Bingeing on China’s banking IPOs
The IPO of China’s largest commercial bank, Industrial and Commercial Bank of China (ICBC), looks set to be a runaway success if demand for the simultaneous offering in Hong Kong and Shanghai is a reliable gauge.
The issue is being deluged with cash from every conceivable direction: local Hong Kong tycoons, strategic investors from Asia and the Middle East, domestic and international institutions and, of course, Hong Kong’s redoubtable retail investors, who have been clamouring for application forms and financing loans to stag the issue. As application lists closed, the offer had already generated demand exceeding $500 billion for the estimated $22 billion offering.
The sums are staggering and it might be tempting to get carried along with the collective euphoria. But a little circumspection is due. ICBC, like its competitors that are already listed (Bank of China and China Construction Bank), was little more than a zombie lender a few years ago, with a huge capital deficit, rampant non-performing loans and non-existent risk management controls. Is it really credible that such a basket case could have been turned into one of the world’s largest financial institutions, peddling its shares at eyebrow-raising valuations, in just three years?
Perhaps is the answer. But to believe so requires an enormous leap of faith. ICBC has reduced its NPLs from an officially admitted level of almost 25% in 2003 to just 5% today but that was achieved by way of a massive one-off restructuring a year ago that involved the government injecting $15 billion of fresh capital following the fire sale of a further $89 billion of bad assets.
The problems of the past might have been fixed. What of the future? How feasible is it to change overnight the poor lending practices, lax risk management controls and politicization of an institution developed under generations of communist influence?
The size of ICBC underscores the scale of such an improbable task. The bank has more than 18,000 branches, 2.5 million corporate customers and 150 million personal customers – a few customers fewer than the population of Pakistan. In a country that has only just enacted bankruptcy legislation and without effective credit systems that leaves enormous room to repeat past sins.
Proponents point to the work done to fix internal risk management systems and the presence of blue bloods Goldman Sachs, American Express and Allianz on the share register. That can only help matters, true enough, and ICBC has made impressive inroads into increasing non-interest income, which has grown by a compound annual growth rate (CAGR) of almost 37% in the past three years. The bank has also resisted the temptation to grow quickly through aggressive loan growth – loans have increased by a modest 11.9% CAGR over the same period. Yet net interest income still accounts for 90% of operating income, so the problems associated with directed lending and moral hazard will remain with ICBC for years yet.
So why all the fuss? For two principal reasons. The first, and the most credible is that ICBC offers a pure play on continued Chinese economic growth, particularly domestic consumption, The second reason is that ICBC is regarded as cheap, relative to its listed peers, principally Bank of China, China Construction Bank and Bank of Communications. The fact that a likely valuation of more than twice pro forma book value is regarded as cheap underlines the extent to which the market has willingly entered a collective state of denial about the true value of China’s banks and the very real risks associated with investing in them.
Investment banks, some of which have also bought ahead of the IPOs, want to sell the banks’ shares to an eager market as soon as they can; the Chinese government has to sell shares quickly to keep its financial reforms on track; Hong Kong’s tycoons will happily join the free ride; and the retail punter just wants a quick buck. That leaves global investment institutions little choice but to buy, since they dare not miss the return. It is a dangerous cocktail. Drink moderately.
