What if ... HSBC sold Hang Seng for BoCom deal?

China’s banks are under pressure to grow internationally. HSBC wants access to the mainland. The answer to both might be an asset swap.

Companies of China are increasingly focused on international expansion, at the exhortation of Beijing.

Its desire to expand has helped support the international ambitions of local insurers such as Anbang and Fosun International, or securities firms such as Citic and Haitong. But one vital part of this sector has yet to demonstrate such assertiveness: China’s banks.

Chinese individuals are remarking upon their meekness. The South China Morning Post reported that Li Ruogo, former chairman of the Export-Import Bank of China and now an executive vice-president at the International Financial Forum, claimed the international capabilities of China’s banks is not suitable for the needs of the nation’s outbound investments and acquisitions.

Similarly, the newspaper reported that Ma She, deputy director of European affairs at the Ministry of Commerce, as criticising the banks for “underdeveloped” overseas branch networks and poor data sharing management.

To date China’s banks have embarked on tentative acquisitions offshore, in South Africa and South America. But these have been small, and piecemeal.

It looks unlikely the banks would ever unveil grandiose plans to buy a Deutsche Bank, or a Standard Chartered. Instead, for a truly transformational purchase they would be most likely to seek targets close to home.

Hong Kong would be the most obvious immediate candidate, boasting geographic, financial and cultural ties. However, the city has relatively few decent-sized candidates that are obvious acquisition prospects.

Bank of East Asia might be the most obvious potential target. However, the bank recently issued an exchangeable bond in its shares to Sumitomo-Mitsui Financial Group, effectively raising its stake to around 17.5%. That, combined with the Li family’s 11%, might make a takeover bid highly challenging, particularly given the likely reluctance of the Li family to sell out.

But there is another possibility: Hang Seng Bank.

Appealing acquisition

Hang Seng’s biggest shareholder is HSBC. It bought a 51% stake in Hang Seng in 1965, after the latter was tottering following a bank run, and has subsequently raised this stake to 62.14%.

As a result HSBC, which is by far Hong Kong’s largest retail bank, was responsible for 52% of Hong Kong loans (HSBC 40% and Hang Seng 12%) and 55% of deposits in 2014 (HSBC 44% and Hang Seng 11%), according to a report by Dagong Securities, published in May.

The UK-headquartered bank holds Hang Seng at arm’s length, no doubt in order to avoid accusations of monopolistic practices. But it would be very reluctant to sell it. Understandably so; Hang Seng reported a profit of HK$20.05 billion ($2.59 billion) for the first half of 2015, had total assets of HK$1.3 trillion, while it was trading at 1.93 times price to book value on Wednesday, according to Bloomberg. It enjoys strong retail banking and insurance businesses and is growing in wealth management too.

Acquiring Hang Seng would make a potentially appealing addition to a Chinese state-owned bank. It would offer the lender immediate scale in Hong Kong, North Asia’s leading financial centre. More importantly, Hang Seng would provide expertise in international banking practices and customer services.

For Hang Seng, the backing of mainland lender with international aspirations would offer it the opportunity to flourish into commercial and retail banking outside of Hong Kong.

Getting a sale done

Hang Seng’s strength and financial stability means HSBC would be very reluctant to part with it. Yet it might be persuaded to do so for a large enough incentive. 

As it happens, Beijing could give HSBC what it may want most of all:  ownership of a local nationwide bank.

The most likely is Bank of Communications. HSBC has owned around 19% of BoCom for years, and hoped to eventually get majority control, but these plans are currently impossible due to China’s 20% foreign ownership limit in its banks.

Beijing could offer HSBC an exemption to its foreign ownership limits (potentially utilising the idea that HSBC’s local Hong Kong bank unit, The Hong Kong & Shanghai Banking Corporation, is applicable to buy larger stakes in China banks). Then it could sell HSBC enough shares to give it a controlling interest at a competitive rate (following, no doubt, a very thorough audit).

In return, HSBC would agree to relinquish Hang Seng to a local bank for a similarly competitive valuation.

The biggest challenge would be building enough political support for such a deal. 

It would likely require sanctioning by the State Council, plus the Ministry of Finance, State-owned Assets Supervision and Administration Commission and the China Banking Regulatory Commission. Additionally, the Chinese bank would need to agree to the purchase of Hang Seng Bank.

However, if the political will could be found, it should be relatively straightforward to sell shares in BoCom to HSBC. The Chinese government owns 46.3% of BoCom, with the National Council for Social Security Fund owning another 4.78% and Sasac holding a further 4.66%, according to 4-traders.com.

Securities fast track

HSBC might ask for another favour in return for giving up BoCom: rapid approval of its new securities joint venture.

The bank HSBC agreed to establish a joint-venture securities company with Shenzhen Qianhai Financial Holdings, of which it would own 51%, on November 2. However, the deal is subject to regulatory review and approval, which can take a long time – some JV players have been waiting years to get final approval on certain licences.

Therefore HSBC would likely want fast-tracked approvals that gave its JV full underwriting, trading and wealth management access to China’s local capital markets.

In addition to offering HSBC incentives, Beijing could also – if it so chose – place pressure on it to divest Hang Seng via the compliant politicians who run Hong Kong’s government.

For all the operating separation of HSBC and Hang Seng, the fact remains the two comprise a dominant percentage of Hong Kong’s retail banking sector. In most countries this would cause antitrust concerns.

Coincidentally, Hong Kong’s government introduced a new Competition Ordinance on December 14. International law firm Linklaters noted “the impact of the new law will grow over time, but it will ultimately lead to a more mature marketplace in which consumers will benefit through enhanced competition.”

Costly acquisition

Aside from political will, the biggest sticking point of any deal over bank acquisitions would be cost.

Neither purchase would be cheap. BoCom had a market capitalisation of Rmb416 billion, or $64.13 billion, as of Thursday, giving it a price-to-book valuation of 0.94 times. Assuming BoCom’s balance sheet didn’t raise any major concerns, HSBC might spend $21.8 billion to raise its stake from 19% to 51%, assuming it paid on a par price-to-book valuation.

Hang Seng is a bit cheaper. Its market capitalisation was HK$281.4 billion ($36.3 billion) on Thursday, giving it a price to book valuation of 1.98 times. At that valuation, a Chinese bank would need to pay $18.5 billion to gain a simple 51% majority stake from HSBC. 

To put those price tags into perspective, the largest banking M&A on record in Asia-Pacific, Westpac Banking Corporation’s $17.9 billion purchase of St. George’s Bank in 2008. Malaysia’s CIMB, RHB and Malaysia Building Society did discuss a three-way merger worth $22.3 billion in 2014, but the plan was scrapped early this year.

Beijing would need to have a truly unshakeable desire to get one of its banks to expand internationally to sanction such an expensive M&A. And it would be hard for the Chinese government to cajole HSBC into such a sale without giving it in return the sort of local bank control it has thus far been unwilling to allow.

But China appears keen to get its banks to support the expansion of its companies and the usage of its currency overseas. And HSBC really wants more mainland access.

Stranger deals have been struck.           

What if… is a column that analyses unusual M&A ideas in Asia. These deals might not take place, but perhaps they should. 

¬ Haymarket Media Limited. All rights reserved.
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