The Bank China Wants Us to Forget

The bank that China hoped the world had forgotten blinked briefly into view in December 2005, enjoying 15 seconds of fame following some hastily made comments by the banking regulator, before vanishing just as quickly. Agricultural Bank of China (ABC) is the weakest and most troubled of China’s big four state banks. While Bank of China (BOC) and Industrial and Commercial Bank of China (ICBC) scurry to restructure and follow rival China Construction Bank to market in Hong Kong, ABC festers in the dark.

According to official internal figures, ABC’s non-performing loans (NPLs) at the end of November were 25 per cent of its total loans portfolio – down a whisker from 26.7 per cent at end-2004 but still amounting to a huge Rmb700bn (US$87bn). Worse is the total stock of agricultural-related loans – making up 23 per cent of the total loan book – with 90 per cent non-performing, according to Li Shiqin, head of financial institutions at the bank. “This is a very hard problem for the government,” says Li. “If we keep this 23 per cent on our books, it will take a long time to restructure – this is really what is holding us back. Our very big problem is our stock of NPLs.”

And with bad loans set to rise next year following several years of scattergun lending to failed industrial and commercial enterprises, these NPL figures are only set to worsen. Meanwhile, each of ABC’s big four rivals have a bad-loan ratio in the low to middle single digits, thanks to state-mandated capital injections and NPL bailouts. Beijing-headquartered ABC also has more staff, at 489,000, and a greater number of branches, at 31,004, than any of its key rivals.

Perhaps unsurprisingly, Beijing’s silence has been deafening with regards to the bank that’s run in theory as a commercial lender, but in reality is part-mandated to provide policy loans to 900 million impoverished, socially restive farmers, who form the backbone of the Communist-run one-party state. That’s what made China Banking Regulatory Commission (CBRC) chairman Liu Mingkang’s comments in early December 2005 all the more surprising.

Caught on the hop by a television reporter, Liu at first heaped praised on restructuring at the big state banks, but included Hong Kong-listed Bank of Communications as the fourth bank instead of ABC. Papering over his error, he announced that ABC was ‘preparing for reform and restructuring’, and would have its bad loans peeled away before a possible overseas stock sale. Liu gave no timetable for any course of action.

ABC’s Li says the bank and the government are tussling over how to shed the Rmb400bn block of bad agriculture-related loans. She says two options are under discussion. The first is a state-directed bailout of bad loans to one of the country’s four state asset management corporations or to the Agricultural Development Bank, a policy bank created in 1994 to take on board ABC’s huge stock of bad loans. That would cut bad loans and make a state bailout a moderate addition to the combined US$60bn lavished on the other three state banks prior to restructuring. The other option is to keep the bad-loan stock on board, making a future recapitalization much larger. Discussions will be ongoing for years, Li says.

Restructure of ABC

Internally, however, it’s clear that China’s agricultural lender does not want to be ignored. The bank is on the cusp of setting up a fund-management joint venture with French rural lender Credit Agricole. And, in December 2005 it signed an insurance distribution deal with US property and casualty insurance giant Liberty Mutual Group, whose chairman and CEO Edmund Kelly is a friend of Chinese premier Wen Jiabao. ABC is the country’s biggest distributor of insurance products via its sprawling branch network and the bank, which is prevented from selling its own insurance products, is in talks with other domestic and overseas insurers over distribution rights.

Despite official diffidence, the bank is determined to plough ahead with its own restructuring. In late spring 2005 it formally applied to be allowed to restructure – the first step toward a recapitalization, bad-loan bailout, restructuring as a joint stock bank and, finally, a listing – the path chosen for its chief state bank rivals. Again, government officials at ABC’s regulatory overlords – the Finance Ministry, the People’s Bank of China, China SAFE Investments and the CBRC – stayed quiet. Unabashed, ABC pushed ahead. In July it hired PricewaterhouseCoopers to do a pilot audit on branches in four locations, in Jilin, Zhejiang and Guizhou provinces as well as the eastern city of Ningbo. The pilot will be expanded to include all of the bank’s 31,004 branches next spring, says Li. She adds that the bank has also boosted its fee-based income from 1 per cent of revenues in 2000 to 10 per cent in 2004, and is rapidly shedding employees – 30,000 last year and the same in 2005, with another 30,000 set to receive a pink slip in 2006.

And, says Li, if the failed agricultural loans are cleared out, ABC is in a far healthier shape than many believe. She points to figures showing that bad loans as a percentage of total lending between 2000 and 2005 stands at just 4.18 per cent. That’s comparable with current bad-loan ratios at CCB and Bank of China.

Public Offer?

