Bloomberg News

China Banks Seen Extending Slump on Investor Stake Sales

July 13, 2011

(Adds audit office’s debt estimate in 27th paragraph.)

July 14 (Bloomberg) -- Chinese banks, the cheapest among major emerging markets’ lenders, may drop lower as overseas banks and funds trim stakes to meet capital rules and curb risks amid concerns that the nation’s record credit boom will unravel.

The country’s five biggest banks trade at an average 7.7 times forecast earnings, according to data compiled by Bloomberg. That compares with 8.09 for Brazil’s largest banks, 8.11 for Russia and 14.8 for India. Standard Chartered Plc and Qatar’s sovereign fund are among investors that will be allowed to sell their holdings in the banks starting July 16.

The three biggest Chinese banks posted their worst quarterly stock performance in 2 ½ years on concern that local governments may default on loans. The lenders’ credit outlook may sour in the absence of a government plan to deal with the issue, Moody’s Investors Service said this month, while regulators globally are demanding banks increase buffers.

“You will certainly see share sales by some of these cornerstone investors,” said Sandy Mehta, chief executive officer for Hong Kong-based Value Investment Principals Ltd. “The U.S. and European financial companies obviously need capital for themselves. And there are more distressed opportunities in financial sectors” elsewhere, he said.

A 12-month lockup period on 22 percent of Agricultural Bank of China Ltd.’s Hong Kong-listed shares, valued at about HK$27 billion ($3.5 billion) and held by Qatar Investment Authority, will expire July 16, the Beijing-based bank’s filings show. Restrictions on 4 percent held by Standard Chartered also end that day, a year after China’s third-largest lender by market value made its trading debut.

Continuing Ties

Limits on most of Bank of America’s 10.2 percent stake in China Construction Bank Corp., worth $20 billion, will be lifted Aug. 29, according to the Chinese bank, which is the world’s second-largest lender by market value.

“We remain a significant shareholder in China Construction Bank and we intend to continue the important long-term strategic alliance with CCB originally entered into in 2005,” said Bank of America spokesman Jerry Dubrowski.

A spokesman for Qatar’s sovereign fund declined to comment, and said he can’t be identified due to company policy.

Deutsche Bank AG, which owns 20 percent of Huaxia Bank Co., a stake worth $2.35 billion, according to data compiled by Bloomberg, was freed to sell about 8.6 percent of the Chinese lender this year and can divest another 3.9 percent from October.

“Deutsche Bank is fully committed to the development of its business in China and partnership with Huaxia Bank,” Michael West, the German bank’s Hong Kong spokesman, said in an e-mail without elaborating. Deutsche Bank will be free to sell its remaining Huaxia shares from April 2016, the Beijing-based lender’s filings show.

‘Solvency Problems’

Foreign investors including Bank of America, New York-based Goldman Sachs Group Inc. and Royal Bank of Scotland Group Plc in Edinburgh have trimmed more than $22 billion of holdings in Chinese lenders since the start of 2009, according to data compiled by Bloomberg.

Most recently, Temasek Holdings Pte raised $3.63 billion selling almost a tenth of its stake in Construction Bank and about half of its shares in Bank of China Ltd. on July 5. That was hours after Moody’s said the credit outlook for Chinese lenders may sour, and sparked a more than 3 percent drop in the two lenders’ Hong Kong shares the next day.

Temasek’s Stakes

“Investors’ sentiments have turned more negative this month because of the issue of the local government debt,” said Stanley Li, an analyst at Mirae Asset Securities (HK) Ltd. in Hong Kong. “There’s also evidence suggesting that some local governments could have solvency problems. Together with the Temasek sell-down news, sentiment on the Chinese banking sector as a whole has become more gloomy.”

The sales still leave Singapore’s state-owned investment company with a $12 billion stake in Construction Bank, based on yesterday’s closing price, and about $2.5 billion invested in Bank of China, the nation’s third-largest lender by assets. It also holds a stake worth about $250 million in Agricultural Bank, according to Bloomberg data.

“Temasek maintains its long-term positive outlook on Chinese banks,” the fund company said in an e-mailed response to queries yesterday, without commenting on specifics.

Bank of America, the biggest U.S. lender by assets, may sell some of the Construction Bank stake it began accruing before the Chinese lender’s October 2005 initial public offering, three people briefed on the plans said last month. The Charlotte, North Carolina-based lender was the second-biggest shareholder in Construction Bank at year end, with Temasek the third largest, according to Bloomberg data.

