FAST CHINESE LOAN GROWTH BUOYS PROVINCIAL BANK'S AMBITIONS

UNCLAS SECTION 01 OF 04 SHANGHAI 000494 SENSITIVE SIPDIS DEPT FOR EAP/CM NSC FOR MEDEIROS, LOI, SHRIER STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/KATZ/MAIN USDOC FOR ITA DAS KASOFF, MELCHER, SZYMANSKI, MAC/OCEA TREASURY FOR OASIA/INA -- DOHNER/HAARSAGER/WINSHIP TREASURY FOR IMFP -- SOBEL/CUSHMAN STATE PASS CEA FOR BLOCK STATE PASS CFTC FOR OIA/GORLICK MANILA FOR ADB USED PARIS FOR US/OECD E.O. 12958: N/A TAGS: ECON EFIN EINV PGOV CH SUBJECT: FAST CHINESE LOAN GROWTH BUOYS PROVINCIAL BANK'S AMBITIONS ¶1. (SBU) Summary: Bank of Jiangsu (BOJS) -- a model for government-led reform of China's municipal-level commercial banks -- appears to be prospering from the current lending boom, and has set its sights on becoming a trans-regional bank. Within Jiangsu Province in East China, BOJS is building a high-profile borrower base among pillar industries such as steel and plate glass, and sees these borrowers poised to seize greater market share as the Central Government attempts to scale back production overcapacity. BOJS is tracking non-performing loans (NPLs),but will not be able to fully determine if there is a rise in its NPL ratio for several years. End Summary. ========== Background ========== ¶2. (SBU) EconOff met on November 25 with Bank of Jiangsu Deputy President Liu Changji. BOJS is a one of new breed of regional banks Central Government authorities hope will mitigate the risks found in single-city commercial banks -- such as overdependence on a few local enterprises -- and bolster services to small- and medium-size enterprises (SMEs). By value of assets, BOJS is currently the 20th largest bank in China, according to a 2009 KPMG study. Liu said that assets reached RMB330 billion (approximately US$48 billion) at the end of the third quarter this year. ¶3. (SBU) Regulators have facilitated the establishment of at least a dozen regional banks over the past few years, generally by merging several city commercial banks -- themselves the successors to the urban credit cooperatives of an earlier era -- into a larger province-wide bank. These are known as regional share-holding commercial banks (difangxing gufenzhi shangye yinhang). BOJS is the largest of these banks not yet listed on China's stock market -- Shanghai Pudong Development Bank and Bank of Beijing are examples of city commercial banks that have already listed. BOJS opened for business in January 2007, formed from the merger of the city commercial banks of the municipalities of Wuxi, Suzhou, Nantong, Changzhou, Huai'an, Xuzhou, Yangzhou, Zhenjiang, Yancheng, and Lianyungang. The Nanjing city commercial bank was not included, because this became the separate Bank of Nanjing, which since has been listed. ================================== A Local Bank Growing Quickly . . . ================================== ¶4. (SBU) Lending by BOJS surged in the first three quarters of 2009 by 40-50 percent, said Liu. This compares with average loan growth of approximately 27 percent since the bank's founding, based on figures from the bank's public accounts. The rapid growth has compelled the bank to replenish its capital by at least RMB5.5 billion (approximately US$806 million) to stay above the China Banking Regulatory Commission's (CBRC's) prudential capital adequacy ratio (CAR) of 10 percent -- once with subordinated debt in August 2008 and twice in 2009, including a private offering of additional equity in July and another subordinated debt offering in October. ¶4. (SBU) Liu said that BOJS's ability to raise capital repeatedly shows the market has faith in the bank's performance. He also put a positive spin on the fast lending growth, pointing out that at its founding the bank planned to double the size of its assets within three years. BOJS passed this milestone in July, he said, and the bank will reach its three-year anniversary in January 2010. (Comment: Nonetheless, SHANGHAI 00000494 002 OF 004 Chinese media reported that the bank fell below the CAR standard in July this year before it went back to the markets, which appeared to raise concerns among regulators and investors over how BOJS is managing its growth. End comment.) ¶5. (SBU) BOJS is now focusing on growth beyond Jiangsu's borders, as one of the first regional banks to be granted a trans-regional banking license by the CBRC. BOJS has two branches outside the province, said Liu, one opened in Shanghai in January 2008 and the second in Shenzhen in May 2009. In mid-2007, BOJS announced its intention to seek a foreign strategic partner, which Chinese banks