Industrial & Commercial Bank of China IPO

The Chinese bank puzzle

SINCLAIR STEWART AND GEOFFREY YORK




From Saturday's Globe and Mail

POSTED AT 9:51 PM EDT ON 29/09/06


Toronto and Beijing — The world's largest IPO is still a month away, but Ding Qiang is already mapping out his strategy. It's not the money that's the problem — the veteran Beijing stock investor has more than $300,000 (U.S.) of his own cash waiting at the ready — but getting the opportunity to spend all of it.

China has been staging a series of progressively larger initial public offerings for its Big Four banks, and the attendant investor frenzy, some would say madness, is escalating in lockstep, conjuring images of the gold rush spawned by the Internet boom.

Hong Kong bank branches have resembled movie theatres on opening night, with lineups queuing out the door as hopeful investors jockey to buy shares. Such is the unabashed confidence in the prospects for these banks that one woman reportedly plowed three times her annual salary into Bank of China's $11.2-billion offering in June. China Merchants Bank, a smaller player, was so overwhelmed by the response to its $2.4-billion IPO this month that retail orders were oversubscribed by nearly 270 times.

Analysts are predicting this demand will reach even greater heights on Oct. 27, when Industrial & Commercial Bank of China launches what is expected to be a $19-billion IPO of its shares, beating the previous record set by Japan's NTT DoCoMo Inc. in 1998.

The febrile activity is easy enough to understand. The Chinese Economic Miracle is in full swing, and making a bet on the country's major banks is seen as one of the easiest ways to ride the wave. These are the institutions, after all, that are lending money to China's burgeoning industrial base, and that help to finance everything from new home purchases to the country's increasing need for foreign acquisitions. If you believe growth will continue at its double-digit clip, and that the country is serious about its privatization plans, the demand for Chinese banks stocks seems perfectly logical.

Lurking behind this infectious enthusiasm, however, is the bigger question of whether China's state-owned banks, riven as they have been by fraud, largesse, and hundreds of billions of dollars worth of bad loans, are stable enough to be foisted onto public shareholders. This is a country, despite its continuing reform efforts, where transparency remains dim, where ascertaining objective financial data can be an exercise in frustration, and where the state keeps a leaden hand even on the so-called “private” companies that have been spun off in the markets.

Few believe that these banks will collapse — the popular view is that Beijing has too much at stake to let that happen — or that the failure of one or two would incite an international financial crisis. Yet there are persistent concerns that the banks' well-rooted debt issues could rear their head during a recession and wreak some unanticipated havoc, not just with investors, but with China's increasingly important role in the global economy.

ICBC, because of its sheer size, looms as perhaps the biggest symbol of China's emerging promise.

China has traditionally favoured the Hong Kong stock exchange for IPOs of its state-run businesses, but now, for the first time, it will pursue a simultaneous listing on the Shanghai Stock Exchange, where it will sell about a quarter of ICBC's shares, providing mainland Chinese with a chance to get a piece of the action.

“We're all excited about the news,” Mr. Ding said. “The Chinese economy has developed so fast, but until now the mainlanders had no way to enjoy the result of this fast development. But now China is trying to let us share in the economic results.”

ICBC is the largest bank in the world's most populous country, with $815-billion in assets spread among about 18,000 branches. To give a sense of the sheer scale of the company, consider this: It has upwards of 150 million customers, or roughly five times the number of people who live in Canada. Analysts have crunched the numbers, and estimate that if demand is as heady as expected, ICBC will boast a market capitalization of around $180-billion. That's good enough for fourth-place worldwide, and about three times the size of Canada's biggest firm, Royal Bank of Canada.

In the eyes of investors, ICBC also comes with a guarantee of sorts, however implicit: That as the nerve centre of the Chinese financial system, its IPO-driven reformation is a “political task” the government cannot allow to fail.

“The main buyers in the mainland listing will be government-owned institutional investors, such as insurance companies and state investment companies,” said Victor Shih, a political scientist at Northwestern University in Evanston, Ill., who specializes in the Chinese banking system.

“Under the current macroeconomic policies, those entities are under pressure to invest in ‘safe' instruments, and ICBC shares would fall in this class. I have no reason to think that ICBC shares will not do well.”

Zhiwu Chen, a professor of finance at the Yale School of Management, has seen the challenges of Chinese privatizations up close as an independent director of a handful of firms there. For him, China's decision to invite investors into its “Big Four” banks (ICBC, Bank of China, China Construction Bank, and, if it ever sorts out its problems, Agricultural Bank of China) is the only way to cure these institutions of their ills, and at the same time incite more profound political and economic change.

