China Boom-to-Bust Concerns Revealed in Agricultural Bank Slide
Kerry Stokes made his first billion dollars operating television stations and selling dump trucks in his native Australia. Now, he’s betting a chunk of that fortune on a bank that operates in the backwaters of rural China.
Stokes became one of the cornerstone investors in Agricultural Bank of China Ltd. (1288), whose July 2010 initial public offering was the world’s largest, raising $22 billion. Investors such as Hong Kong billionaire Li Ka-shing and the sovereign wealth funds of Kuwait, Qatar and Singapore joined Stokes, 70, in wagering that the bank will benefit from the rapid development of China’s agrarian inland areas, where growth is already outstripping that of the wealthy coastal cities, Bloomberg Markets magazine reports in its December issue. They agreed to maintain a stake for at least one year.
The payoff is far from assured. Global investors increasingly have doubts about the future of Chinese banks, which in 2009 and 2010 went on a 17.6 trillion yuan ($2.8 trillion) lending spree, according to People’s Bank of China data.
Fitch Ratings estimated in a report issued in April that as much as 30 percent of all loans in China’s banking system -- or $2.46 trillion -- could become nonperforming. Hedge-fund manager Jim Chanos told Bloomberg News in September that he was shorting Agricultural Bank and other Chinese lenders.
Investors worried about nonperforming loans pushed the MSCI China Financials Index down about 25 percent from July 1, 2010, to Oct. 25 of this year.
Concern About Loans
Concerns about bad loans have affected Agricultural Bank, too, even though it’s benefiting from increasing investment in western and central China. Its shares had lost 17 percent of their value since the IPO as of Oct. 10 and then jumped when Central Huijin Investment Ltd., a unit of China’s sovereign wealth fund, began buying the stock. On Oct. 25, the shares were back at the IPO price.
“Industry is moving west and money is flowing into those areas -- no question,” says Singapore-based Mark Mobius, executive director of Templeton Asset Management’s emerging- markets group. “But in one fell swoop, bad loans can wipe out any profits you make.” Mobius, who manages $50 billion, holds just $9.6 million worth of Agricultural Bank stock, according to data compiled by Bloomberg.
The economic health of China -- and its banks -- is increasingly important as the world economy teeters on the brink of another financial crisis. China has accounted for more than 40 percent of global growth since 2008, according to Bloomberg data. It holds 31 percent of all foreign reserves. Of the world’s seven biggest banks by market capitalization, four are Chinese. Agricultural Bank, with a market value of $136 billion, ranks No. 3 in China, behind Industrial & Commercial Bank of China (601398) Ltd. and China Construction Bank Corp. (939), and vies for fourth in the world with Wells Fargo & Co. (WFC) and JPMorgan Chase & Co. (JPM)
After three decades of searing growth that has averaged 10 percent a year, the country as a whole will grow at 8 or 9 percent in the second half of this year and in 2012, according to Qu Hongbin, Hong Kong-based chief economist for China at HSBC Holdings Plc. (HSBA) Year-over-year growth in the third quarter fell to 9.1 percent, China’s National Bureau of Statistics reported on Oct. 18. Investors polled in a Bloomberg survey in September said they expect China to grow only 5 percent annually by 2016, half the current rate.
Agricultural Bank’s Turf
The inland areas where Agricultural Bank is the largest lender are the exception, with growth of more than 10 percent, Qu says.
Agricultural Bank takes in 22 percent of all deposits and makes 14 percent of all loans in the counties and other subdivisions of China’s provinces that account for 70 percent of the population and 49 percent of gross domestic product, according to Warren Blight, a banking analyst at Keefe Bruyette & Woods Inc., a New York-based investment bank that specializes in financial companies.
And with loans amounting to just 55.5 percent of deposits, Agricultural Bank has plenty of money to lend, adds Blight, who has an outperform rating on the stock.
“Agricultural Bank is a proxy for China’s new growth engine: rural China,” says Lewis Wan, Hong Kong-based chief investment officer at Pride Investments Group Ltd., which manages $200 million of China assets.
Pumping Money Inland
That trend will continue, Qu says, as the government of Premier Wen Jiabao pumps money into central and western regions, where the poorest 700 million of China’s 1.3 billion people live. The most-notable examples of this spending are on roads and railways largely funded by a $585 billion stimulus package Wen announced in 2008 to fight the impact of the global economic crisis.