have traditionally used to signal an improvement in corporate governance, risk control, and competitiveness prior to a stock market listing. =========================================== . . . Thanks to Ties to the Government . . . =========================================== ¶6. (SBU) BOJS maintains close ties with officials in the municipalities that founded the bank, explained Liu, especially with the comparatively wealthy Yangtze River delta cities of Suzhou, Wuxi, and Nantong. The background of the three BOJS vice presidents and of the board of directors illustrates these connections. Liu himself was formerly the president and party secretary of the Nantong City Commercial Bank, as well as having served as a vice president of the Nantong Sub-Branch of the People's Bank of China (PBOC); the two other BOJS vice presidents have the same credentials from Suzhou and Wuxi, respectively. All three also serve on the board of directors. Other directors include an official concurrently serving in both the Wuxi Finance Bureau and the Wuxi Construction and Development Investment Corporation and officials from the Suzhou International Development Group Corporation, the Nantong Chemical and Light Industry Corporation, and the Lianyungang Cotton and Hemp Corporation. ¶7. (SBU) Liu said the PBOC guided the merger process that established BOJS, and that this was financially and administratively supported by the Jiangsu provincial authorities. The province has a continuing direct financial connection to BOJS: according to a statement by the bank's auditors, almost half of BOJS's start-up capital was injected by the Jiangsu International Trust and Investment Corporation (JSITIC),and JSITIC continues to hold a board seat. Other board members include the former head of the Jiangsu Land Tax Bureau and the former party secretary of the Jiangsu branch of the Agricultural Bank of China. In addition, said Liu, BOJS maintains strong ties with local governments because it serves all 52 of Jiangsu's counties. ¶8. (SBU) However, Liu asserted that the large local government presence on BOJ's board and among its shareholders did not necessarily translate into undue influence over BOJS's lending decisions. Even in a small bank, said Liu, the board is not able to interfere too much, due to banks' regulatory responsibilities for prudential lending processes; in a large bank like BOJS, he continued, shareholders have even less control. The bank interaction with shareholders is limited to providing them with a good annual report, said Liu. ==================== . . . And Businesses ==================== ¶9. (SBU) BOJS is increasing its strategic links with local SHANGHAI 00000494 003 OF 004 businesses, said Liu, and Chinese media in recent months have highlighted several deals clinched by BOJS. In April 2009, the bank provided a two-year, RMB3 billion (approximately US$440 million) line of credit to Jiangsu's Shagang Group Company, reportedly China's largest privately held steelmaker. Liu mentioned that Shagang also is one of BOJS's key equity stakeholders, implying that Shagang bought into the bank's July 2009 equity offering. Similarly, when BOJS opened its Shanghai branch, it announced "strategic cooperation agreements" with the major property developer Shanghai Greenland Group and Nanjing's Yurun Group, China's largest meat supplier. Local firms also play a leading role in management: Nanjing-based Huatai Securities, for instance, holds a seat on the board of directors and, according to a leaked report in Chinese media, controls five percent of the bank's equity. Jiangsu Phoenix Publishing House also holds a board seat and, according to the same leaked report, controls another five percent of equity. ¶9. (SBU) Liu was not concerned that a Central Government crackdown on industries with overcapacity would negatively affect BOJS. It is true, said Liu, that many of BOJS's borrowers are in sectors targeted for consolidation, but in the coming shakeout "there will only be loser companies, not loser industries." BOJS's borrowers are strongly competitive, he asserted, citing Shagang, which he said has high profits and low prices internationally, and Yonggang Steel, which he also said is very efficient. (Note: Shagang and Yonggang are located just north of Suzhou and Wuxi. According to press reports, Shagang recently gained control of a significant percentage of Yonggang's production capacity. End note.) Huarun Plate Glass, with a 10 percent market share, is another borrower that will survive the crackdown, said Liu. ¶10. (SBU) Forty to fifty percent of BOJS's equity