New shareholders to help Bank of Jinzhou handle its NPL burden

China is restructuring Bank of Jinzhou Co Ltd, a troubled city commercial bank, by introducing new investors to deal with its nonperforming loans, improve corporate governance, and prevent the triggering of systemic risk.

The Hong Kong-listed bank announced on Sunday that certain shareholders of the bank transferred part of its domestic shares held by them to ICBC Financial Asset Investment Co Ltd, Cinda Investment Co Ltd and China Great Wall Asset Management Co Ltd.

As of Sunday, the domestic shares of the bank being transferred to ICBC Investment, a wholly owned subsidiary of Industrial and Commercial Bank of China Ltd - the country's largest commercial lender, and Cinda Investment, a subsidiary of China Cinda Asset Management Co Ltd - one of the country's four largest State-owned distressed asset managers, shall represent 10.82 percent and 6.49 percent of the total issued ordinary shares of the bank, respectively, said the announcement.

The number of shares outstanding of the city commercial bank headquartered in Jinzhou, Liaoning province, is 7.78 billion.

China Great Wall AMC also signed share transfer agreements with certain transferors to acquire part of the bank's domestic shares, according to a news release issued by the asset manager on Sunday.

The reorganization of Bank of Jinzhou is another landmark event in the process of supply-side structural reform in the financial sector following the takeover of the distressed Baoshang Bank Co Ltd by the Chinese authorities, said Li Shanshan, Xing Yanran and Lu Yilin, analysts at BOCI Research Ltd, in a report on Monday.

"We think that the government resorted to this approach for two reasons. First, the fundamentals of Bank of Jinzhou should be better than Baoshang Bank. Second, its share structure is much more diversified with the largest shareholder holding less than 5 percent of its shares, so the share transfer will pave the way for the optimization of its ownership structure and corporate governance," said the analysts.

ICBC announced that it intends to spend no more than 3 billion yuan ($435 million), through ICBC Investment, to purchase the shares of Bank of Jinzhou.

"Based on the announcement of ICBC and our estimate, the total price of ICBC's subsidiary to acquire Bank of Jinzhou will be no more than 3.6 yuan per share, corresponding to a price-to-book ratio of about 0.5 in the first half of 2018, similar to the average dynamic P/B ratio of the small - and medium-sized listed banks in Hong Kong," said the analysts.

The premium of the purchase price compared with comparable peers is reasonable considering the transfer of real control, they added.

Bank of Jinzhou sparked market concerns since its auditors resigned in late May. Ernst& Young Hua Ming LLP and EY said in a resignation letter to the bank that there are indicators that some loans to the institutional clients were not used in ways consistent with the purpose stated in the credit document, according to the bank, which delayed its 2018 annual results announcement to the end of August. Its Hong Kong-listed shares have been suspended from trading since April 1.

As of the end of June 2018, its nonperforming loan ratio increased by 22 basis points from the end of 2017 to 1.26 percent. Meanwhile, the provision coverage ratio fell by 26.54 percentage points to 242.1 percent, according to the bank's 2018 interim report.

"The asset quality of Bank of Jinzhou has gone sour. When dealing with the troubled lender, the top priority of regulators is to defuse financial risks by introducing new shareholders who will inject capital into the bank. Next, the new shareholders must strengthen corporate governance of the bank and restructure the risk management function," said Wu Qing, chief economist of China Orient Asset Management Co Ltd.

"China's banking industry is facing a reshuffle. This is even more so for small city commercial lenders and small rural commercial lenders," he said.

The measures to deal with embattled banks will vary from one to another. For banks that are relatively large in terms of total assets and fairly influential to the financial market, regulators are more likely to take over the banks, just like what they did with Baoshang Bank. For banks whose problems are not very serious, regulators may prefer a restructuring. For small banks that have little impact on the financial market, regulators may allow them to go bankrupt, according to Wu.

"The restructuring of Bank of Jinzhou will have much less market impact than the government's takeover of Baoshang Bank. As the market expectations are already formed, the impact will be even less if similar situations occur to more commercial lenders," he said.