Some 3,700 kilometers (2,300 miles) of new railways have been built in the West -- double the figure for eastern China, Qu says. Four-fifths of the 400,000 kilometers of new highways were also built in inland regions.
In the first eight months of this year, so-called fixed- asset investment -- which includes road and rail construction plus other long-term projects such as factories, mines and real- estate development -- jumped by 30 percent in inland China compared with just 23 percent in the East, the National Bureau of Statistics reported in September.
City of 33 Million
Even the relentless migration of Chinese from the countryside to the city is occurring at a faster rate in inland areas, which house some of the country’s great conurbations as well as the farmland that feeds the world’s largest population. From 2005 to 2009, the number of urban dwellers in inland China rose by more than 4 percent compared with a 2.7 percent increase in the East of China, according to HSBC.
A prime example: Chongqing, a sprawling municipality of 33 million people -- one and a half times the size of Beijing or Shanghai. Located on the Yangtze River 1,450 kilometers west of Shanghai, its GDP tripled to 793 billion yuan from 2004 to 2010 while Shanghai’s merely doubled.
Wuhan, a city of 8.4 million also on the Yangtze River, Chengdu, capital of the western province of Sichuan, and Chongqing have attracted investors such as Ford Motor Co., Intel Corp. and Pfizer Inc.
Founded in 1951 by Mao Zedong to finance rural cooperatives, Agricultural Bank has by far the widest reach of China’s big four lenders. It has more customers -- 320 million - - than the U.S. has people. And its 23,500 branches far outnumber the 16,200 outlets operated by Industrial & Commercial Bank of China (1398), known as ICBC, the world’s biggest bank by market value.
While Agricultural Bank’s total assets of 11.46 trillion yuan are smaller than ICBC’s 14.9 trillion yuan, they’re close on the heels of Bank of China Ltd. (3988), with 11.48 trillion, and Construction Bank, with 11.8 trillion.
Stokes, the Australian billionaire, says he decided to invest $250 million in Agricultural Bank shares based on his personal experience. In 2000, he acquired the franchise to sell Caterpillar Inc. earthmovers across a swath of rural China, from the North Korean border to the windswept prairies of Inner Mongolia. Stokes says he had never been previously tempted to invest in Chinese bank IPOs.
“Our focus is in the regions, and Agricultural Bank is a story we understood better than most people,” he says, sipping tea in his art-filled private office just outside Sydney’s main business district.
Even though the stock has declined since the IPO and the lockup period has expired, Stokes plans to hold on to his shares. He says the bank’s customers are similarly loyal.
“Agricultural Bank’s deposit base is probably the soundest of any bank in the world,” he says.
One such customer is Lai Kebin, 45, who says Agricultural Bank’s backing helped him lift himself out of poverty and into China’s newly wealthy class. Lai has built his fortune by exploiting the lush sugar cane fields of Guangxi autonomous region, 2,000 kilometers south of Beijing.
Lai was raised in the regional capital, Nanning, a city of 6.7 million, in a family so poor that they could afford only cotton shoes for him to wear to school.
He spent his first eight years in the workforce toiling at a low-level government job before the speeches of reformist leader Deng Xiaoping inspired him to set up his own sugar firm, Yong Kai Group.
Within a year, Lai had got his first loan from Agricultural Bank. Back then, the Yong Kai Group was worth 3 million yuan (about $520,000) and employed 200 workers. Today, it’s one of China’s top 10 sugar producers, according to the China Sugar Association. This year, Yong Kai’s revenue will top 10 billion yuan and employees will total 3,000. In 2007, a Citigroup Inc. (C) venture capital unit invested $50 million in Yong Kai. Lai says he plans to sell shares in Hong Kong at an unspecified date.
Like many Chinese entrepreneurs, Lai has also expanded into real estate. In the process, he and other developers have transformed Nanning, until recently a city of mostly two-story buildings, into a high-rise metropolis of office towers and condominiums. Those residential apartments include a development called Fond England guarded by concrete soldiers with British army bearskin hats.
Lai credits his success to China’s leaders’ decision to encourage rural development, as well as to the financing he received from Agricultural Bank.
‘A Bank With Scale’
“The hills, water and people are still the same,” Lai says. “What has changed is government policy.”
Lai says he now also borrows from other banks, including ICBC, although he still favors the lender that gave him his start.
“Agricultural Bank is a bank with scale, and the fact that it is inclined to agriculture business makes it an easier funding source for us,” he says.