is currently held by private firms, Liu asserted. Chinese media reported in August 2009 that the equity issued by BOJS to bolster its capital adequacy was targeted at private firms, and noted that, prior to the share issue, 30 percent of BOJS's equity was held by private firms. (Comment: Liu did not specify how a firm is determined to be private; in China this term frequently covers spin-offs of former state-owned enterprises and nominally private firms that, nevertheless, have deep ties to local governments. End comment.) Liu said that 29 percent of BOJ's lending goes to small- and medium-size enterprises, which typically are privately owned. =========================== NPL Risks May Be Increasing =========================== ¶11. (SBU) Liu reported that BOJS bad loans currently account for 1.4 percent of BOJS's lending portfolio, but said he could not be sure if this would trend higher following 2009's lending surge. It will be difficult to know which loans are non-performing for several years, Liu explained: if a loan has not gone bad in three years, it's a good sign; if it is still being repaid on time after five years, it will probably be okay; however, only after eight years will it be clear if a loan will perform as anticipated. To some extent, BOJS's larger size helps provide greater resources to withstand losses from risky lending by the city commercial banks that merged to form BOJS, Liu asserted. Liu said that BOJS treats local government debt as high quality, since in ten years he has not seen a local government default. ¶12. (SBU) Information from BOJS's auditor statements suggests SHANGHAI 00000494 004 OF 004 that the NPL problem could be partially obscured at present. BOJS reports its loan quality according to the CBRC's five-part categorization: normal loans, loans under observation, sub-prime loans, doubtful loans, and NPLs. At the time it was founded, BOJS could claim a two percent NPL ratio, according to an auditor's report. That said, based on EconOff's calculations, BOJS 's losses from NPLs are more likely seven percent and perhaps as high as 25 percent. (Comment: Since Liu appeared to be citing only most restrictive definition of NPLs, current probable losses for BOJS are almost certainly also mounting. End comment.) ¶13. (SBU) The accelerating pace of BOJS's lending in the third quarter raise further concerns about the bank's NPLs: BOJS reported lending growth of 37.5 percent in the first half, which then accelerated to 40-50 percent rate for the first three quarters. Liu admitted that BOJS was currently focused on slowing the growth rate of lending through the end of the year. In late October, CBRC Chairman Liu Mingkang reportedly called in chairpersons of city commercial banks with lending growth above 40 percent to warn against rapid balance sheet expansion. CBRC Chairman Liu at the same time publicly warned that city commercial banks should "not strive for speed, not strive for scale, and not strive for ranking." ======= Comment ======= ¶14. (SBU) In many ways, BOJS shows how a financial institution in this intermediate market niche between the five major Chinese state-owned commercial banks and the smaller city commercial banks can survive and even thrive. However, the BOJS model for Chinese banking reform may be simply enlarging the scale of excessive lending to local enterprises that led to the problems in China's city commercial banks in the first place. BOJS Deputy President Liu clearly emphasized the connections that BOJS is building with Jiangsu's favored pillar industries, appearing confident that Jiangsu firms will win market share despite central edicts to cut back overcapacity. He thereby sidestepped the bigger question of what China -- and the world -- will do as bankers like Liu in each province finance the expansion of manufacturing capacity so that their borrowers become "too big to fail." ¶15. (SBU) Some limits on the BOJS model are also apparent. On the one hand, Central Government regulators are more cautious about new NPL risks building up. BOJS's expansion is also limited by fallout from the global financial crisis, as foreign financial institutions have a decreased appetite for investment abroad and BOJS has not yet linked up with a foreign strategic partner. In addition, the slow pace of initial public offerings on the Shanghai Stock Exchange means BOJS could miss its target of going public within three years. Not being able to access this additional capital and managerial expertise will probably set back BOJS's further expansion plans once the current lending boom ends. BEEDE