Vegetable wholesaler Han Chaofeng pulls up outside his local bank branch, parks his three-wheeler truck and uses his postal savings account to send money back to his family in a rural part of Anhui province, some 170 miles away.
“If I want to transfer money to their accounts, they don’t have to walk miles to a bigger town to withdraw it,” says Han who has been using his account at the Postal Savings Bank of China (PSBC) since he moved to the more prosperous Zhejiang province for work in 2011.
Han is one of China’s 278 million migrant workers, many of whom rely on the world’s biggest bank by number of branches to transfer money, borrow working capital for small businesses and to buy insurance.
As PSBC prepares for its $7 billion to $8 billion initial public offering in Hong Kong this year, likely in the third or fourth financial quarter, the challenges for its management are manifold, including attracting mainland investors while China is tightly regulating money flowing offshore. One option people familiar with the matter say is a dual-currency IPO in Hong Kong.
The main challenge is explaining to investors PSBC’s role in Chinese society, which is mainly to help people like Han access financial services and provide liquidity in the country’s financial system with its Rmb7.3 trillion ($1.13 trillion) of assets.
“Can global capital get comfortable around the reach of China Postal? China Postal represents wildly different ways of life and ways to access money,” said one person working on the IPO.
They also have to overcome investors’ doubts about a state-controlled bank’s ability to lend to myriad small businesses in a profitable way and resist political pressure to act as the nation’s piggy bank in times of economic or financial stress.
China needs to get this IPO right. This partial privatisation is a high-profile example of the country’s drive to use private capital to help boost flagging economic growth in the world’s second largest economy.
Also, if PSBC flourishes it has the potential to considerably narrow the gaping wealth divide between China’s richest people, mostly living in urban areas, and its rural poor. China’s wealth gap is wider than the most recent readings for the US and Germany, according to China’s official statistics bureau and the World Bank.
“Helping the poor become middle class, that is the significance of this transaction,” Jin-Yong Cai, the former head of the World Bank’s investment arm, the International Finance Corporation, told FinanceAsia in an interview. IFC invested in PSBC under his leadership.
Social stability is becoming an increasing challenge for the Beijing government as economic growth slows to a forecast 6.5% to 7% this year, one of the lowest rates in 25 years. In industrial areas, workers have rioted to protest steel mill and pit closures.
PSBC plays a unique role in Chinese society due to the spread of its network across the country. It serves nearly 500 million clients, according to its website, more than the population of the United States at 323 million. It reaches them via more than 40,000 outlets across the country according to its website. That makes it the largest bank by number of branches in the world, according to bank data provider SNL.
“Postal Savings Bank has a special purpose in China, collecting deposits from small households and putting them to in the interbank market, and being a liquidity provider in the financial system,” said Cai who is now at private equity firm TPG.
PSBC owes its extensive reach to its parent, China’s postal service. PSBC started weaning itself away from China Postal Group in 2007 but is still reliant on it in many ways. Of PSBC’s 40,000 outlets, 80% are run by the group.
PSBC chairman Li Guohua said in an interview with Chinese financial magazine Caijing in December 2015 that if it did not share resources with the state-owned postal service, China Post Group Corp, it would have to hire an extra 200,000 people to run local branches. PSBC declined to answer questions from FinanceAsia.
Such an extensive network means the potential for scaling up the services it provides to China’s citizens is immense. Its loan-to-deposit ratio is less than 40%, which means it still has plenty of room to expand its balance sheet.
PSBC also has a relatively clean balance sheet compared with its domestic peers, partly due to the short history of the bank. Its non-performing loan ratio was 0.9% of total gross loans as of end 2015, well below the sector’s average 1.7% as of the end of 2015, according to the banking regulator.
People working on its IPO said this was a major selling point to international investors worried about China's economic slowdown. "Investors underweight in Asia want to invest in companies they feel are safe and stable," said one investment banker.
However the relatively young bank needs to cultivate the financial expertise to expand its services.
