Investors Cool to 2 Chinese Bank Offerings

Two Chinese banks that sold nearly $2 billion worth of shares in Hong Kong stock market listings received lukewarm receptions on Wednesday from investors concerned about how China’s financial system will cope with a potential deluge of bad debt that could swamp the country’s economy.

Huishang Bank Corporation, a regional banking group based in eastern Anhui Province, priced its initial public offering at the bottom end of the marketed range on Wednesday, raising 9.2 billion Hong Kong dollars, or $1.19 billion, according to two people with knowledge of the deal, who declined to be identified because the information was not yet public. Also Wednesday, shares of Bank of Chongqing closed slightly down on their first day of trading after the company raised 4.2 billion dollars in a share sale.

Although both banks had boasted net profits that grew at more than 25 percent annually during the past three years, and had reported bad loan levels that were well below the industry average, they were able to list only after pricing their shares at practically no premium to the value of their assets.

That implies investors are skeptical about the quality of the loans on the banks’ books and their ability to increase future profits â€" an extension of a growing wariness toward Chinese banks and a reflection of broad doubts about the health of the country’s financial system.

“There are growing concerns that the government is becoming less tolerant of egregious lending, and that examples may be made among smaller or poorly capitalized lenders,” said Ben Simpfendorfer, an economist and the managing director of Silk Road Associates, a financial consulting firm in Hong Kong. “Those fears may play out across the sector more generally.”

In the five years since the global financial crisis, China’s economic resilience has been driven by a doubling of bank lending and the rapid rise of so-called shadow banking.

Local governments were responsible for much of that borrowing, as they plowed money into hulking infrastructure or pet projects in an attempt to create jobs and increase gross domestic product.

Now, as growth slows and the new leadership in Beijing searches for ways to rein in wasteful investment and reckless lending â€" topics that analysts say are on the agenda of a key Communist Party planning session that begins Saturday â€" some analysts and investors see big trouble ahead, especially for the financial institutions that bankrolled local government spending sprees.

Because local governments in China are banned from taking loans or issuing bonds directly, and cannot guarantee such debt, they have relied on specially created holding companies called financing vehicles. At the end of June, total bank debt accumulated by these local government financing vehicles amounted to 9.7 trillion renminbi, or $1.6 trillion â€" equal to about 13 percent of all bank loans in China, according to a report published this week by Moody’s Investors Service, a credit rating agency.

Moody’s surveyed nearly 400 local government financing vehicles in June, concluding that only 53 percent of them had enough cash available to meet their debt and interest payment obligations in 2013 without resorting to refinancing â€" or taking on new debt to pay off the old. “The standalone financial profiles of many L.G.F.V.’s are very weak,” the ratings agency concluded.

Ted Osborn, a partner at PricewaterhouseCoopers in Hong Kong who specializes in restructuring bad debt, described the problems at small city commercial banks and regional banks as “the biggest issue that China needs to overcome.”

“The big banks will of course always be supported by the government, but if you take a look at these smaller banks, they have lent probably half of that financing to the local government vehicles,” he said Tuesday at a financial forum in Hong Kong organized by the law firm Latham & Watkins and the Asia Securities Industry & Financial Markets Association.

Mr. Osborn cited a side effect of a wide-ranging anticorruption campaign China is conducting at the behest of President Xi Jinping: The many midtier government officials who have been implicated are often the same people who approved and directed the loans to local government projects that are raising concerns among investors.

“If these loans are bad and more loans go bad than expected, these smaller banks don’t have the capital â€" and don’t have the ability to raise capital â€" that the larger banks have,” he said. “That’s where I see a potential crisis growing somewhere down the road.”

Gaining the ability to raise capital is one factor that has driven China’s smaller banks to seek I.P.O.’s. In its filings for its Hong Kong listing, Huishang Bank disclosed that its lending to local government financing vehicles was equal to 10.7 percent of its total assets as of June. For Bank of Chongqing, the figure was 12.9 percent.

Because local governments cannot offer guarantees for such borrowing, the loans are often backed by the projects they are intended to fund. Doubts have been raised about the quality of that collateral and whether it can generate the returns needed to pay back the debt.

As an example of such a project, Mr. Simpfendorfer, of Silk Road Associates, cited an international marathon course that was built by officials in Changde, in the central province of Hunan. The course, which partly surrounds a lake, was paid for in part by the proceeds from a bond that was issued by a local government financing vehicle.

“It is one of those headline-grabbing projects that makes good press,” Mr. Simpfendorfer said, but he added that it appeared unlikely to generate much of a financial return.

Indeed, even the banks making loans to local government entities have raised doubts over the viability of the projects they are ultimately funding, and whether the debts will be repaid.

“Many projects sponsored by local government financing vehicles are carried out primarily for public interest purposes and are not necessarily commercially viable, and therefore, the operating cash flows generated from such projects may not be sufficient to cover the principal and interest on the relevant loans,” Bank of Chongqing said in a risk disclosure in its I.P.O. filing.

“The ability of a local government financing vehicle to repay its loans may depend to a significant extent on its ability to receive financing support from the government, which support may not always be available due to the government’s liquidity, budgeting priorities and other considerations.”