And You Thought Chinese Banks Were a Safe Investment?

Friday, February 9, 2007 0:51

For years, it has been known that the banking industry was a mess in China. From top to bottom.

They have 45,000 branches, a computer system that is unable to check balances of accounts across town, and risk management teams of 3.

4 years ago, they began to offload NPLs in auctions that for the most part were a failure… and yet they have been the hottest investments around for the last year. Carlyle, B of A, HSBC, and a number of others have put down billions to take up their minority stakes in regional banks … because those banks are “more well managed”.

The truth though, for anyone who has actually tried to train the middle managers in say valuation, is that while many of the managers are capable, they are poorly trained, understaff, and have little power. During one session a member of a second tier bank actually walked out of the room when I said that the valuation of an asset is not based on the replacement value, but on discounted cash flows (we were talking about a real estate asset).

It was as if I was trying to disprove gravity.

For those of you who thought that investing in banks was a good idea(either directly or by through their stocks), I suggest you read the article put out by People’s Daily today entitled China’s Banking Watchdog Exposes Billions of Bogus Mortgages.

Another excellent piece on Seeking Alpha was recently written by Nicholas Vardy’s , entitled The Inevitable Collapse of China’s Banks it lays out a number of issues that would plague the banks, and could ultimately bring them to their knees.

While maybe not reaching the Code Red standard yet, one should not be surprised to see another article soon where banking officials are in the middle of another corruption probe.

The fact that these banks are liquid is only due to the 40% savings rate of Chinese consumers. With the heavy bad debt ratios that exist, these banks would be classified much differently were they in the U.S. or E.U. markets.

It is going to be interesting to see how the markets and investors react as the risk profiles of these banks are without a doubt going to leap a bit. Of course, for the service providers, this could be a nice windfall as banks look to catalyze their recovery teams.

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5 Responses to “And You Thought Chinese Banks Were a Safe Investment?”

  1. Fons Tuinstra says:

    February 9th, 2007 at 1:18 am

    I must disagree here strongly. Not with the analysis that the Chinese banks are in a mess, there is no doubt about that. But that will not lead to the collapse of the banks. The government cannot afford to let them collapse. That is also the reason why Chinese still bring their money to these banks.

  2. rbrubaker says:

    February 9th, 2007 at 2:10 am

    Hi Fons,

    How are you? Any plans for CNY?

    Before I agree with you, I would like to point out that I am only trying to show that investing in these banks is not wise, I do not believe that there is a bank near collapse at this time, but I also believe that there is little being done to reverse the trend…. the NPLs are only getting larger.

    The gov\’t cannot let these banks fail, and that is why they are propping them up by not only infusing cash, but also by limiting the availability of financial instruments in China.

    Playing devils advocate here though – If the problem worsens, and one of the banks actually crumbles. what could the government really do?

    If BOC fell (or was rumored to be on the edge), herd mentality would takeover and there would be a run on the banks…. It would hit BoCom, ICBC, Ag, etc…. everyone remembers HK July 1997 right?

  3. Chris Corkery says:

    February 9th, 2007 at 8:51 am

    While I have no intentions to buy Chinese banks stocks at this juncture, I do wonder why you believe the NPL situation is getting worse. I am under the impression that the nationwide NPL data shows a general decrease, though there are bound to be more mortgage defaults in the coming years. Perhaps I am only thinking of the major banks and not the 2nd tier?

  4. rbrubaker says:

    February 9th, 2007 at 11:28 am

    Hi Chris,

    Long time. How is everything these days?

    The NPL ratio is simply the amount of bad debt over total debt, so as the overall loan portfolio grows the ratio of NPLS goes down.

    So, when trying to figure out if the future will have fewer NPLs one need look to see if credit approval, risk management, and recovery practices have been systematic improved in the last 18 months to 2 years… which I think the article shows clearly has not.

    While working at my former company, I basically worked solely on NPL deals for 18 months. We worked on , Huarong 1 & 2 and CCB 2. the assets were UGLY, poorly documented, and in the case of 6 assets in the last auction… already destroyed. Following those auctions, the majority of the assets were resolved by AMC (asset management company) buying bad debt from other AMC so… with all 4 AMCs under PBOC… NOTHING was really being resolved as the PBOC still owed all the debt.

    the debt was just being moved, and thus the numerator was not getting any smaller..

    So, that means that the denomenator was getting bigger 

    As this was the time where real estate investment was off the charts (see article), we go back to the risk management practices, credit approval practices, and recovering percentages…. and again, as the article shows there have been billion in bogus loans.. and this article is surely not a ful report.

    In addition to the article (one should not believe everything they read), I have continued to follow the situation by living vicariously through friend, and I have yet to here that there has been the quantum leap improvement in banks to lead anyone to believe the new loans will achieve a higher repayment.

    No one doubts that the senior managers are all highly capable people who are trying, but there a lot of hurdles to putting in the sytems to reduce the rate of new debt that goes bad: there is still no nationwide credit system, the banks themselves are not hooked into each other, loan officers are still open to influence, and so on…
    So, with all that in mind, my gues is that the situation will get worse before it gets better.  I DO NOT believe we will see a collapse, but then again, I do not have full visibility into the porfolios (no one does)

    So, it is POSSIBLE that the situation is far worse than expected.
    Anyway… just a few thoughts. Maybe the plan for China\’s 1 trillion dollar reserves is to pay off all the bad debt in the big 4. Maybe its not. But until the middle management can effect change, and local banks are not fiefdoms, it is going to be hard to take out the political lending… and thus reduce NPLs.

  5. rbrubaker says:

    February 9th, 2007 at 12:00 pm

    One more thing:

    For those that remember the controversy Jack Rodman created in May by announcing (and then retracting a report of China’s NPL situation), this link has an overview. As you wil see, the report indicated that NPLs had doubled since 2002.

    And that is coming from one of the top experts in China on NPL (E&Y advised Huarong directly and assisted in preparation of documents for at least one auction).