In a pre-IPO round of financing in December, PSBC secured Rmb45.1 billion ($6.96 billion) for a 16.92% stake from 10 investors including some of the biggest names in finance that also pledged to help it improve and expand its product offerings.
These institutions included IFC, New York-headquartered JP Morgan and e-commerce giant Alibaba.
“Postal Savings Bank in my view has the best network and so the best possibility over time to improve financial inclusion. We can use it almost like a laboratory, working with the government to create the most efficient SME financing and financial inclusion institution. In doing so I believe investors will do well, as the bank will have a more profitable business,” said Cai.
Investment banks Morgan Stanley and CICC arranged the fundraising.
PSBC’s reach and important function as a provider of financial products also poses a question for private investors. How can the bank cut costs if it is providing a social service? China’s postal service historically operated at a loss subsidised by deposits.
The group charged PSBC Rmb50.3 billion in 2014 for operating the branches they share, according to Li in his interview. That’s almost a third of PSBC’s reported revenue for 2014, Rmb50.3 billion.
Chen Pengjun, head of a county-level branch in Zhejiang, told FinanceAsia that a few outlets in remote villages could lose up to Rmb400,000 ($62,000) each every year.
“Some remote outlets are suffering big losses every year. But what can you do? You have to keep running them, as you have to keep providing services for farmers and low-income people,” he said. “It’s part of the government policy.”
In terms of corporate governance; in September 2011 the PSBC chairman began serving as general manager of Postal Group. While the group once provided five of the bank’s seven directors and the Ministry of Finance two, Li said in his interview he was now the only director sent by the group on a board of eight.
“I don’t think its role and position will change much due to a few foreign investors or the IPO. Because of its strong network, it has many special functions that other Chinese commercial banks don’t have,” Wu Xiaoqiu, the director of finance and securities institute at Renmin University, told FinanceAsia on the sidelines of the Boao Forum in Hainan on March 23.
PSBC is looking to raise around $7 billion to $8 billion in its Hong Kong listing, making it potentially the biggest IPO in the world this year.
It has chosen investment banks: Bank of America Merrill Lynch, CICC, Goldman Sachs, JP Morgan and Morgan Stanley to advise on its listing. UBS is financial adviser.
One of the challenges PSBC faces is that tapping onshore money has become more difficult since China has been trying to limit capital flooding out of the country. One of the routes money flowed out of mainland China into Hong Kong IPOs was the Qualified Domestic Institutional Investor (QDII) programme and China earlier this year squeezed supply of products under the scheme. Most banks' quotas have largely been used up helping Chinese companies make investments offshore this year and borrowing other institutions' remaining quota is becoming prohibitively expensive.
One possibility is to tap into the RMB deposits already offshore by launching a dual-currency IPO. People familiar with the matter said that this was one possible scenario but is not yet part of the official execution plan.
To be sure Chinese companies have raised money in offshore bond deals and saved profits from overseas operations and bankers are keen to put this capital to work for them in IPOs such as PSBC's.
Another issue is that the valuations of Chinese banks are under pressure as they are highly leveraged against the slowdown in the Chinese economy. Many of the mainland-headquartered banks listed in Hong Kong trade below their book value, including ICBC and China Construction Bank.
The Hang Seng China H-Financials index, which tracks these banks, is down 39% from its recent high of May 26 last year and is trading at a price-to-book ratio of 0.83% estimated 2016 earnings.
At the same time, state-controlled banks are not allowed to sell stock below their last reported book value as doing so would be politically unpalatable. So if PSBC prices above book value it will look relatively expensive to potential investors.
After a month-long discussion with investors, PSBC set the final price for its pre-IPO fundraising round in December at Rmb3.89 per share, giving PBSC a price-to-book value of about 1.18 times.
Li said in his Caijing interview that the most “tangled” issue during the fundraising was the price setting.
“The more strategic support the investors offer you, the more they will request on the price,” Li said. “We’ve reached an ideal price, but it will pose certain pressure on our IPO price.”