“The semi-privatizations have turned out to be the only way that the Chinese government can really shake things up and remove the entrenched interests in some of these state-owned banks,” he said in a recent interview. “[The banks] will never be ready unless they are forced to take the challenge.”

Not everyone is so certain. The chief issue dogging the sector is a residue of profligate, indiscriminate lending that left many banks saddled with staggering amounts of bad loans. For decades, banks functioned as thinly guised financing arms of the government, handing out money to all manner of state-owned enterprise.

“The big banks are junk,” said Kent McCarthy, founder of U.S. hedge fund Jayhawk Capital Management LLC, which specializes in Asian securities. “They're less junky now than they were 10 years ago, but they'll still be junky 10 years from now.”

Mr. McCarthy, a former Goldman Sachs banker in Hong Kong, described the valuations some of these banks enjoy as “ridiculous,” and likened reading the prospectuses for their offerings to a “comedy show.” While he acknowledged public shareholders should accelerate the pace of banking reform, he predicts there will be two or three painful blowups in the sector before it gets its house in order. “It's going to end badly,” he promised. “We're in the ‘nuts' stage — we're not at ‘super-nuts.' This could be one of those things where they shoot up another 20 per cent or 30 per cent first.”

In the mid-1990s, the soured loan problem was so crushing that China injected more than $60-billion into its main banks to keep them solvent. It also created asset management companies whose function was to siphon off more than $150-billion worth of bad loans from the Big Four's balance sheets.

The result, Chinese authorities say, is that non-performing loans at the Big Four have been winnowed down to just $133-billion. Yet there are more than a few skeptics who believe Beijing is radically understating the problem. Several analysts have estimated problem loans at between $400-billion and $600-billion. (Ernst & Young, which put the figure at $358-billion, retracted its projection after a sternly worded rebuke from Chinese authorities, and sanctioned the official estimates.)

“You can't blow up your balance sheet at 20 to 25 per cent a year and not incur a very substantial portion of bad loans,” said Gordon Chang, an outspoken critic of China's debt problems and author of The Coming Collapse of China. “You can't do that with a well-managed bank in a well-regulated society. How the devil can you do it China? This is just ludicrous.”

The U.S. investment banks advising on the IPOs stand to make a healthy profit. The fees themselves are very lucrative: a 2.5-per-cent cut on the ICBC offering alone will yield nearly half-a-billion dollars in commissions. The far bigger payoff could accrue to firms like Goldman Sachs, which in May injected $2.6-billion for a stake in ICBC. Analysts say that investment could easily double. China Construction Bank has gained 45 per cent since going public with a $9.2-billion offering last October, and China Commercial Bank rocketed 25 per cent on the first day of trading in Hong Kong last month.

“People are going to make money in the short term, but long term, these have got to be bad investments because the banks are not as solid as the government says they are,” Mr. Chang insisted. “They've got better systems, they've got better computers, their offices look nice, all sorts of things. But these banks are essentially weaker than they were before. China is just piling up more and more non-performing loans, and eventually it's going to come crashing down, because economically this doesn't make any sense.”

Last year, bank lending in China increased 9.7 per cent, and was up another 10.4 per cent in the first half of 2006 alone. At that pace, insist investors like Mr. McCarthy, China must be inhaling vast amounts of additional bad loans.

The government has said it is fully committed to reforming the sector on the eve of a massive deregulation set for the end of the year. That's when foreign banks can open branches across the country and offer local currency services.

But a cleanup of these banks will take more than commitment, analysts say. Beijing still faces the huge and time-consuming challenge of transforming the banking culture, re-educating staff, centralizing lending decisions, and learning how to market new products.

“There's definitely a ‘China hype' story that's behind a lot of this,” said Michael Pettis, a finance professor at Peking University and a director of the New York hedge fund Galileo. “It's linked to the excess of global liquidity, the huge amount of risk appetite and a tendency to focus on the positive, rather than the negative. China is one of the hottest areas of international interest, and there's perhaps an overexcitement about China investments.”

Don't tell that to Mr. Ding. He's less worried by the pitfalls than by the ability to get his hands on $300,000 worth of ICBC shares. “I don't worry about the risks of investing in ICBC,” he says. “Every bank has bad loans, but ICBC is the most powerful bank in China, with the biggest market share, and it is reforming continuously. Unlike other big Chinese banks, no big scandal has ever been reported at ICBC. Every rich person in the world would like to buy shares in Chinese banks.”




