Wednesday, November 15, 2006
The first thing is whether this will get Guo Shuqing into trouble According to the advisor, he repeatedly contacted Guo Shuqing about the problem. Did Guo look into it? Or did he want to speed up the IPO? Will the CBRC or the State Council look into this allegation? I doubt it, since CCB can always trod out the KPMG findings to refute the whistle-blower. But, can someone raise this issue when they (meaning the Standing Committee) discuss the future of Guo Shuqing? Yes.
Second, the Chinese strategy of co-opting foreign banks is working. BOA probably knew that the allegation was true, but decided to do nothing about it. To be sure, it was faced with no good option. It could have sunken the deal by suing CCB, but what would have been the point? It might have won a few millions in settlement in a US court, but BOA would have been forever barred from China. Instead, it probably used the information to negotiate a slightly better deal, but CCB and Huijin still had the upper-hand since they knew that BOA couldn't credibly walk away from negotiations. So now these large American banks, including now Citibank, are trapped in China's web of political lobbying. Instead of relying on transparency and the legal system, they must do back-room deals with the government and be held hostage to the threat of being barred from China.
What about the other two listed banks? ICBC and BOC. I have heard reliable rumors of similar practice in the BOC. I have not heard of similar practice in the ICBC, at least not recently, but I somehow suspect that it is also a widespread practice there. But it doesn't seem like the public cares much about a few billion in hidden NPL here and there. They invested in these banks because of China's economic future. This is all fine as long as China's growth trajectory continues at its current pace.
November 15, 2006
Rare Look at China’s Burdened Banks
By DAVID BARBOZA
BEIJING — Two years ago, one of China’s largest state-owned banks hired a senior risk adviser who had previously worked for major banks in the United States. His mission was to advise the Chinese bank on how to clean up its books, by helping assess loans that were going bad.
The banker’s career at the China Construction Bank, however, would prove to be contentious and short. It ended with his firing in July, after he repeatedly told top executives that up to $3 billion in bad loans might have been intentionally hidden from outside auditors, just months before the bank’s first sale of stock to public investors.
Officials at the bank strongly dispute the assertions, saying they investigated and dismissed them. The bank called the risk adviser a disgruntled employee.
But the dispute between China Construction and the banker — who spoke on condition that he not be identified because of fear of reprisals in China — provides a rare glimpse inside a banking system that analysts say continues to have widespread problems that could ultimately threaten the country’s breakneck economic growth.
The analysts say that China’s big banks have made too many loans for political or social reasons, rather than commercially sound ones, that may never be repaid. While the government has sought to ease the problem by spending $400 billion since 1998 to cover bad loans for real estate projects or to state-owned enterprises, fears remain that banks are still burdened with many more troubled loans than they acknowledge.
Even a top official of the central bank recently acknowledged that bad loans remained an issue. “The task of avoiding a rebound in nonperforming loans is still huge and difficult,” Wu Xiaoling, deputy governor of the People’s Bank of China, told a financial conference recently, according to a Chinese Web site, sina.com.
Today, countless new buildings, and cranes constructing still more of them, fill the skylines of cities across China, financed by loans from the banks. But half-completed buildings and warehouses, where construction has stopped, also dot cityscapes.
If loans to many of these borrowers are not repayable, as analysts suspect, the losses at some point could weigh down the country’s financial system, potentially constraining the banks’ ability to lend to new projects or companies.
Yet the amount of bad loans that Chinese banks officially report on their books is well within a range that would be acceptable for Western banks.
At China Construction Bank, officials noted that outside auditors had signed off on the books. And at the end of 2004, the bank said it had some $10.31 billion in bad loans on its books, or just 3.92 percent of its $263 billion in total loans, according to the bank’s filing. An additional $3 billion in bad loans, the amount supposedly hidden, would be sizable but not enough to threaten the bank’s stability and thus not a cause for major concern, the banking analysts say.
Similarly, China’s commercial banks officially have an estimated $163 billion in nonperforming loans, a manageable 7.5 percent of their total in June 2006, according to the China Banking Regulatory Commission.
But analysts say the bad-loan figure could be more than double the official reports. Fitch Ratings said its own estimate of problem loans is closer to $480 billion. The agency, along with other analysts, suspects that most of those loans are on bank books in the “special mention loan” category, the second and lowest level of performing loans, though still deemed good.
“A lot of analysts have been skeptical” of the bad loan figures, said Charlene Chu, a Fitch analyst. “The improvement in the nonperforming loan ratios have been so dramatic that some analysts question whether they can improve that fast.”
Despite these concerns, some of the world’s largest financial institutions are buying stakes in Chinese banks. In the last year, Bank of America, Goldman Sachs, the Royal Bank of Scotland, UBS, Merrill Lynch, HSBC and American Express have all bought minority stakes in Chinese banks ahead of planned initial stock offerings.
For now, many of those investments look like winners. China Construction’s public offering in Hong Kong in the fall of 2005 raised $9.2 billion and at the time was the biggest stock offering worldwide in four years. The Bank of China topped that, raising $11.2 billion in an initial public stock offering in mid-2006. And late in October, the Industrial and Commercial Bank of China, the country’s largest bank with more than $800 billion in assets, sold a 16 percent stake, raising about $22 billion.
“The China theme is hot, and everyone wants some exposure,” said Jonathan Anderson, the chief Asia economist at UBS.
The dispute between China Construction and its senior risk adviser began toward the end of 2004. He had joined the bank earlier that year to help China Construction as it was preparing for its initial public stock offering in October 2005.
The adviser, who studied at Beijing University and later earned a Ph.D. in applied mathematics at an American university, had previously worked for two leading multinational banks in the United States.
