China Merchants Bank's rights issue won't address all its capital woes

The rights issue will ease China Merchants Bank's capital pressure considerably, however, even after the cash replenishment, CMBÆs capital will remain thin compared to other leading banks in China.

The long-awaited $3.2 billion rights issue of China Merchants Bank (CMB) is one step closer to happening. The lender has announced a plan to offer 1.3 new shares for every 10 held by investors of its Shanghai- and Hong Kong-listed stock, but analysts warn the bank will remain a thinner capitalised lender even after the capital replenishment.

CMB, the country's fifth-largest lender by market value, has seen its core capital deteriorate and a significant rise in leverage after its expensive acquisition of Hong Kong's Wing Lung Bank and rapid loan expansion over the last 12 months. Proceeds from the fundraising will be insufficient to shield the bank against hidden credit risk, analysts say.

There is also ongoing speculation that China Banking Regulatory Commission will take further measures to tighten credit growth in China --- a major source of income for all lenders in the country. The banking regulator has warned it will refuse approvals for business expansion and limit banking operations if lenders fail to meet the capital adequacy requirements. The tightened rules are forcing Chinese banks to look for tens of billions of dollars in fresh capital from the equity markets.

CMB will issue 2.48 billion new shares comprising approximately 2.03 billion A-shares to investors in Shanghai and 449 million H-shares in Hong Kong, the bank said in a filing to the Shanghai stock exchange late on Monday.

As of February 21, the bank had a total of 15.65 billion outstanding A-shares and 3.46 billion H-shares, according to the filing. The offer would price the lender's new shares at Rmb8.85 apiece to its renminbi-denominated A-shares; and HK$10.08 each to its H-shares, according to analysts.

By comparison, Shanghai and Hong Kong-listed shares in CMB have been trading at an average of Rmb16.7 and HK$19.6 respectively over the past three months, data from Bloomberg shows.?The rights issue would ease the bank's capital pressure considerably, however, even after the cash replenishment, CMB's capital will remain thin compared to other leading banks in China, said She Minhua, a banking analyst at Haitong Securities in Shanghai.

"The offering will increase CMB's tier-1 capital ratio to about 9%, while Chinese banks average is 9 to 10%," he said, adding that the bank would report a 2009 profit of Rmb17.2 billion representing an 18% decrease year-on-year.

Fitch Ratings recently downgraded CMB's creditworthiness to 'D', which is the seventh grade in a scale of nine grades from 'A' to 'E', to reflect the bank's weakening standalone credit risk.

"Subtracting intangibles from the acquisition [of Wing Lung Bank], CMB's ratios of tangible assets and tier-1 CAR (capital adequacy ratio) dropped to 3.8% and 6.6% respectively in the third quarter of 2009," Charlene Chu, head of Fitch's financial institutions ratings in Beijing, wrote in a report.

Fitch notes that CMB's planned Rmb22 billion rights issue should bolster capitalisation considerably. However, even after this exercise, core capital is likely to remain just on par with other Chinese peers rated 'D', she said.

Fitch downgraded CMB and China Citic Bank on the same day saying they are carrying additional hidden credit risk because they are also active issuers of wealth management products that are packed with loans.

Fitch's report was released before the holiday week of Chinese New Year, and was the firm's first downgrade rating in Chinese lenders over the last six years. The report casts a shadow over the nation's banking sector.

However, Standard & Poor's said the government is likely to extend "extraordinary support" towards important banks if they run into financial difficulties.

"The government is the largest shareholder of many Chinese banks, and some can attribute some of their historical and potential bad loan problems to the government's encouragement to support the economy," it said in a research note.

CMB first indicated that it was in need of new capital last August after it agreed to pay 3.1 times book value for a controlling stake in Wing Lung Bank. The deal was the most expensive bank acquisition on record in Hong Kong.

Bank of China, the most aggressive state-run bank in terms of expanding its loan books last year, said last month that it plans to sell up to Rmb40 billion ($5.8 billion) of domestic convertible bonds to replenish its capital.

Chinese banks have come under strain after last year's excessive lending, which totaled Rmb9.6 trillion. Bank of Communications estimates China's listed banks will need to raise Rmb200 billion from the equity markets to re-fill balance sheets this year, while BNP Paribas forecasts the country's lenders need Rmb368 billion to ensure adequate capital.

CMB didn't name the underwriters in the stock exchange filing but it's reported that China International Capital Corp and UBS are arranging the rights issue.

The announcement sent CMB's shares lower in Shanghai where its shares fell 1.72% and ended at Rmb15.46. The Hong Kong-listed shares regained losses before the end of trading and closed at HK$18.94, about 1% higher.


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