-based head of research at BOC International, Bank of China’s investment banking arm, believes that the banks are being open. "To be honest, China has to some extent been a victim of its own success," he says. "The government and the banks have to invest in something, and it’s not going to be cartloads of gold bullion, so they’ve been buying all of the US debt they can get their hands on."
A Shanghai-born investment banker sees it rather differently. "I’ve been lied to by Beijing for years, so why would they be telling the truth on this?" he says. "They were very quick to reveal their magic numbers, and that tells me there will be bodies buried elsewhere. The final figures will be much worse."
Then again, does it really matter? China has a history of dusting under the carpet any losses at its treasured leading banks – it has done so before, and there’s no reason to believe it wouldn’t do it again. Besides, the profitability of both China’s leading banks and the country itself (with an economy growing at just shy of 12%) make it easier to swallow any short-term losses. "Their exposure may be $11 billion," says Bill Belchere, chief Asia economist at Macquarie in Hong Kong, "but even if you tripled that figure to $30 billion, it’s nothing they can’t handle."
Yet Belchere notes that the real danger to China still comes from sub-prime exposure – albeit via a possible resulting downturn in Europe and the US. "European banks and insurance companies are holding a big slug of this stuff, and that will hit export-dominated Asia, causing a slowing in China’s economy in the next few quarters. That’s the danger to China in all of this."