Depressed Shares

“It isn’t very rational for these investors to sell at a time when the Chinese banking sector is surrounded by short-term issues,” said Victoria Mio, a Hong Kong-based portfolio manager at Robeco Hong Kong Ltd., whose parent oversees $200 billion in assets globally. “Their valuation is really depressed.”

Still, Construction Bank shares had more than doubled and Bank of China’s gains had surpassed 30 percent since Temasek bought the stakes before their IPOs more than five years ago.

Standard Chartered said it doesn’t plan to sell its stake in Agricultural Bank when the last of the restrictions for holders of Hong Kong-listed shares expire this week.

“We are very pleased to be a cornerstone investor in the bank and seeing good progress in developing business opportunities through our strategic partnership with them,” Gabriel Kwan, a spokeswoman for the London-based lender in Hong Kong, said in an e-mailed response to questions.

Fourfold Returns

Goldman Sachs continues to hold shares worth $7.33 billion in Industrial & Commercial Bank of China Ltd., the world’s biggest lender by market value, since an agreement barring the U.S. bank from selling them expired in April 2010, according to the Chinese lender’s annual report. The $4.25 billion already raised by Goldman Sachs and its affiliates from selling some ICBC shares was more than four times what it paid.

David Wells, a spokesman for Goldman Sachs in New York, declined to comment on the firm’s plans for its stake in ICBC.

HSBC Holdings Plc owned 10.5 billion shares in Bank of Communications Co. as of Dec. 31, accounting for a 19 percent stake, with no restrictions on when it can exit, according to the Shanghai-based lender’s annual report. The London-based lender has no plans to change its holdings, Gareth Hewett, a spokesman in Hong Kong, said yesterday.

Bad Debts

Selling equity may become more attractive for some investors as a record $2.7 trillion two-year credit boom that allowed China to lead the global economic recovery threatens to trigger defaults. The lending spree, which included loans to local governments and counties to finance infrastructure projects, left the nation with 51.4 trillion yuan ($7.9 trillion) in outstanding loans by the end of 2010, exceeding the combined size of China and India’s economies.

“You always suspect that part of this lending has gone into projects with little to no returns, and that these loans will become bad debts at some point. We are getting to that stage,” said Lee King Fuei, a Singapore-based fund manager at Schroders Plc, which oversaw $323 billion as of March 31. “If all these bad debts actually come through at the same time when the domestic economy in China slows down, I think this will increase the selling pressure.”

Inadequate Information

China’s national auditor last month underestimated the size of local-government loans that could become problematic, Moody’s said July 4. About 8 percent to 12 percent of loans made by Chinese banks may become delinquent or could have low prospects of being repaid, the ratings company estimated.

China can contain the risk from loans to local governments, the central bank said on July 11. The National Audit Office, which reported last month that local governments had about $1.7 trillion in liabilities including $1.3 trillion owed to banks, this week denied understating the debt.

“The transparency on local government bank loans is not enough,” May Yan, a Hong Kong-based analyst at Barclays Capital, said by telephone on July 7. “We don’t know the local government loan portfolio of each bank: When there is inadequate information, the market tends to be pessimistic.”

The Hang Seng Finance Index, which tracks 12 stocks listed in Hong Kong including ICBC, Construction Bank and HSBC, is the worst performer among industry groups tracked by the city’s benchmark equity index this year.

Stocks ‘Oversold’

The slump in shares has forced at least one lender to delay fund-raising plans. China Everbright Bank Co., based in Beijing, last month deferred the start of a $6 billion Hong Kong share sale because of weak markets, two people with knowledge of the deal said at that time. The lender, which is listed in Shanghai, was scheduled to start the roadshow June 27.

Still, Chinese banking shares may rebound when the lenders report first-half profits next month and demonstrate that their “earnings power remains solid,” Robeco’s Mio said. Net income in the six months ended June 30 probably climbed 45 percent, Agricultural Bank reported on July 12, citing a preliminary review.

The banks “have built in enough provisions to absorb a lot of the potential non-performing loans,” Mio said. “There is no need to be more bearish. Chinese banking stocks are oversold right now.”

--With assistance from Sanat Vallikappen in Singapore, Eva Woo in Beijing, Arif Sharif in Dubai and Hugh Son and Christine Harper in New York. Editors: Chitra Somayaji, Russell Ward

To contact the reporter on this story: Stephanie Tong in Hong Kong at stong17@bloomberg.net

To contact the editor responsible for this story: Chitra Somayaji at csomayaji@bloomberg.net


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