Chinese Banks in Focus; CIC’s Morgan Stanley Stake Sours - China Weekly 08.09

CHINA WEEKLY

Chinese banks dominated headlines last week as stress-tests were performed by the China Banking Regulatory Commission (CBRC). The results showed 20% of all outstanding loans to state-owned companies were in trouble as of the end of June, according to an unidentified CBRC official. The official quoted in the Japanese business newspaper Nikkei said the loans failed to meet lending standards and could results in default, although “the risks are still manageable, and the loans are not seen as non-performing”. The report put the total amount of current loans to state-controlled firms at 7.7 trillion yuan meaning that 1.54 trillion yuan are in the ‘problem’ category. The report followed statistics released by the CBRC, saying non-performing loans at commercial Chinese banks represented 1.3% of the lenders’ total portfolio or 454.91 billion yuan as of the end of June. The CBRC said these figures indicated a 0.28% drop, but it didn’t clarify the comparison period.

Earlier in the week the banking regulator had sought to reassure markets following reports that it had ordered lenders to do stress tests assuming a 60% drop in housing prices, up from a 30% drop. The CBRC said “stress tests are one commonly used method for commercial banks to manage risk, they do not represent possible changes to real-estate policy”, in an attempt to play down the meaning of the tests. The tests also were reportedly widened to include credit risks related to the cement and steel sectors, which are seen as leveraged to the nation’s booming property market. While the market accepted the official comments from the CBRC and helped the Shanghai Composite reverse early losses on Friday to finish 1.4% higher there is underlying concern about the potential fallout that a large decline in asset prices could have on the banking sector.

Elsewhere in the banking sector, some banks in Beijing and Shanghai have voluntarily stopped issuing mortgages for purchases of third homes the Shanghai Securities News reported, citing industry sources. Banks were permitted to cease these activities in Beijing already since mid-April. The ICBC and AgBank have stopped issuing mortgages now in Shanghai too and other banks in the two cities are expected to follow suit in the coming days. Xia Bin, an advisor to the PBoC was quoted as saying the government’s policies on the property market announced in the first half of 2010 shouldn’t be changed as they are preventing overly fast price rises in parts of the country.

Moving away from the banks property related concerns but remaining in the sector, the China Investment Corp. (CIC) is faced with a sizeable dilemma regarding its $5.6 billion stake in Morgan Stanley. For more than two years, quarterly dividends rolled into the CIC coffers at a healthy rate of around 9% a year, a pleasant payoff for the Chinese sovereign wealth fund’s stake which was purchased in 2007, just months after the CIC was formed. But attached to the deal was a special financing clause that, like a storm cloud, has been steadily growing in risk potential for the CIC. The storm has now arrived. The CIC’s stake is in equity units that must be converted into publicly traded common stock on Aug. 17. The conversion is going to result in a sizeable paper loss for the CIC since the conversion is expected to cost between $48.07 and $57.68 per share at a time when Morgan Stanley stock is hovering around the $27 mark. After the mandatory conversion, CIC’s stake is expected to reach 11.64% or 171.6 million shares, the size of its stake could cause some problems. The US Treasury imposed more stringent regulations on foreign mergers and acquisitions, these rules opened the door for the Committee on Foreign Investment to look closely at certain foreign holdings above 10%, which could potentially include CIC’s stake. This concern factored into the fund’s recent decision to sell large blocks of Morgan Stanley common stock on the secondary market. CIC started selling stock on July 21 to bring the fund’s holdings below 10% and avoid tighter regulatory scrutiny, some 4.5 million shares were sold and according to market filings, CIC sold another 575,000 the following day. A further 14.6 million shares were sold July 27 bringing the CIC stake down to 10.68%. As if this wasn't enough, much to the CIC’s dismay they learned a year after inking their deal, Morgan Stanley had gotten a $9 billion investment from Japanese banking giant Mitsubishi UFJ in October 2008, as the global financial crisis intensified, and Morgan Stanley granted Mitsubishi far more favourable terms than those obtained by CIC. While the CIC is likely to be able to dodge scrutiny from government agencies what was once heralded as an excellent investment has soured considerably for the CIC.

In other news, China’s service sector growth accelerated in July, making the fastest pace of expansion in three months, according to HSBC’s PMI. “This improvement in the July service PMI reading, though modest, reflects the resilience of the domestic part of the economy, in particular consumer-related sectors” said HSBC Chief China economist Qu Hongbin. The rise in the July PMI marks the 20th consecutive month of expansion for the services sector.

Finally, China will boost the number of commercial banks permitted to import and export gold, the nation’s central bank said. The new regulations will broaden the market for such trades beyond the five largest commercial banks and help expand the scope and depth of the gold market in China. Analysts cited in the report said the liberlised trading rules would likely bolster China’s demand for the precious metal.

Written by Jonathan Granby, DailyFX Research Team

If you wish to contact the author with questions or comment, email jgranby@fxcm.com

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