Customers such as Lai are boosting Agricultural Bank’s earnings growth. In the first half of 2011, profit jumped 45 percent to 66.7 billion yuan from a year earlier after increasing 46 percent in 2010. Those gains compared with an average 30 percent rise for its three rivals.
Agricultural Bank is expected to report tomorrow that net income in the third quarter of 2011 jumped 34 percent to 32.6 billion yuan compared with a 26 percent increase by ICBC, which will report its earnings on Thursday, according to the median estimate of six analysts surveyed by Bloomberg News.
“We can say with pride that the Agricultural Bank has staged a wonderful dance of concerted urban-rural growth,” Chairman Xiang Junbo told investors in August.
War With Vietnam
Xiang, 54, spent his early adult life as a lieutenant in the People’s Liberation Army and took a bullet in the thigh while fighting in China’s 1979 border war with its then- communist rival Vietnam -- a bloody, inconclusive and now largely forgotten conflict in which both sides claimed victory.
Today, more than three decades after quitting the army to study finance and law, Xiang sees rural China as his new battleground. And he’s anticipating a more clear-cut victory than he ever achieved as a soldier.
“They’ve all lost the battlefield of the countryside,” he said of his rivals in an interview after the first-half results announcement.
Xiang may have more difficulty convincing investors about the quality of his loan book. As of June 30, 1.67 percent of Agricultural Bank’s loans were nonperforming. That’s more than the 1 percent for Bank of China and 0.95 percent for ICBC. It’s still reporting a lower rate than some international banks, such as HSBC Holdings, which has 2.04 percent.
Government Debt Exposure
Like other Chinese banks, Agricultural Bank is exposed to local government debt, which the national auditor this year said some authorities had obtained by offering illegal guarantees and would struggle to repay. Xiang says that financing to local authorities is under control, accounting for about 10 percent of the bank’s total lending of 5.38 trillion yuan ($846 billion).
Chinese banks have overstretched in the recent past, when lenders were so awash with nonperforming loans as to be technically insolvent. From 1998 to 2008, China’s government had to bail out the four big banks to the tune of more than $650 billion before they could sell shares to the public.
Agricultural Bank, which Xiang joined in 2007 as president, got 815.7 billion yuan. Last year, Agricultural Bank’s three state-controlled rivals returned to the market to raise an additional $35 billion in capital. Xiang says Agricultural Bank won’t need to ask investors for more money until at least 2013.
More Capital Needed?
Still, its core capital adequacy ratio, an indicator of financial strength, fell to 9.36 percent in the first half of 2011 from 9.75 percent at the end of 2010. Sanford C. Bernstein & Co. banking analyst Mike Werner says the bank may have to return to the capital markets if it is to meet the 9.5 percent level required by 2013 under the Basel III accords.
Agricultural Bank also faces growing competition, especially from thousands of rural credit cooperatives. Foreign banks, too, are seeing opportunities in inland China. HSBC, Europe’s biggest lender, has 17 rural branches. Citigroup has opened four offices it describes as rural lending companies because they don’t take deposits.
So far, Xiang’s biggest foreign investors are hanging on for the ride. Sovereign wealth funds, banks, public companies and individuals paid a total of $5.45 billion as cornerstone investors. The lockup period expired in July, and as of Oct. 24 none of the biggest investors had sold their shares, according to Bloomberg data.
Qatar Holding LLC bought $2.8 billion of shares, and the Kuwait Investment Authority acquired $800 million. Singapore sovereign wealth fund Temasek Holdings Pte. invested $200 million, and Li Ka-shing invested $100 million. Standard Chartered Plc (STAN), the London-based bank that makes most of its profits in Asia, invested $500 million; Dutch lender Rabobank Groep NV invested $250 million, the same as Stokes’s Seven Group Holdings Ltd. (SVW)
Stokes is digging deeper into the market in more ways than one. His earthmoving equipment unit, WesTrac China Ltd., has signed a deal with Xiang under which Chinese contractors buying his earthmovers, which sell for $100,000 to $300,000, will be able to finance the purchases with Agricultural Bank loans.
“The transformation taking place in rural China means they are moving from wheelbarrows to excavators,” Stokes says. “Until now, getting finance for our customers has always been a challenge.”
The loan deal is giving Stokes some return now for his ties to Agricultural Bank. As China’s economic engine continues its shift toward the burgeoning hinterland, Stokes says he’s willing to wait for his bank stake to pay off.
To contact the editor responsible for this story: Laura Colby at email@example.com