Analysis: China regional bank IPOs look to cash in on rural

By Kelvin Soh and Soo Ai Peng

HONG KONG/SHANGHAI (BestGrowthStock) – China’s regional banks with national aspirations are set to fuel the next wave of public offerings in the world’s top IPO market, presenting a compelling growth story tempered by uncertainties over their fiscal health.

Chongqing Rural Commercial Bank (3618.HK: ) will become the first Chinese regional rural lender to go public with a HK$10.5 billion ($1.35 billion) initial public offering in Hong Kong next week, paving the way for its peers to follow suit.

More than two dozens regional banks, especially big city lenders such as Bank of Shanghai and Bank of Hangzhou, have long said they would seek a listing on the domestic stock markets.

The regional banks offer investors a window to the untapped potential of China’s inland areas. But their close links to debt-laden local governments also make them a riskier bet compared with the larger national banks that Beijing considers too big to fail.

“The fundamentals of rural banks are generally not as strong as the state-owned banks,” said Patrick Yiu, associate director at CASH Asset Management, with some $100 million under management.

“The central government won’t step in to help clean up their loans like it did with the bigger guys, so investors are likely to be looking for the growth story in these rural banks rather than a safe investment.”

Chongqing Rural Bank exemplifies the wave of listings to come, with numbers that are a decidedly mixed bag.

Its net profit this year is expected to rise at least 51 percent to 2.85 billion yuan ($428 million), and it boasts a healthy net income margin of about 3 percent, ahead of the major domestic banks. But it has a non-performing loan (NPL) ratio of about 3 percent, far higher than the bigger names.

CLEANING UP THE BOOKS

Clearly, some are sold on the rural bank story, with Chongqing Bank attracting a solid list of cornerstone investors that includes the likes of Abu Dhabi-based Capital Investing.

But those investors came on board only after a major clean up of the bank’s books, which had weighed under an NPL ratio of more than 10 percent as recently as 2007 under a former Chinese banking culture where most lending was policy-driven.

Chongqing Bank said in its prospectus it may not be permitted to dispose of or write off NPLs on a similar scale in the future, even as it still learns to behave more like a true commercial lender.

Due to all their uncertainties, including whether or not they can rely on the government to bail them out in times of trouble, rural banks may command lower valuations than their bigger peers.

“The valuations of the big banks are not that excessive, so they (the rural banks) will have to price their IPOs at a lower multiple for us to look at them,” said Michael Lai, investment director at Fortress Capital in Kuala Lumpur, which has some $70 million under management.

China’s major state-owned banks such as ICBC (601398.SS: ) and China Construction Bank (0939.HK: )(601939.SS: ) typically trade at a price-to-book ratio of between 2 and 3.

Chongqing Bank’s Thursday pricing of its IPO in the middle of an indicated range gave it a price-to-book ratio of 1.8 times, in a deal that would see it raise $1.35 billion.

RURAL ROOTS

Many of China’s regional banks, including rural ones, trace their lineage back to credit co-operatives set up to fund and support local policy initiatives that may not have been attractive to big state-owned banks such as Bank of China

(3988.HK: )(601988.SS: ).

They are also likely to have their operations concentrated in a single geographical area, which means any slowdown in the local economy could affect their performance.

“State support and geographical concentration are among the factors we look at when deciding on a bank’s rating, and smaller banks are more likely to have their operations in a single area,” said Charlene Chu, an analyst at Fitch Ratings. Fitch has not rated Chongqing.

Despite their desire to be more market-oriented, many of the rural banks may come under pressure from local officials to make loans on unfavorable terms, pushing up their NPLs.

“Investing in regional banks will take a bit more work and more research,” said Lai at Fortress Capital. “You will have to look at the regional economies. You may have to be on the ground to know them well.”

On the flip side, the geographic limitations could give such banks greater growth prospects than national rivals, with some such as Bank of Beijing having already expanded beyond the area of their origin.

“The geographical expansion is the main selling point for these smaller city commercial banks,” said Wang Mingfei, a banking analyst at Orient Securities in Shanghai. “City commercial banks have an edge over the larger ones mainly because of their growth potential and their uniqueness in terms of market niche.”

(Editing by Doug Young and Muralikumar Anantharaman)

Analysis: China regional bank IPOs look to cash in on rural