Read Online Red Capitalism by Carl Walter, Fraser Howie - Free Book Online Page B
Authors: Carl Walter, Fraser Howie
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banks directly to the state’s coffers. Why wouldn’t international investors keep the cash in the first place?
FIGURE 2.7 Bank IPOs pre-fund cash dividends paid, 2004–2008
Source: Wind Information for IPO amounts; Statement of cash flows, bank annual reports
Investors, as opposed to speculators, put their money in the stocks of companies, including banks, in the expectation that management will create value. But in these three banks, this is not what is happening because the capital did not stay in the banks. Yes, the minority international investors acquired stocks that vary in value in line with market movements. This gives the impression of value creation on their portfolios, but these movements are, in fact, due more to speculation on market movements driven by any number of factors including, for example, overall Chinese economic performance. This should not be confused with value investing: the banks themselves are not putting the money to work to make the investor a capital return. For this reason alone, the market-capitalization rankings are misleading.
As for the Chinese state, which holds the overwhelming majority stake in these banks, such payouts mean the banks will require ongoing capital-market funding after their IPOs. This, in turn, means the government must, in effect, re-contribute the dividends received as a new equity injection just to prevent having its holdings diluted. There can be only one IPO for each bank and one infusion of purely third-party capital. 10 What is the purpose of running a bank that pays dividends to a state that must then turn around and put the same money back again? Why sustain dividend payout ratios at 50 percent or higher? This begins to look very much like some sort of Ponzi scheme, but to whose benefit?
Of course, it is more than that: China’s banks are the country’s financial system. But, as the analyst said, they operate a business model that requires large chunks of new capital at regular intervals. With high dividend payouts and rapid asset growth, consideration must inevitably be given to the issue of problem loans. How can banks as large as China’s grow their balance sheets at a rate of 40 percent a year, as BOC did in 2009, without considering this? Even in normal years, the Big 4 banks increase their assets through lending at nearly 20 percent per annum. Throughout 2009, as the banks lent out huge amounts of money, their senior management emphasized over and again that lending standards were being maintained. How was it, then, that the chief risk officer of a major second-tier bank could exclaim even before 2009: “I just don’t understand how these banks can maintain such low bad-loan ratios when I can’t?” His astonishment suggests there may be less-than-stringent management of loan standards by the banks’ credit departments. This is undoubtedly true.
The most important fact behind the quality of these balance sheets, however, goes beyond common accounting manipulations or even making bad loans. These things are inevitable almost anywhere. It goes back to the financial arrangements made by the Party when weak bank balance sheets were restructured over the years from 1998 to 2007. A close look at how these banks were originally restructured highlights the political compromises made during this decade-long process. These compromises have been papered over by time and weak memories on all sides: it is highly likely, for example, that China’s national leaders believe that their banks are world-beaters. In the past, sweeping history under the carpet might have been enough; people would have forgotten. Today, it is far from enough, even for those operating inside the system. The key difference with the past is that the quest to modernize China’s banks was made possible by raising new capital from international strategic investors and from subsequent IPOs on international markets. China’s major banks are now an important part of international
FIGURE 2.7 Bank IPOs pre-fund cash dividends paid, 2004–2008
Source: Wind Information for IPO amounts; Statement of cash flows, bank annual reports
Investors, as opposed to speculators, put their money in the stocks of companies, including banks, in the expectation that management will create value. But in these three banks, this is not what is happening because the capital did not stay in the banks. Yes, the minority international investors acquired stocks that vary in value in line with market movements. This gives the impression of value creation on their portfolios, but these movements are, in fact, due more to speculation on market movements driven by any number of factors including, for example, overall Chinese economic performance. This should not be confused with value investing: the banks themselves are not putting the money to work to make the investor a capital return. For this reason alone, the market-capitalization rankings are misleading.
As for the Chinese state, which holds the overwhelming majority stake in these banks, such payouts mean the banks will require ongoing capital-market funding after their IPOs. This, in turn, means the government must, in effect, re-contribute the dividends received as a new equity injection just to prevent having its holdings diluted. There can be only one IPO for each bank and one infusion of purely third-party capital. 10 What is the purpose of running a bank that pays dividends to a state that must then turn around and put the same money back again? Why sustain dividend payout ratios at 50 percent or higher? This begins to look very much like some sort of Ponzi scheme, but to whose benefit?
Of course, it is more than that: China’s banks are the country’s financial system. But, as the analyst said, they operate a business model that requires large chunks of new capital at regular intervals. With high dividend payouts and rapid asset growth, consideration must inevitably be given to the issue of problem loans. How can banks as large as China’s grow their balance sheets at a rate of 40 percent a year, as BOC did in 2009, without considering this? Even in normal years, the Big 4 banks increase their assets through lending at nearly 20 percent per annum. Throughout 2009, as the banks lent out huge amounts of money, their senior management emphasized over and again that lending standards were being maintained. How was it, then, that the chief risk officer of a major second-tier bank could exclaim even before 2009: “I just don’t understand how these banks can maintain such low bad-loan ratios when I can’t?” His astonishment suggests there may be less-than-stringent management of loan standards by the banks’ credit departments. This is undoubtedly true.
The most important fact behind the quality of these balance sheets, however, goes beyond common accounting manipulations or even making bad loans. These things are inevitable almost anywhere. It goes back to the financial arrangements made by the Party when weak bank balance sheets were restructured over the years from 1998 to 2007. A close look at how these banks were originally restructured highlights the political compromises made during this decade-long process. These compromises have been papered over by time and weak memories on all sides: it is highly likely, for example, that China’s national leaders believe that their banks are world-beaters. In the past, sweeping history under the carpet might have been enough; people would have forgotten. Today, it is far from enough, even for those operating inside the system. The key difference with the past is that the quest to modernize China’s banks was made possible by raising new capital from international strategic investors and from subsequent IPOs on international markets. China’s major banks are now an important part of international
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