Finance

Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

Everyone suspects that Chinese banks understate their soured debt. Nonperforming loans at 1.67 percent of total assets, the highest since 2009, are still well below where many analysts believe they should be.

But two lenders from the mainland that are set to break a drought in listings in Hong Kong have been pretty open on other fronts.

Quiet Times
After record IPO volumes last year, Hong Kong's new listings market has had a slow start
Source: Bloomberg

China Zheshang Bank is set to be the city's biggest initial public offering this year, having already sold $1 billion shares to cornerstone investors in a sale that may reach $1.75 billion. It's scheduled to list at the end of the month and price its stock Monday. State-controlled Bank of Tianjin, which is about 14 percent owned by Australia's ANZ, is due to price its $1.23 billion IPO Friday. Like Zheshang Bank, a large chunk of shares, some $560 million, have been sold to anchor investors.

The pair have also disclosed relatively low nonperforming loans -- Zheshang's soured debt was 1.22 percent as of Sept. 30 while Bank of Tianjin puts its at 1.34 percent as of Dec. 31.

So far, no surprises. But a closer look at the duo's sale documents throws up some interesting other tidbits.

Bank of Tianjin highlights that banks' profits are being challenged by the rise of e-commerce and associated non-bank online payment platforms, such as Alipay and Tenpay, noting that third-party online payments in China rose 50 percent in 2014 to 8.08 trillion yuan ($1.2 trillion).

Cyber Threat
China's online alternative finance market, the world's largest, has seen volumes surge
Source: Cambridge-Tsinghua-Sydney Asia-Pacific alternative finance study, in partnership with KPMG

``We cannot assure you that we will successfully meet the challenges from Internet finance companies,'' its prospectus states, and ``our business, financial condition and results of operation could be materially and adversely affected'' if the bank can't come up with an effective response.

Of course, that's a problem all lenders face the world over but Chinese banks are particularly up against it considering the nation is, according to KPMG, the world's largest market for alternative sources of funding.

Zheshang had little to say on that front beyond noting that Internet banking headwinds were an issue (perhaps because Alibaba's finance affiliate, Alipay, is one of its cornerstone investors). Instead, alarm bells should be going off for investors regarding its big push into shadow banking.

Total assets surged almost 50 percent to just over 1 trillion yuan from the end of 2014 as Zheshang embarked on a ``full asset class operation strategy'' to reduce its reliance on the ``traditional model of providing deposit, loan and remittance services." (Perhaps we're old fashioned, but isn't that what banks are supposed to do?)

It said that as of Sept. 30, investments in trust plans, asset management plans and wealth management products were 387.2 billion yuan, or 38.6 percent of total assets. That's up from 23 percent at the end of 2014. According to analysts at DBS Vickers, 20 percent or less is the norm for even the most enthusiastic shadow banking lenders in China. 

Zheshang also said it had exposure, albeit quite low, to sanctioned countries including Iran, Sudan and Syria via a small amount of remittances it processed for some customers.

Worrying, no? But perhaps these disclosures are of little significance when it comes to a stock's ultimate performance. Three of the Chinese banks that listed in Hong Kong last year -- Bank of Jinzhou, Bank of Qingdao and Bank of Zhengzhou -- are all outperforming the broader Hang Seng index, so far this year at least:

Holding Up...for Now
Despite worries about their bad loan levels, recently listed Chinese banks have outperformed Hong Kong's benchmark stock index
Source: Bloomberg

Whether the same good fortune will be bestowed on Bank of Tianjin and Zheshang remains to be seen. But along with the super-low nonperforming loan numbers, investors would be wise to read the fine print.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Nisha Gopalan in Hong Kong at ngopalan3@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net