Banks Find Promise Unfulfilled in China Forays

 By ALISON TUDOR

Jan. 13, 2013

  'smiles' all round

In June 2005, when Bank of America Corp.'s then-Chief Executive Ken Lewis flew to Beijing to sign a $3 billion pact to acquire a 9% stake in one of China's biggest state-run banks, he hailed the deal as "a long-term investment."

In Mr. Lewis's view, the money the bank put into China Construction Bank Corp. should have given the Charlotte, N.C., lender an entry into the world's fastest-growing economy and a clear shot at tens of millions of potential banking customers.

ENLARGE

Ken Lewis with China Construction Bank's Guo Shuqing in 2005. REUTERS

The Bank of America chief at the time was part of a parade of top international bankers who piled into China in the mid-2000s to announce investments in domestic banks and insurers, touting the prospects of growth and cooperation.

Global financial institutions poured about $33 billion into Chinese banks between 2004 and 2009, according to the website of the Chinese regulator, the China Banking Regulatory Commission.

The deal yielded a tidy profit but little else for Bank of America. The U.S. bank sold down its holding to about 1% as of November 2011.

Other banks have faced similar setbacks in China. From HSBC Holdings PLC to Goldman Sachs Group Inc., some of the biggest names in global finance have been busy unwinding their investments amid tougher new capital rules and a general sense that the deals didn't deliver what they promised: an entry into a lucrative and promising market.

"Banks are stuck with investments that aren't useful strategically," said Derek Ovington, CLSA Asia Pacific's regional head of bank research.

Global firms sold about US$44 billion worth of shares in Asian financial institutions in 2012 to institutional investors or other strategic buyers, up from US$32.7 billion in 2011, according to data provider Dealogic. The retreat is gathering pace as a host of new regulations, including the so-called Basel III capital rules, make holding minority stakes in financial institutions more expensive.

Under the third edition of the Basel accord on international capital standards, if the sum of a bank's minority investments in other financial institutions exceeds 10% of its core capital, then the amount in excess of that threshold must be deducted from its own capital. Also, if the bank owns more than 10% of another financial institution, then up to 100% of the investment could be deducted from its core capital, according to lawyers and bankers.

The latest deal to struggle is one of the biggest, and messiest: HSBC's 15.57% stake in Ping An Insurance (Group) Co. The stake was set to be sold to Thai conglomerate Charoen Pokphand Group for $9.39 billion. The deal is now on the rocks as Chinese regulators seek more information amid concerns that other investors are also helping fund the deal, which may be in violation of China's insurance rules.

The HSBC deal is typical of what went wrong with foreign forays into China's financial services. The British bank had hoped that plugging into Ping An's huge networks of agents would boost sales of its wealth-management products to the Chinese, say analysts and people familiar with the deal. However, Ping An's management chafed at being a small part of HSBC's network and worked to offer the same products itself, said a person with knowledge of the integration. For the 10 years it has held a Ping An stake, the U.K. lender has had few initiatives with the insurer.

On the positive side, the sale price for HSBC's Ping An stake is nearly six times what the U.K. bank paid for it. HSBC has raised the carrying value of the stake over the years and said it would book a profit of roughly $2.6 billion. If the deal goes through, HSBC said its core Tier 1 capital ratio will be boosted by half a percentage point, and total capital ratio by a full percentage point.

Other landmark transactions such as Goldman's successive sales of its stake in Industrial and Commercial Bank of China Ltd. have had similar effects.

To be sure, some banks are still holding on to their stakes. HSBC itself has a 19% stake inBank of Communications Co. , China's fifth-largest bank by assets. Spain's CaixaBank SA owns 16.1% of Hong Kong's Bank of East Asia Ltd. And Deutsche Bank AG controls 19.99% of midsize Chinese lender Hua Xia Bank Co.

Many of these European banks say they are adamant they won't sell, given China's growth. BNP Paribas SA even bought an additional 2% of Bank of Nanjing Co. in December, supplementing its 12.7% stake. BNP's head of retail banking in Asia, Philippe Aguignier, said that by investing in a small bank it has more influence, although the French bank has only one director among 13.

Todd Marin, J.P. Morgan & Co.'s Asia-Pacific vice chairman of investment banking, said that the reluctance to divest "may change should euro-zone banks face increased financial pressures, given the economic challenges at home and regulatory requirements for greater capital."

Paget Dare Bryan, a partner at law firm Clifford Chance who advises financial institutions on the implications of forthcoming regulation, said that "banks are looking at their minority stakes and asking themselves, are they really worth it?"

Countries started to phase in Basel III beginning Jan. 1. Even though the U.S. is delaying implementation to study the rules further, U.S. financial companies are subject to stiff annual "stress tests" to prove they can withstand economic hardship as well as beefed-up analysis by credit-rating companies.

"Selling minority shares contributes to improving capital ratios for us and Basel III, so it is a very efficient strategy to pursue, especially if the investments don't contribute much to profitability," said Yuri Yoshida, Standard & Poor's director of financial institutions ratings.