Global Banks Are 'Divorcing' China

HSBC Group is expected in the next few months to sell its 8.0% stake in the Bank of Shanghai.  The financial services giant could receive as much as $800 million from its shares in the second-tier Chinese lender. 

Why do analysts think HSBC will unload its holding soon?  It looks like the Bank of Shanghai is set to raise $2 billion by selling newly issued stock, on the Shanghai and Hong Kong exchanges, with a value of up to 30% of its existing shares.  The listing could occur before June, so HSBC will have to act now if it does not want to be trapped by a lock-up period, typically imposed on existing shareholders for periods of up to a year.

Two years ago, nobody thought HSBC would ever dispose of major Chinese assets.  Now, there is talk it might get rid of all of them. 

Analysts sense a change in sentiment because HSBC is already dumping Chinese assets.  This year it completed the sale of its 15.6% interest in Ping An to Thai conglomerate Charoen Pokphand Group for $9.4 billion.  Previously, the shares in China’s second-largest life insurance company had been described as “strategic.”  Then, there are rumors that the institution, once known as the Hongkong and Shanghai Bank, will also sell its half interest in HSBC Life Insurance, which laid off 130 sales staff recently.

The investment community is even talking about a once-unthinkable event, the disposal of HSBC’s 18.7% holding in Bank of Communications .  John Bond, when he headed HSBC, wanted to increase the stake in Bocom, as China’s fifth-largest lender is known, and eventually control it.  Today, however, HSBC looks like it will never achieve management control.

The dominant view is that HSBC will be content to continue holding its Bocom stake because, as one unnamed Shanghai analyst told the South China Morning Post, a sale would mean “HSBC’s China story will be over.”   That analyst may think it is inconceivable that any major bank would ever exit China, but the country is no longer that important to the world’s financial community.

In fact, it looks as if HSBC will have to work hard to find another bank to take its Bank of Shanghai shares.  The fact that it could not find a financial institution to buy its Ping An stake is a sign that, in general, foreign bankers are “divorcing” China, as South China Morning Post columnist Doug Young recently put it.

The reason for the unhappiness is clear.  HSBC, for instance, sold Ping An because it was unable to get “strategic returns” from the insurance company.

HSBC is not the only institution to feel this way.  Analysts think Bank of America sold the bulk of its remaining China Construction Bank holding in 2011 and Goldman Sachs unloaded another tranche of shares in the Industrial and Commercial Bank of China this January because, like HSBC, they were frustrated that their large stakes weren’t helping them further their China businesses.  Chinese banks simply do not believe that they need enduring relations with foreign counterparts, which are now getting impatient.

This is a good time for foreign banks to pull the trigger.  For one thing, foreign institutions have been bailing out of China with big profits.  HSBC, for example, announced it would record an after-tax gain of $2.6 billion from its disposal of Ping An. 

Furthermore, prospects for the Chinese banking sector are not especially bright.  Profits at the big banks fell last year, and, as the International Business Times reports, profitability is on a long-term downward trend. 

Most important, there are growing concerns that Chinese banks are perched at the edge of a cliff.  They have been hiding substantial liabilities through various means, including moving unwanted assets off their books into “wealth management products”—high-yielding investments offered by technically unrelated pools—while nonetheless retaining risk of loss.  The China Banking Regulatory Commission, to its credit, issued regulations at the end of last month to force banks to rein in the shadowy products, but as a practical matter the rules only begin to address systemic problems. 

The infamous wealth management products, unfortunately, are not the only problem that could sink Chinese banks.  In fact, Standard & Poor’s, at the end of March, said it thinks bank exposure to local governments and shaky developers is a bigger issue. 

No one knows the full extent of China’s non-performing loan problem, but it is not a good sign that Beijing’s regulators are issuing warnings.  On Friday, the CBRC announced there had been an unspecified increase in bad loans in the first quarter of this year.  Presumably, the official non-performing loan ratio for Q1, when it is finally released, will exceed the 0.95% year-end 2012 figure.

Nonetheless, do not expect the new number to fully account for problem loans.  China’s faltering recovery is primarily the result of debt-fueled investment in unviable projects, such as “ghost cities,” and the banks will eventually be forced, one way or another, to bear inevitable losses.

In the absence of real non-performing loan numbers, we should not be surprised that foreign institutions have been selling down their positions in Chinese banks.  And the process will undoubtedly continue.  Doug Young, the columnist, implies a disappointed Citigroup could be the next big institution to unload once-coveted China holdings. 

So how bad is the situation?  HSBC is selling Chinese assets to raise capital to grow its business in .  .  . Europe.

Follow me on Twitter @GordonGChang