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Morningstar | Chinese Banks Involved in Investigation on North Korea Sanctions, We Retain our FVEs at this Stage

On Tuesday, the media reported that Shanghai Pudong Development Bank, along with China Merchants Bank, or CMB, and Bank of Communications, or BOCOM, were found in contempt for refusing to comply with subpoenas in a North Korea sanctions violation investigation conducted by a U.S. judge. The H-Shares of CMB and BOCOM declined by 7.7% and 3.7%, respectively, though both companies officially denied involvement in any investigations related to possible violations of sanctions, and are in compliance with related United Nations resolutions and Chinese laws.

We maintained our fair value estimates for both companies at current stage. Shares are fairly valued, trading at 1.5 times forward price/book for CMB and 0.6 times for BOCOM. We believe the risks are manageable as Chinese banks are primarily domestic operations. Total overseas business merely represents 4% and 10.5% of total assets respectively for CMB and BOCOM, and 3% and 9% of profit before tax, respectively, in 2018. It’s still unknown to us whether such investigation exist and the final outcome is hard to predict, given the potential political intervention from both the U.S. and China governments as the yearlong trade talks are reaching a crucial stage. Even if these two Chinese banks are required to pay fines similar to what HSBC and Standard Chartered did in the past, we estimate limited decline in net profit of 1.5% to 2% for both BOCOM and CMB. Given any potential payment is an one-off event, we believe it is not sufficient to trigger change to our fair value estimates for banks. We will revisit our valuations once further information is disclosed.

From the Chinese banks' official statements released on Tuesday, we suspect these banks may be involved in an investigation where the U.S. courts requested records and customer information connected to the alleged movement of payment in violation of international sanctions on North Korea. The subpoenas were issued in December 2017 as a part of a U.S. investigation related to North Korea sanctions, which has led to the U.S. Treasury Department’s punitive actions on a small Chinese urban commercial bank Bank of Dandong, barring any bank from doing business and conducting transactions with Bank of Dandong. However, the impact on this bank was limited, as the bank’s operations were primarily domestic, similar to most Chinese banks. According to the Bank of Dandong’s financial reports, the bank recorded 19.5% year-on-year growth in total revenue and 7% growth in total assets in 2018. Current financial difficulties faced by the bank was primarily the result of the deteriorating credit profile of the bank’s largest borrower Dandong Port Group which failed to work through the asset restructuring plan amid the troubling Northeastern economy.

U.K. banks such as HSBC and Standard Charted were also fined by U.S authorities for money-laundering in the past. HSBC agreed to pay a record of USD 1.9 billion fines to the U.S. government in 2012 for laundering USD 881 million drug money flowing out of Mexico. Standard Chartered agreed to pay USD 947 million for processing USD 438 million transactions between 2009 and 2014, which violated sanctions against a string of countries including Iran. With the fines determined by the authorities, it is difficult estimate the likely amount. The three Chinese banks are accused of laundering over USD 100 million for North Korea’s sanctioned Foreign Trade Bank, according to media reports and based on similar proportion, we estimate the total fines for three Chinese banks would be about USD 216 million，which represents about 1.9% and 1.6% of 2019 net profits for BOCOM and CMB, respectively.