Bank of China to Seek Funds Through Rights Issue

Trading in shares of Bank of China Ltd. (OTC: BACHY) was halted on the Hong Kong stock exchange yesterday for no specified reason. Shares did continue to trade on the Shanghai exchange.

Presumably the halt had something to do with the bank’s announcement today that it would initiate a rights issue on both the Shanghai and Hong Kong exchanges to raise $8.9 billion to boost its capital base and enhance its capital adequacy ratio.

The bank has been the most prolific lender in the government’s effort to increase lending over the past year. The bank recently sold $5.9 billion worth of convertible bonds and its chairman stated that the bank would not need to raise more cash.

Apparently that has changed. The Wall Street Journal reports that the change of mind is intended to accommodate Central Huijin Investment Ltd., which owns 67.53% of the bank in its role as an investment arm of the government’s sovereign wealth fund. Huijin did not participate in the convertible bond offering, and the rights issue will allow the firm to get a piece of the action.

Bank of China’s capital adequacy ratio has fallen to just barely more than 11%, below the government’s regulatory minimum of 11.5%, likely as a result of its open-handed lending of more than $1 trillion in the past year. The question, of course, is how many of those loans will go bad in the next few years. Chinese banks do not have a good track record with non-performing loans, due at least in part to the government’s willingness to make up the banks’ losses.

One can hardly condemn China’s banks for going after more capital. It seems that no amount of additional equity is too much for investors to absorb. The coming IPO of the Agricultural Bank of China is expected to top $23 billion. The Industrial & Commercial Bank of China plans to raise around $4 billion in a convertible bond issue and to sell new shares in an amount up to 20% of existing Hong Kong-listed shares.

Certainly part of the attractiveness of China’s bank shares is the implicit government guarantees of profitability. By itself, though, that isn’t enough. The banks need to show that they can stand on their own and deliver profits for investors. That is difficult when the government dictates where and how much the banks must lend.

Issuing more and more convertible debt or new shares will eventually dilute shareholders’ investment and either the government will have to make up the difference or the banks will need to stand on their own and deliver. If the former, returns are essentially regulated, and investors will cool to the banks because returns are too small. If the latter, the banks will need to get much better at resisting government intervention on the question of where to lend. Right now, there’s no reason to believe that the banks are becoming more independent.

Paul Ausick