Brent Lewin/Bloomberg News
Updated July 20, 2016 3:41 a.m. ET
For a microcosm of the $31 trillion Chinese banking system, it’s worth examining Bank of Zhengzhou,
an immensely profitable business that increasingly looks like a bad-risk warehouse in dire need of a thicker capital cushion.
The Hong Kong-listed Chinese provincial commercial bank announced this week it intends to return to investors for fresh equity—via a new listing in Shanghai and share sales in Hong Kong. To replenish its regulatory capital, the bank also plans to raise up to 5 billion yuan ($746 million) of debt, 2 billion yuan more than it had previously flagged.
The timing seems curious, given that Bank of Zhengzhou’s Hong Kong IPO was just last December. The risks at the heart of China’s financial system explain why it’s coming back for more so quickly.
Bank of Zhengzhou has been a poster child for highly profitable but opaque loan-like assets. Last year, the bank held $9 billion of these bundles of risk—accounting for over 60% of all its loans—making Bank of Zhengzhou one of the biggest holders among listed banks. China’s banking regulator earlier this year cracked down, saying banks had to provision for the loans underlying these investment-management products and include them on their balance sheets.
Like many Chinese banks of late, Bank of Zhengzhou has embedded these assets deep within its books. Typically, they’re used to hold souring loans out of sight of regulators, to minimize provisioning for them. Adjusting for these credit products could drop Bank of Zhengzhou’s core tier 1 capital-adequacy ratio to 7.85% from its current 10%. Meanwhile, its loans continue to rapidly go bad.
On its face, Bank of Zhengzhou seems profitable enough to replenish its capital. In contrast to the paltry profit growth at China’s large banks in recent years, Bank of Zhengzhou’s net profits were up 36% in 2015. But that’s because an increasing part of its mainstream corporate banking business is being replaced by a business with far greater credit risk. Almost 60% of its income comes from its treasury operations, such as managing proceeds from loan-stuffed wealth-management products that it issues to customers. One reflection of the increased risk: While loans last year grew 20%, risk-weighted assets grew 34% and investment in such financial assets grew almost 40%.
Setting Bank of Zhengzhou apart: With a price 1.1 times book, well above its peers, it can tap investors for fresh cash under rules that require equity be raised above book value. Investors don’t seem to mind the dilution; the share price is at a post-IPO high. They may just be happy that Bank of Zhengzhou, unlike peers, has access to cash in the first place.
Write to Anjani Trivedi at [email protected]