China might keep the weakest bank all to itself

September 30, 2009

Faced with a backlash against foreign investors, Beijing may
be tempted to offer shares in the last of its big four banks to
a domestic audience.

That decision may reflect China’s new found confidence in
the wake of the credit crisis. But it also means Chinese investors
will retain full responsibility for the country’s weakest bank.

The Agricultural Bank of China might end up just listing in
Shanghai without any endorsement from foreign institutions,
bankers close to the deal say. The bank claims it is still
keeping its options open.

But if AgBank pursues this path, it would be in sharp contrast
to the privatisation of China’s three other large banks, all of
which attracted foreign strategic investors before listing in
both Hong Kong and Shanghai.

There are three explanations for this change of direction.
First, China has become a lot more confident in its banks, which
have weathered the financial storm better than their foreign

This means it has less need for foreign banks to
provide a seal of approval before launching a public offering.
China’s Social Security fund is expected to be AgBank’s only
strategic investor, though China Life also stands a good
chance of participating, bankers say.

AgBank is probably not happy with the arrangement, as its
chairman has said it wanted to have foreign strategic investors
and failure to attract them will be regarded as a loss of face.
But the post-credit crunch list of qualified foreign investors
with deep pockets and rural banking expertise is very short.

When China formulated its plan for bank reforms at the start
of the century, diversification of the investor base was one of
its key goals. Bringing in strategic — particularly foreign —
investors was seen as beneficial to improving the ownership
structure of the state-owned banks and breaking the “blood ties”
that existed between banks and various government departments.

Foreign investments also helped put a value on the banks’
equity which provided a guide to the flotation price. But
Beijing has rightly become more wary of foreign investors after
supposedly long-term strategic partners such as Royal Bank of
Scotland and Bank of America cashed in their
investments in Chinese banks in order to raise much-needed cash.

After the recent meltdown, the idea that Western
institutions have anything to teach China’s second-largest bank
about risk management also seems fanciful.

But the authorities should not get carried away by the
history of successful IPOs of Chinese banks. AgBank is much
weaker than peers such as ICBC and CCB, whose stock prices
have roughly doubled since they went public three years ago.

The bank only published its first audited annual report this
April. As recently as 2007 it was technically insolvent, with a
non-performing loan ratio of 24 percent, before a $30 billion
capital injection and massive bad debt carve-out.

Agbank’s NPL ratio dropped to a more respectable 4.32
percent by the end of 2008, but is still more than double the
level of other state-owned lenders. Its loan loss reserves as a
proportion of total NPLs was just 63.5 percent, compared with
156 percent for the 12 other listed Chinese banks at the end of
2008, according to Fitch.

Earnings have been under pressure from weak asset
quality and high expenses associated with AgBank’s
massive 24,000-branch network.

Listing in Shanghai does not mean AgBank will have to
compromise on valuation. For dual-listed companies, domestic
shares trade at a 12 percent premium to their Hong Kong
counterparts because there is a lot of money chasing
a limited pool of investments.

By excluding foreign investors, Beijing can boast that it is
keeping all the upside from rural reforms and urbanisation to
itself. But if things do not work out as planned, Chinese investors
will have to bear all the losses.


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