By Clare Baldwin and Nishant Kumar
HONG KONG, July 12 The Ping An Insurance Group Co of China Ltd has, for years, been the country's financial industry darling.
With close ties to the top of the ruling Communist Party, it has grown into a financial services giant with a market capitalization of $48.5 billion, thanks in part to an aggressive push into banking.
But a government crackdown on risky lending has left Ping An's banking arm exposed to the turmoil roiling China's markets, and threatens to create a financial headache for Beijing.
The pressure building on Ping An Bank is the starkest sign yet that the punishment meted out by Chinese policymakers to lenders relying too heavily on interbank funding is rippling wider, threatening larger, systemically-important institutions.
It is also sending ripples internationally. Charoen Pokphand Group, controlled by Thai billionaire Dhanin Chearavanont, is sitting on a $1.8 billion paper loss on its $9.4 billion investment in Ping An, a deal partly financed by UBS AG .
If China's financial markets continue to wobble, Ping An Bank would likely have to write down assets and both the bank and life insurance businesses would need to be recapitalised by about $20 billion to keep them above solvency minimums - more if Ping An raises its stake in Ping An Bank - said Thomas Monaco, a managing director at Hong Kong-based research firm Forensic Asia Ltd.
"In the case of Ping An you have a fundamental breakdown in all of their major businesses," said Monaco, who has a "sell" rating on the stock.
Ping An raised $2.5 billion through a private placement in Hong Kong in 2011. It got the go-ahead from the China Securities Regulatory Commission in March to issue 26 billion yuan ($4.24 billion) worth of convertible bonds.
China's central bank briefly allowed short-term interbank rates to surge last month - sending a blunt signal of its determination to rein in risky lending that left the financial sector reeling.
Ping An's shares have fallen about 20 percent this year and, in a more ominous sign of trouble ahead, short-sellers have piled into its Hong Kong listed shares.
It is now the third most-borrowed stock in the Hang Seng Index - a measure of interest from "shorts" who sell borrowed stock hoping to profit from buying it back cheaper later - according to data from Markit. As much as 39 percent of the Ping An shares that could be borrowed were out on loan on July 10, up from about 4 percent in February.
Privately run Ping An is China's second-largest insurer. It also has a bank subsidiary and a brokerage arm. In addition, Ping An owns one of China's 66 trust companies, which buy loans from banks and package them into investment products.
Ping An Bank accounts for only about 11 percent of the Group's net fees and commission income, but its aggressive tactics have left its parent company exposed in Beijing's crackdown.
With one of the smaller branch networks in China - 450 branches in 33 major cities - Ping An has turned to shorter-term and more volatile wealth management and trust products to attract depositors. Such products, along with acceptances, letters of credit and guarantees, accounted for about a third of the bank's outstanding credit at the end of last year, according to a June analysis by Fitch Ratings.
Even so, Ping An Bank still has one of the higher loan-to-deposit ratios in China, and a high overall cost of deposits, meaning any upset in the market could squeeze the bank's available cash.
Fitch calculates that 75 percent of Ping An Bank's loans must be repaid in order to meet short-term cash outflows, and that it is the least prepared to cope with credit deterioration.
One measure of the difficulty Ping An Bank has in generating cash from its banking business is its net interest margin, a metric used to assess how successful a lender is at generating income compared with its cost of funding.
Ping An Bank's net interest margin fell to 2.37 percent last year, below the China bank median of 3.4 percent. Ping An said this was due to the central bank's lower interest rate policy and to more interbank business.
Ping An Bank's bad loans more than doubled last year.
The bad loans were concentrated in eastern China, and were fully manifested last year, Daphne Chan, an external spokeswoman for Ping An, told Reuters in an e-mail. She said that most of the loans were secured and collateralised, adding that Ping An Bank was relatively healthy and had very few assets that needed to be written down.
She said that, while the bank's capital adequacy ratios were in compliance with relevant regulations, Ping An had plans to raise additional capital to shore them up.
"We have formulated a series of plans to enhance our capital adequacy, including a 20 billion yuan private placement and a 50 billion yuan subordinated term debt," Chan said.
Ping An's conglomerate model and exposure to banking is unique among Chinese insurers, and can be traced back to its close ties with the Communist Party, which helped it avoid being broken up in the wake of the Asian financial crisis.
Its core insurance business is still performing well, although its investment portfolio has suffered due to volatile equity markets.
Ping An's trust, the fourth-biggest in China, showed a 43 percent increase in net profit last year.
But such trust companies are also part of the vast "shadow banking" system that Beijing is taking aim at in order to control credit growth, and the crackdown is expected to force trusts to pare back their business.
"In our view, Ping An is still the best-run insurance company in China," Morgan Stanley insurance analyst Ben Lin wrote in a research report earlier this week, rating the stock as an "overweight," a rating usually interpreted as a "buy".
"However, concerns about the bank and trust operations could continue to weigh on the stock," he said.