Last week, Industrial & Commercial Bank of China (ICBC) floated its initial public offering. The Chinese bank raised $19.07 billion, making it the biggest IPO in history.
In terms of assets, ICBC is the largest bank in China, so investors fell all over themselves to get a piece of its IPO. Retail demand for the Hong Kong-listed shares were oversubscribed by a factor of 78, while the Shanghai-listed shares had 49 times more orders than shares available.
Of course, we’ve seen a whole string of Chinese bank IPOs recently. Since June 2005, we’ve seen at least four other big ones:
Bank of Communications ($1.6 billion)
China Construction Bank ($8 billion)
Bank of China ($11.2 billion)
China Merchants Bank ($2.6 billion)
With all these new publicly traded banks out there, you’re probably wondering if now’s a good time to jump in. My take might surprise you …
I Wouldn’t Touch a Chinese
Bank with a Ten-Foot Pole
I know it may sound odd coming from an Asia cheerleader like me, but I have real concerns about how Chinese banks operate.
In the U.S., bankers lend money based on credit worthiness, profitability, interest rates, and most importantly … the likelihood of getting paid back.
In China, the loan approval is very different. Loans are political decisions, often based on social goals. Chinese banks have frequently made loans if the projects were going to create jobs.
Profits, let alone payback, aren’t expected. In fact, unprofitable businesses are often kept alive with more loans. Talk about throwing good money after bad!
Eventually, the businesses start to drown in debt and it’s obvious that the loans won’t ever get repaid. In the U.S., these loans are called non-performing loans, or NPLs. The last numbers I saw from the Chinese government estimated that Chinese banks were sitting on NPLs equal to 35% of China’s gross domestic product!
In fact, the mountain of NPLs got so large that the Chinese government had to do something about it … 
Selling Chinese Banks to Stupid
Investors in Three Easy Steps
The solution was obvious, China decided to pass ownership of these troubled banks onto other investors. Here’s how they did it …
Step 1: Wash the books – The Chinese government transfers the bum loans from Chinese banks to “asset management companies.â€
Step 2: Swap paper – These asset management companies buy the bum loans and pay for them with IOUs.
So, the bank gets rid of an NPL and replaces it with an IOU from a state-owned asset management company.
Suddenly, the bank’s books look clean as a whistle!
Step 3: Sell to foreigners – The Chinese government then sold the bank to foreign owners either through private sales or by taking the bank public.
These investors are so eager to jump on anything with Made in China stamped on it that they snap up these white-washed Chinese banks.
The process I just described is exactly how ICBC got where it is today.
First, the company transferred $85 billion in loans to a company named Huarong …
Then, it received $15 billion from Central Huijin Company, a state-owned recapitalization agency …
Last, it sold a 5.8% stake to Goldman Sachs for $3.7 billion.
This little process allowed ICBC to chop its non-performing loan ratio from 21% to 4.1%!
Does any of this mean that ICBC’s stock won’t go higher? No. Over the short term anything can happen.
Over the long-term, however, I expect the financial hanky-panky at ICBC and other publicly-traded Chinese banks to blow up in investors’ faces.
China Is Still Where the Growth Is,
You Just Need to Invest Carefully
Let me clarify: I still believe there are amazing investing opportunities in China and the rest of Asia. In fact, I believe the best opportunities can be found across the Pacific Ocean.
However, just because a company operates over there doesn’t automatically make it a good investment.
I know, I know – the Dow Jones has been on a roll. But China is growing at least five times faster than the U.S.! So every investor should have at least some investments tied to the country.
As I just showed you, the Chinese banks – and their Swiss cheese loan portfolios – are not the way to go. Here are a few better suggestions:
First, there are dozens of high-performing, Asian-focused mutual funds. One of my favorites is U.S. Global China Opportunities (USCOX). I like it because it not only invests in Asia but does so with a strong natural resources emphasis.
Second, you can also invest in exchange-traded funds, such as the Xinhua China 25 Index (NYSE: FXI).
Third, there are a few dozen Chinese stocks that are traded on the New York Stock Exchange as American Depositary Receipts. Two that my Asia Stock Alert subscribers own are China Mobile (CHL) and CNNOC (CEO).
Fourth, many American companies are rapidly expanding their presences in Asia. Restaurant stocks like Starbucks and Yum! Brands can be found on many busy Asian street corners.
And there are also less obvious plays that are doing gangbuster business over there, too. Two examples: Pentair (water pumps) and MEMC Electronic Materials (silicon for solar panels).
There’s still no better time to seek out opportunities in China … you just need to be careful where you look.
Best wishes,
Tony
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