That’s all well and good, but despite the rhetoric and determination, Agricultural Bank’s broader future is still at the mercy of a cabal of powerful but ambivalent mandarins. Li admits that an initial public offering (IPO) in Hong Kong, or even on China’s belatedly reflating domestic bourses, remains at least five years away. “I don’t believe we can list before 2010. It’s going to take a long, long time,” she says. “The government is smart – they should consider taking us public at a later date. Perhaps Mr Liu (Mingkang’s) reforms are too ambitious. He needs to succeed and succeed quickly, but the market needs more time to digest all of these reforms and IPOs.”
She says Agricultural Bank will not submit its formal listing proposal to Chinese authorities before 2007, while foreign investment in the lender is unlikely for at least a couple of years.

Ivan Chung, managing director of credit ratings at Xinhua Finance, says Agricultural Bank is “less appealing to foreign strategic investors relative to the three other state banks, and can hardly command a good valuation”. That hasn’t stopped global investment banks pitching for a role in its restructuring. JPMorgan, Lehman Brothers and Morgan Stanley have all visited to pay homage to ABC chairman and CEO Yang Mingsheng, who is widely viewed as a visionary among Chinese and foreign bankers and politicians. But they are wasting their time for now according to Li, who says “we’re a long way from picking one”.

Agricultural Bank is the only big four bank without an investment banking arm. CCB has China International Capital, Bank of China runs investment house BOCI, and ICBC owns a majority of lesser-known investment bank ICEA.

The ‘Peasants’ Bank’

ABC has always been the black sheep of China’s banking family. Formed as the Agricultural Cooperative Bank in 1951 from the defunct Farmers’ Bank and Cooperative Banks, it was quickly merged into the PBoC. In 1979, after China began its re-emergence on to the world stage, it was restructured as Agricultural Bank of China, and began lending to farmers, rural credit cooperatives and rural enterprises. By 1994, with its stock of NPLs at more than 90 per cent, newly minted Agricultural Development Bank was set up to take over ABC’s policy loans.

Yet ABC still makes policy loans, as Li admits. “Many of the loans we make are still policy-related. This makes the problem (of restructuring) even harder,” she says.

“In theory the government wants Agricultural Bank to be more commercial,” says Julia Fan, a banking analyst at CICC. “But if this is the case, why do they still make policy loans? They have no choice. They are forced to make these loans, and this makes reforms much more complicated.” She adds: “You need to also reform the Agricultural Development Bank, the rural credit cooperatives that rely on it (and which number some 30,000) and you need to reform the SOEs (state-owned enterprises) that borrow from it. It’s not easy.”

Still seen by most Chinese as a policy lender and often derided as the ‘nongmin yinhang’ or ‘peasants’ bank’, ABC is the key plank in China’s lurching attempts to reform its agricultural sector. “We still play a very important role in China’s rural development,” says Li, who has been at the bank since 1988. “We provide a large part of financing to farmers particularly in strong farming provinces such as Sichuan, Yunnan and Jiangxi, and in the poorer western part of the country.”

Xinhua Finance’s Chung says fully commercializing ABC would create enormous distress among China’s poor farmers, and says this scenario is unlikely. “What would be possible is to list their profitable operations in major cities while leaving the agricultural business in state hands. Over time maybe the agricultural sector will become more viable, and they can be floated or acquired by the listed arm.” This approach of splitting state firms, listing their commercially viable assets in Hong Kong, stockpiling cash, and using it to buy back the less-lucrative assets, is a well-worn path in China.

Any Loan You Want

Conscious of the financial consequences of lending to poor farmers unable to repay even the smallest loan, ABC has broadened its loan book to include shopping malls, mortgages and car loans. Since 1984 the bank has progressively cut lending to rural residents and enterprises, down from 95 per cent of total outstanding loans in 1985 to 23 per cent in 2004. “We will increasingly reduce our lending to agriculture each year,” says Li. “In the past five years our loans to the agricultural sector are less than 10 per cent. Lending to infrastructure and energy (concerns) is the largest, around 30 per cent of our loan book.”

Aggressive consumer lending, particularly to car owners, concerns many analysts. Outstanding car loans at ABC totalled Rmb39.9bn at the end of 2004, up 25 per cent from 2002, and making up 31 per cent of the country’s fast-growing automobile financing market. Outstanding mortgages totalled Rmb237.6bn, up 26 per cent year on year. ABC needs to take risks to improve the size and quality of its loan book and boost profits, in order to cut NPLs internally, but analysts such as CICC’s Fan fear auto loans are too risky for a bank with little corporate governance, loan compliance and risk management skills. “This is a dangerous game to play,” she says. “They have clearly set themselves some tough profit targets. But default rates on auto loans are running at 50 per cent or higher, so there is a lot of risk in what they are doing.”