Asked about his time at China Construction, the risk officer confirmed that he had differences with top executives, but said he wanted to avoid a public dispute. Officials at the bank, responding to inquiries, confirmed that it had a disagreement with the former employee and discussed details about the differences.
As a senior adviser, he was allowed to travel through the country, going from branch to branch to assess the bank’s nonperforming loan ratio — which was among the bank’s most sensitive data. At one point, he reported directly to the chairman.
The government had been pressing the big four state banks to sharply improve their nonperforming loan ratios, and China Construction had turned in the best numbers at that point, reducing its share to 3.92 percent of loan assets late in 2004, down from 17 percent in 2002.
But the risk adviser began cautioning that bad loans were being hidden at the bank’s branches, erroneously labeled as good loans, even though company records showed that they were impaired. He told bank officials that in Beijing and Tianjin alone, he had uncovered $750 million in bad loans that had been deemed good. Though large northern cities, the two account for just a small fraction of nationwide loans.
The risk adviser wrote to his superiors, including the chairman at the time, Zhang Enzhao, that many nonperforming loans were being hidden in the “special mention loan” category. According to Fitch Ratings, at the end of 2005, nearly 12 percent of the bank’s loans were in that category.
Mr. Zhang, though, resigned in March 2005, after a lawsuit filed in the United States accused him of accepting a $1 million bribe from an American company doing business in China. He was in time replaced by Guo Shuqing, a well-regarded former official of the central bank, who pushed China Construction to go forward with a public listing. (Mr. Zhang recently was sentenced to 15 years in prison for accepting bribes.)
The risk adviser persisted. China Construction officials recently acknowledged that months before the bank’s public offering, he sent letters or e-mail messages to the new chairman, Mr. Guo, as well as the bank’s president and other executives. In that correspondence, he told them that the bank was hiding some of its bad assets.
The red flags were raised at a critical time, because unanticipated bad news could have resulted in a delay in the offering. The bank went ahead, maintaining that after an audit by KPMG there were no undisclosed problems in its loan books. After the stock offering, the bank says the risk adviser continued to press for the problems to be fixed.
Another senior official at the China Construction Bank, who spoke on the condition that he not be named for fear of reprisals, said that internal risk controls were inadequate and that the outside auditors from KPMG often battled with bank officials over bad-loan assessments.
China Construction Bank officials say that even the suggestion there were hidden loans is preposterous.
“Hidden bad loan information does not exist at C.C.B.,” a spokesman said. The bank added that in August 2004, a team of internal investigators looked into some of the risk adviser’s assertions and found no evidence there were “mischaracterized loans” on the books.
In a statement issued in response to questions, China Construction said, “Our bank’s management and responsible persons in our risk management department conducted a diligent discussion and evaluation of the issues he raised, concluding that he had not provided any valuable evidence and that his reasoning was simplistic and arbitrary, with some things clearly contrary to common sense, and therefore it did not have a minimal level of persuasiveness.”
The bank cited several letters from the risk adviser, reading them aloud or making reference to them in an interview at its Beijing headquarters several weeks ago. Bank officials said that even though the risk adviser was one of the institution’s top-ranking risk officials, he was unqualified to assess its loan portfolio.
Moreover, it questioned his motives. In one letter the bank released in part, the adviser told the bank in August 2005 that it had three choices: to give him a new assignment, fire him with a severance package or, if it refused either of those two, he would ask his New York lawyer, among other things, to reveal information about the bank — “especially about several key risk management department executives,” who, he said, “manipulated C.C.B.’s bad loan ratio.”
In July, the risk adviser was fired, the bank said, for forging his sick-leave papers.
No one outside the China Construction Bank was told about the accusations until July, when officials at Bank of America — which paid $3 billion in 2005 to acquire a 9 percent stake that is now worth more than $9 billion — say they received a letter from the former adviser detailing some of his findings and arguments that the bank was manipulating its figures.
They rejected the accusations as “unlikely” after interviewing the adviser by telephone and then holding discussions with China Construction officials.
Bank of America, based in Charlotte, N.C., said in a statement: “KPMG, the bank’s outside auditor, and the global underwriters of C.C.B.’s initial public offering conducted extensive reviews of C.C.B.’s loan portfolio prior to the I.P.O. last October. Based on our knowledge of those exhaustive efforts, and our own due diligence prior to our initial investment, we thought it unlikely these allegations were true.”
Still, Bank of America officials say they passed on the letter containing the accusations to board members of China Construction Bank. A KPMG official in Beijing declined comment.
China Construction Bank officials say the company’s loan portfolio is in good shape, that top auditors now regularly peruse the loan books and new risk-management procedures have been put in place.
All these help explain, they say, why the company’s shares have risen sharply since it went public.
I think that you vastly overestimate the amount of leverage that the Chinese government has over BOA. BOA could have allowed itself to be outbid by another suitor and walked away. The threat of being barred from China is not much of a threat if you think that there are still some systemic problems in the banking system that you don't know about.
In particular, there is a lock in period before BOA can cash out of the CCB deal. If BOA thinks that there is a major problem that will cause it to lose money before the lock-in period ends, it makes no sense to go forward with the deal.
Finally the NYT article is very confused in its accounting. The 7.5 percent bad loan ratio is largely concentrated in the Agricultural Bank of China. The $400B number from Fitch doesn't contradict the $163B from the Chinese government since the Fitch number counts about $250B in rural credit cooperatives and loans that have been moved to the asset management companies. The $163B number from the Chinese government counts only bad loans in the big four, and those are almost all in ABC.
There is also the strong temptation here to assume "good whistleblower versus evil corporate managers" but that's not necessarily always the case. The possibility exists that BOA and CCB looked into the risk managers position and correctly concluded that they were incorrect.
Prof. Shih, your comment?
Either way, thanks!