Farmers’ market

“Few think it is feasible that Agricultural Bank of China could be listed anytime soon,” wrote FinanceAsia in a cover story from August 2006. That turned out an apt prediction and the reason was simple: the bank required massive reforms, with its non-performing loans peaking at $119 billion the following year.

Four years ago it looked – with good reason – like the ‘unlistable’ bank. But in one of those acts of will now so readily associated with the Chinese government, a colossal restructuring effort began. Central Huijin (see WiC62) injected $19 billion of new capital and Rmb800 billion of dud debt was hived off the balance sheet. New management was appointed and by 2009 the bank was able to report an NPL ratio of just 2.9% and profits of Rmb65 billion (up 26% on 2008, no less).

The last of the big four Chinese banks to IPO, Agricultural Bank has also been somewhat lucky in its timing. Only weeks ago, skittish markets had analysts questioning whether such a large deal made sense; some called for its delay. However, with sentiment resuscitating over the past few days, the bank was able to make its debut in a slightly sunnier market.

Even still, the deal was far from a runaway success – the stock price rose only 0.75% in its first day of trading in Shanghai yesterday (tiny by the standards of Chinese IPOs, which normally leap by a double digit percentage). It opened slightly perkier in Hong Kong – up 1.9% this morning – and may still confound the sceptics by becoming the world’s biggest ever IPO: it will raise $22.1 billion if the overallotment option is exercised within 30 days. At the current stock price it ranks as the world’s eighth biggest bank by market capitalisation.

What are investors buying?

No shortage of superlatives here. Agricultural Bank has more customers (320 million) than America has people, making it the world’s biggest retail bank, with 23,624 branches. With total assets of $1.3 trillion and deposits of $1.09 trillion, it is also the most rural of the state banks, which Hebei Youth Daily says could prove an advantage – since it gives investors a direct exposure to China’s booming countryside economy (see WiC53, Talking Point).

And on Wednesday, the Shanghai Securities News reported that Agricultural Bank was set to post a 40% jump in its net profit for the first half of the year. The report – which the bank’s management did not confirm – suggests that a surge in loans has led profits to rise to Rmb48 billion in the first six months.

In fact, this earnings leak was a break with IPO practice in Hong Kong, London and New York – where a blackout on financial information usually accompanies the publication of the prospectus. But perhaps such a fillip was necessary in Shanghai where retail investors showed a lack of enthusiasm for the transaction. Indeed, in a first for a major China IPO, the dual-listed deal saw the Hong Kong listing price set higher than its Shanghai counterpart (by 6%). In the past, the reverse was true. That seems to indicate that domestic investors are less bullish about Agricultural Bank than international fund managers.

A surprise outcome?

The fact that the deal made it across the finish line should not come as a total surprise. In the weeks leading up to the listing, Chinese regulators blocked other IPOs from launching in Shanghai – to give it a clear run at whatever liquidity was up for grabs. And about half the deal was locked up by strategic cornerstone investors, such as the Kuwait and Qatar sovereign wealth funds, major banks such as United Overseas Bank, US agricultural giant Archer Daniels Midland and rich tycoons like Hong Kong’s Li Ka-shing. That ensured that, although the deal was large, it was far from indigestible.

How did it happen?

Getting Agricultural Bank to market was a challenge. From the start this was no ordinary bank. As FinanceAsia pointed out in its article back in 2006, reforms at the bank were “handled as carefully as a live grenade”. It was a restructuring that the government could not afford to go wrong: a bungled reform risked political instability in the countryside, “the traditional fount of Chinese revolution.”

Founded by Mao Zedong in 1951, Agricultural Bank had always been a highly politicised institution – more akin to a policy bank than a commercial entity. Under its previous head, Yang Minsheng (who began life as a village cadre and never went to university), it came up with no fewer than 13 restructuring plans – all unworkable and mostly viewed as delaying tactics by the government’s more reform-minded ministers.

The big change came in July 2007, when Yang was replaced by Xiang Junbo. The new man swapped his role as vice-governor of the central bank for the twin positions of chairman and Party secretary of Agricultural Bank (as Richard McGregor points out in his book, The Party, the latter role is the crucial one, since it is the position that actually confers the real political clout, and with it the ability to make meaningful changes).

Born in 1954, Xiang, described by China Youth Daily as a “legendary man”, began his career in the army. He saw action and was injured in China’s 1979 war with Vietnam. After studying economics at Renmin University, he joined the National Audit Office.

Audit in China is not a career for the faint-hearted. But Xiang excelled in the job. The son of a professor of literature, he even penned films in his spare time – Far in the Mountains and the Legend of the Purple Sword – about rooting out corruption. He lived a dramatic life too, leading high profile audits, one of which led gangsters to call his home and threaten his family. Like Eliot Ness, he gained a reputation as ‘untouchable’, and was promoted to the central bank in 2004.

When he was sent to Agricultural Bank, the first thing he did was to install his own distinctive culture (lots of auditing) and reassert control of a very decentralised decisionmaking system – in an effort to radically improve risk management. He knew what he wanted to achieve: “Agricultural Bank will observe an outstanding change in three years, a fundamental change in five years, and will become a first class commercial bank in 10 years.”

Buyer beware…

So according to Xiang’s own schedule, we’re still seven years away from Agricultural Bank becoming ‘first class’. And the Financial Times has warned investors that, for now, “it is generally viewed in China as the worst performing and worst managed of all the banks”. The Economist magazine agrees: “Pessimists see it as a Chinese version of Fannie Mae and Freddie Mac”.

While earnings may look good now, a shock may be ahead. The bank made $150 billion of new loans last year to support the government’s rally to stimulate the economy. What percentage of these will go bad? How much of the capital raised in the IPO will be sucked up in writing bad loans off?

In fact, it’s probably best not to think of this as a ‘privatisation’. As last year’s lending splurge revealed, listed or not the banks remain in thrall to government diktat. That is a risk for investors.

Reportedly, the Ministry of Finance and Huijin both tried to get the IPO postponed too. Their fear was that a poor trading performance in the coming weeks could threaten the ability of China’s other big banks to raise tens of billions in much-needed equity capital from a saturated market.

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