China capital raising fast becoming bank elixir

HONG KONG: China’s banks exist in a capital-raising conundrum. It goes like this: Everyone is always terrified they’re about to flood the market with stock. As a result, the shares never get expensive enough to sell.

There are signs that’s finally changing.

Striking a blow for balance sheets everywhere, Agricultural Bank of China Ltd. last month announced a $16 billion private placement, the biggest additional equity sale by any Chinese company ever. 

The result? Thanks to the way the sale was constructed, with government entities providing the cash, the stock surged. Other lenders from Ping An Bank Co. to China Citic Bank Corp. have also announced plans this year to sell convertible bonds.

The case for capital raising, especially for joint-stock banks, is clear. Loans are expanding, accounting standards are tightening, and credit previously hidden from the loan book is finally getting the risk-weightings it deserves.

With profits rising and asset quality improving, the time may be right to raise money. For one thing, better results helped pushed shares of at least a few lenders near valuations where regulators will let them sell stock. A stronger capital position also assuages fears that a future increase in bad loans -- a real risk when debt is equal to 266 percent of China’s economy -- will wipe out your stock.

“You get a strengthening in your capitalized level, which will actually help you grow more loans,” said Ken Shih, a financial analyst at DBS Vickers Hong Kong Ltd. 

“This year or coming one to two years will be a very good timing. If you look at the credit cycle, it’s still trending on a favorable upcycle: interest rates are going up, asset quality is still improving, corporate financing demand is coming back to the banks.”

And the government is on board. The banking regulator said last month it will change rules to support commercial banks’ sales of capital tools including perpetual bonds. It also lowered the minimum bad-loan coverage ratio, a move that helps ease capital pressure.

One reason pressure to raise capital is growing is that tighter regulations have forced Chinese banks to increase risk weightings on loans that were previously disguised as investments. 

Excluding the Big Four, listed Chinese banks’ risk-weighted assets grew 11 percent last year while assets expanded just 6 percent, according to the latest available data compiled by Bloomberg. To bring the sector’s core tier 1 ratio to 10 percent -- a reasonable minimum target -- it will have to raise another 1.05 trillion yuan ($167 billion) of such capital, UBS Group AG estimates.

Here’s a QuickTake Q&A on China’s campaign to curb financial risk.

For investors, the fear of dilution from a wave of equity issuance has always been a concern, to the extent that one-time book value -- below which Chinese banks can’t sell new shares -- became a ceiling for their valuations. 

That, along with concerns over unrecognized bad loans, is why Chinese banks are much cheaper than their global peers. The 20 largest Chinese lenders by market value have an average price-to-book ratio of 0.97, compared with 2.50 for banks in emerging Asia excluding China.

One route around the valuation threshold is convertible bonds. Six banks have already announced plans to sell a total of 188.5 billion yuan of such notes this year, compared with about 144 billion yuan of such offerings sold since 2003, according to data compiled by Bloomberg.

“That’s actually quite a smart solution because you avoid your sticker shock-type capital raises,” said Jason Bedford, an analyst at UBS in Hong Kong. “People often want to avoid the JSBs because they fear the minute they hit one time book, they’re going to hit the market and raise a bunch of capital. With these instruments, you can gradually convert over time.”

Strengthening the joint-stock banks’ capital position is good for their long-term stability, but for now their stocks are still being battered by concerns over tighter regulation. A persistent deleveraging campaign since late 2016 has enervated their risky but lucrative business model of relying on short-term liabilities such as certificates of deposits and wealth management products to fund lending.

Still, more broadly, the Chinese banking sector is looking healthier as the economy recovers. Net interest margins and bad loan ratios are stabilizing, and loan growth still looks strong. 
The Big Four’s shares reflect such optimism: Agricultural Bank has jumped 23 percent in Hong Kong this year, while Bank of China Ltd. has gained 10 percent, dwarfing the 4 percent advance for the benchmark tracking Chinese enterprises listed in the city.

Any price pullback after capital-raising would be a good chance to boost holdings as current normalized return on equity suggests better valuations, said Claude Tiramani, a Paris-based fund manager at LA Banque Postale Asset Management SA, which has added to its position in blue-chip Chinese banks recently.

“The recapitalization process is starting,” he said in an email. “The government looks serious in its willingness to solve the banking problem and more broadly the debt problem.” - Bloomberg