Thursday, September 01, 2005

China's Banks See Fresh Wave Of Foreign Investment

By KATE LINEBAUGH and MARY KISSEL Staff Reporters of THE WALL STREET JOURNAL August 31, 2005 11:19 a.m.

HONG KONG -- Singapore state-owned investment company Temasek Holdings Pte. Ltd. confirmed a $3.6 billion investment in Bank of China on Wednesday, marking the largest single investment in a Chinese bank to date and placing the historically passive fund at the center of an unusually aggressive bet on a risky sector.

Earlier Temasek announced its acquisition of a 10% stake in Bank of China, China's second-largest bank by assets, for US$3.1 billion. The Singapore company also committed to buying $500 million dollar's worth of shares during Bank of China's upcoming initial public offering.

With that commitment, Temasek joins a consortium that includes Royal Bank of Scotland Group PLC, Merrill Lynch & Co. and Hong Kong billionaire Li Ka-shing, that pledged $3.1 billion to the Chinese lender earlier this month. The deal also confirms Temasek as a major force in the Chinese banking sector, and exposes it to an industry rife with fraud, mismanagement, and a history of shaky loans.

Earlier this year, Temasek committed to buy $1 billion worth of stock in China Construction Bank's upcoming initial public offering, and could buy an additional $1.4 billion more, said a person familiar with the matter. Temasek owns a roughly $190 million hunk of China Minsheng Banking Co., one of the first banks with private owners.

Temasek, a $52 billion fund with a wide-ranging investment mandate, isn't a household name outside of Asia-Pacific. But in Singapore, a tiny city-state roughly the size of Washington D.C., it has played a pivotal, unique role in developing that country's economy. For much of its history, it didn't worry about trying to maximize return on investment or diversification like a private sector player might. Its mission was simple: support Singapore Inc., and promote the public good. Its chief assets were Singaporean strategic assets, such as power and water companies, and even local zoos and parks.

But over the last two years, Temasek has undergone a radical makeover. Under new management, it has pushed abroad into new markets, plowing money into South Korea, Indonesia, and Pakistan in search of higher returns on its investments. And in its new overseas ventures, no market has figured bigger than China.

Consortium Agrees to Commercial Bank Stake

Separately yesterday, a group of investors including the investment arm of Goldman Sachs Group Inc., American Express Co. and Allianz AG of Germany signed a preliminary agreement with China's biggest lender by assets, Industrial & Commercial Bank of China, to buy about a 10% stake for more than $3 billion, according to a person familiar with the matter.
Theses two latest deals would bring to more than $15 billion the amount of money foreign investors have agreed to put into Chinese banks since June, though not all the deals have been formally completed.

Underlying the appeal of China's lenders is the potential profit to be earned from the country's rapid economic growth, expected to be 9% this year, and the rise of the Chinese consumer. Penetration rates among China's 1.3 billion people for credit cards and insurance are low, and the budding popularity of cars, home ownership and other symbols of middle-class status hold the promise of big growth in consumer loans. Investing in the country's biggest lenders, which have upward of 10,000 branches, gives foreign banks access to the broadest market possible.

For the past decade, China has embarked on a massive program to transform its banks from piggy banks for government-decreed lending into commercial entities with professional
management so they can better compete when the market is opened to foreign competition at the end of next year. As part of that, Beijing has pumped $60 billion into its three biggest banks to offset bad loans, ordered the overhaul of credit-risk systems and put in place audit committees and board structures to try to ensure management acts in the best interest of the bank.

"Ten years ago, Chinese banks were not commercially run at all," said David Marshall, a banking analyst with Fitch in Hong Kong. But, he notes, "it will take many more years before Chinese banks have robust risk-management systems and sound financial profiles."

The downside risks are formidable. Corruption and theft is chief among them. Earlier this month, Chinese state media reported that a former head of Bank of China's listed Hong Kong unit was given a suspended death sentence for embezzlement. In April, the bank revealed a lending scandal that it said cost its Beijing branch about $78 million. The chairman of China Construction Bank resigned in March amid allegations of corruption.

Beyond that is the issue of asset quality. The banks themselves aren't very profitable and "if the economy takes a stumble, the impact on the banks will be disastrous," says Fitch's Mr. Marshall.

Concerns about just that led Royal Bank of Scotland, the world's sixth-biggest bank by market capitalization, to ask for protection against erosion in the value of its investment when it agreed to its $1.6 billion investment in Bank of China earlier this month, according to a person involved in the deal.

The proposed deal signed yesterday with the Goldman-led consortium is a preliminary agreement without price terms, although the investment is expected to exceed $3 billion, according to the person familiar with the talks. While the financial terms are still subject to negotiation, this person said that Allianz will put in about $1 billion, mainly through its principal investment group, American Express between $200 million and $300 million and a Goldman Sachs private-equity fund will provide the rest. Goldman will then sell parts of its stake to other investors. Goldman has already profited handsomely from an investment in China's finance sector. In May, Goldman and Morgan Stanley sold their combined 9.91% stake in Ping An Insurance (Group) Co. for $1 billion, a hefty return on the $35 million each bank invested in 1994.


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