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Pricing the 'biggest IPO in history' --Asia Times Online



BEIJING - The Industrial and Commercial Bank of China (ICBC), the country's biggest commercial bank, started consultations on Wednesday on the pricing of its initial public offering (IPO), probably the largest in history.

ICBC will be the first major Chinese firm simultaneously to list on mainland Chinese and overseas stock markets. Many Chinese blue chips list first on overseas markets before going public on domestic exchanges, drawing increasing criticism from mainland investors.

The final pricing of the shares is likely to take place on October 23, with trading starting simultaneously on the Shanghai and Hong Kong stock exchanges on October 27, the bank said in an announcement to the Shanghai Stock Exchange.

Although the bank did not indicate what the IPO price would be, analysts expect it to be between two and 2.6 times the lender's book value.

"The shares will probably be priced at around 2.1 times its predicted book value this year," said She Minhua, a banking analyst at CITIC China Securities. The bank has great development potential because of its large asset scale and revenue base, said She.

Media reports said the ICBC is in talks to buy PT Bank Halim Indonesia, in a bid to expand outside the country to diversify its sources of income and improve profitability.

ICBC's A-share offering plan was approved on Tuesday by the China Securities Regulatory Commission, after getting the nod for H-share sales in Hong Kong last week from Hong Kong market regulators.

The bank plans simultaneously to issue 13 billion A shares - which typically have enhanced voting rights or other benefits compared with other forms of shares - in Shanghai and 35.39 billion H shares in Hong Kong, it announced.

If the over-allotment or "green shoe" option is fully exercised, the total number of A shares will rise to 14.95 billion and the total number of H shares issued will reach 40.7 billion.

The ICBC's IPO may raise between US$19 billion and $21 billion. The sale is expected to be the world's largest ever IPO, surpassing the record of $18.4 billion raised by Japan NTT Mobile Communications in 1998.

The subscription period for institutional investors in the Shanghai portion of the IPO will take place from October 16-19, while retail investors will be able to subscribe on October 19, ICBC said.

A-share underwriters were to give pre-marketing presentations to price-consultation participants in Beijing, Shanghai, Shenzhen and Guangzhou from this Wednesday to Friday and again from October 9-11.

"ICBC's share offering will put some pressure on the domestic stock market, as part of its funds will turn to the new shares," said She. "But it is unlikely to have a big impact due to sufficient market liquidity."

ICBC's A shares should not have a market value any lower than that of the Bank of China's, said She. BOC's A shares have been traded at between 3.2 and 3.46 yuan over the past month.

However, some analysts worry that ICBC's relatively large non-performing-loan ratio will hurt its performance. The bank has cautioned investors that it faces various business risks including NPLs and increased competition.

By the end of June, ICBC's NPL ratio stood at 4.1%, down from 4.69% in December.

Its loan book showed the bank has the greatest exposure to the manufacturing sector, which accounted for 27.8% of its domestic corporate loans, with the real-estate market accounting for 9.1%.

"A significant downturn in any industry in which loans are highly concentrated may lead to a significant increase in non-performing loans," it said.

In addition, China's banking industry is becoming increasingly competitive as foreign banks prepare for the opening of the financial sector at the end of this year. China is overhauling its state-owned, debt-laden banking sector prior to opening the financial market fully to foreign banks by year-end under a World Trade Organization commitment.

The government has moved to write off the major banks' bad debts, reshuffle them into shareholding companies, invite strategic foreign investors and let them go public.

ICBC is the third of the Big Four banks to go public. Another two of the Big Four, the BOC and China Construction Bank (CCB), have already become publicly listed companies. BOC is listed on both the Hong Kong and Shanghai stock exchanges, while CCB is only listed in Hong Kong. The fourth of the Big Four, the Agricultural Bank of China, is restructuring in preparation for a possible IPO.

Since June 2005, there have been four mainland government-funded banks listed on the Hong Kong stock exchange, raising US$25 billion. In addition to BOC and CCB, the other two leaders are Bank of Communications and China Merchant Bank.

Analysts said the new share offering would help boost the ICBC's capital adequacy and improve its management.




(Asia Pulse/XIC)


http://www.atimes.com/atimes/China_Business/HI29Cb01.html