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Minsheng Bank tells the story of Beijing's credit worries

A woman walks along a footpath towards a China Minsheng Bank automatic teller machine (ATM) in central Beijing March 30, 2012. REUTERS/David
A woman walks along a footpath towards a China Minsheng Bank automatic teller machine (ATM) in central Beijing March 30, 2012. REUTERS/David

By Lawrence White and Michael Flaherty

HONG KONG (Reuters) - The funding crunch prompted by China's central bank was meant to teach a lesson to the Chinese banks that continue to embrace risky lending tactics.

A look at the funding and loan figures at mid-sized lender China Minsheng Banking Corp. <600016.SS> helps explain why the People's Bank of China (PBOC) made its move.

The PBOC's refusal to inject cash into the money market system last week caused a spike in inter-bank lending rates. Suddenly, banks used to borrowing at 3 percent saw the rate at which their peers would lend to them jump as high as 25 percent.

The move, which came as an economic slowdown weighs heavy on China's financial system, sent a clear and painful message to banks overly-reliant on short term funding: clean up your act.

Over the last few years, Minsheng has tapped several lending methods to try and bolster its returns, including heavy usage of something called a reverse repo, which allows a bank to mask the amount of money it is putting at risk.

The bank nearly doubled the amount of high-yield investment vehicles it sells, known in the industry as "wealth management products". Minsheng's borrowing has prompted concern from analysts, and illustrates the type of banking behavior the PBOC is trying to stamp out.

"Its business model in recent years of leveraging up the balance sheet with interbank transactions has run its course and is now at risk of unwinding," Citigroup said on Wednesday in a research note on Minsheng.

Minsheng's lending figures reveal a heavy percentage of loans needing to be repaid to meet short-term cash outflows -- around 40 percent by one estimate, compared with zero for some of China's biggest lenders.

Investors have been quick to punish Minsheng, whose Shanghai-listed shares have dropped 16.7 pct, wiping out $6 billion worth in market value, since last Wednesday.

Some analysts think that sell-off has been overblown.

Investment bank Jefferies, which has a "buy" rating on the stock, said in a research note on Wednesday that the bank's supporters feel that management are risk takers who can manage risks. " is not for the faint of heart, but we see reward outweighing risk," the note said.

Minsheng itself said on Wednesday that the spike in the Shanghai interbank offered rate (Shibor) had not disrupted its operations and it was confident it could control credit risks despite a slowing economy. In a filing to the Hong Kong stock exchange on Tuesday, the bank said it told a conference call with investors that its asset quality was under control.

SELLING SHORT

Short sellers are betting on a further drop in Minsheng's shares. As much as 61.8 percent of Minsheng's Hong Kong stock that can be borrowed -- a measure of interest from short sellers -- was out on loan on June 25, according to data provider Markit, compared with a market average of around 15.3 percent.

Minsheng, the country's ninth-largest bank by assets and the only private bank among the country's 10 largest commercial lenders, debuted on the Hong Kong stock exchange in 2009.

At the time, Beijing was forcing banks to pump loans into the market to help companies ride out a downturn caused by the global financial crisis.

The stimulus spending pushed up inflation, prompting an order from Beijing to pull back on loans beginning around 2010. The consequence was that banks started looking for new lending mechanisms, while customers sought products that promised a better return than a state-mandated 3 percent interest rate.

With a market value of around $36 billion, Minsheng is considered mid-sized by China's standards. It is one of the thousands of small to medium sized lenders across China that seek to lend to the legions of Chinese companies operating inside the country.

To offer such loans, banks can get money in a number of ways: collecting deposits from customers; borrowing from other banks; issuing bonds and issuing equity.

At the end of 2012, Minsheng's interbank funding of less than one-year accounted for 29 percent of its non-equity liabilities, the highest among the Chinese banks that Bernstein Research covers.

In other words, nearly one-third of its money comes from short-term borrowing from other banks, which is both risky and expensive.

FEAR THE REPO

Another concern surrounding Minsheng is its use of a lending tactic called the reverse repo.

The popular structure allows banks to lend to a company, which provides discounted bills as collateral to a third party bank acting as a guarantor.

Because the lending bank's exposure is to that guarantor bank rather than the borrower, the lender can classify the transaction as "interbank business". That kind of transaction comes with a 20-25 percent risk weighting on a bank's balance sheet, instead of the full 100 percent weighting for straight loans.

The smaller risk weighting is critical because only loans with full risk weighting - such as a straight, bank to borrower loan -- count toward Beijing's mandated 75 percent loan-to-deposit ratio that limits how much banks may lend.

Therefore, the reverse repo allows a bank to disguise a full loan as a partial loan, pushing its effective loan-to-deposit ratio well above the state-mandated level.

Minsheng's use of the device increased 376 percent in 2012, Barclays said on June 21. Barclays said in the note that at 23 percent of assets, Minsheng has the second highest exposure to reverse repos of the China banks it covers.

While reverse repo business is legal, China's banking regulator is clamping down on the practice.

"Since 2010 we have seen very aggressive growth in interbank borrowing, of which repo is a part, and this increases the contagion risks from smaller banks," said Qiang Liao, of ratings agency Standard & Poor's.

WMP PROLIFERATION

Another big worry looming in China's banking system, and one of the reasons for the PBOC's actions last week, is the proliferation of wealth management products (WMPs).

Such vehicles packaged assets, offering a 4 percent to 5 percent return over a short-term duration.

As the products grew to around $1 trillion in circulation, the central bank began to fret that some were impossible to track, while others promised double digit returns through sketchy investments.

Other worries -- including product defaults -- surfaced, prompting regulatory action that failed to quell the growth [ID:nL3N0CJ7CR].

Furthermore, banks were using short-term cash to help manage payouts of the products, creating a dangerous mis-match of short and long-term liabilities.

The sales volume of new WMPs launched by Minsheng in 2012 grew 43 percent to more than 1 trillion yuan ($162.73 billion), according to the bank's annual report.

Some 40 percent of the bank's loans must be repaid on time for it to meet short-term cash outflows, according to Charlene Chu, senior director at Fitch Ratings. That compares to zero at three of China's biggest banks, Chu's report said.

($1 = 6.1451 Chinese yuan)

(Additional reporting by Nishant Kumar and Heng Xie; Editing by Alex Richardson)

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