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Warning: Avoid Chinese Banks!
Last week, while financial markets were enduring their second week of dizzying ups and downs, the red hot Chinese market was defying financial gravity. While investors around the world were clamoring to exit "risky assets" like emerging markets and commodities, the Bank of China (BOC), the second-largest state-owned bank in China, successfully raised an eye-popping $9.72 billion in a listing on the Hong Kong Stock Exchange. It's a testament to the resilience of the China story that investment bankers could pull off the BOC deal -- the largest initial public offering of a financial institution in history -- right in the midst of the biggest turmoil in emerging markets since 1998. Demand was overwhelming with institutions bidding for 20 times as much stock as was available. Individual investors oversubscribed by a whopping 76 times. Even blue chip investors like Prince Alwaleed bin Talal, #4 on the Forbes 400 list of billionaires, led a group of Middle Eastern investors to buy a $2 billion stake in BOC. The U.S. Savings & Loan Crisis? Child's Play in Comparison It's no secret that Chinese state-owned banks like BOC are a disaster. The Chinese government has pumped over $434 billion since 1998 to bail out state-owned banks, amounting to 17% of China's GDP in 1999 alone. By way of comparison, the U.S. Savings & Loan scandal of the early 1990s cost the U.S government less than 1% of GDP. Later in 1993, the Chinese government doled out another $45 billion to BOC and China Construction Bank. Add to that the estimated $358 billion in bad loans that China's four largest banks officially have on their books today -- though some estimate the real figure closer to $1 trillion -- and something smells rotten in Shanghai. How did Chinese banks get into this mess? It's worth remembering that China's four big state-owned banks got their start as government financial institutions. Carved out of the old Communist banking system just over 10 years ago, state-owned banks' role was to bankroll the government's massive infrastructure projects and to keep otherwise bankrupt state-owned enterprises afloat. Pumping money into rickety and corrupt institutions did nothing to the change the banks' culture. And on a cart of already bad apples, BOC is worse than most. The former president of the BOC is serving a 12-year jail sentence after he was caught with his hand in BOC's rather large till. Nor will attracting passive portfolio investors with no management control change much. State-owned banks lend money on a political whim. Shanghai's skyline would be much less impressive if it weren't for Chinese state-owned banks financing construction boondoggles that have no chance of ever turning a profit. Gleaming new corporate headquarters notwithstanding, don't underestimate the backwardness of China's banks. BOC does not even have a centralized computer system to keep track of its client accounts. And with six layers of management between the head office and branches, no experience of lending based on commercial criteria, and huge staff numbers, BOC and other Chinese state-owned banks are financial dinosaurs. This skepticism of the Chinese banking story meshes with the conclusions of a panel I held last fall on investment in China at the The London Junto. One of my panelists, Tim Clissold, author of the widely acclaimed Mr. China, revealed how he lost over $450 million investing in China as a private equity investor in the mid-1990s. Clissold's book is chock full of war stories and should be required reading for every investor who wants to learn what its really like to do business in China. Yet, despite their more than cosmetic defects, Chinese banks have succeeded in looking like belles at the banking ball, attracting many eager suitors. The Royal Bank of Scotland paid $3 billion for a 10% stake in BOC just last year. Other banks rolling the dice in the China bank craps table include Bank of America, Citigroup, Goldman Sachs, and UBS. Ironically, attracting investment from Western banks is what gave Chinese banks the credibility to list on public exchanges in the first place. But don't be fooled by the hype. As a partner in a Big Four accounting firm on the ground in Shanghai observed: "The level of foreign interest in Chinese banks defies all logic." The Lessons of History Longtime market analyst Marc Faber provides a poignant reminder of the fate of investors investing in concepts like Chinese bank stocks, from none other than the last century's great emerging market -- the United States of America: "In examining historical economic literature, one cannot help being amazed at how much money investors lost, and how violent recessionary periods were. Foreign investors especially were taken to the cleaners again and again by ruthless and frequently fraudulent stock promoters, swindlers, and corrupt government officials... People who in the 19th century would have bought American canal and railroad shares (most of which failed) are now buying Chinese infrastructure funds." I am as bullish on the issue of how banks profit from a country's emerging middle class as I am on any single theme in global bull markets. In the right environment, banks in fast-growth economies are a license to print money. And I have recommended profitable banking plays to my subscribers to Global Bull Market Alert in countries ranging from Brazil to Korea. But I have two words of advice on Chinese state banks -- "Stay away." Sincerely,
Nicholas A. Vardy
Editor, The Global Guru P.S. If you limit your investment focus to financial markets' current obsession with China, you overlook all the vast -- and often much better -- opportunities in other global bull markets. Investing in global markets is tricky business -- and it takes more than hitching your wagon to the latest hot story -- China or otherwise. To make big profits from global markets, join my subscribers at Global Bull Market Alert, and profit from bull markets wherever they may be on the globe.
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