IFR deal profiles: Shenzhen Development Bank, China Railways

These articles appeared in the IFR Asia capital markets report, June 2008

Shenzhen Development Bank deal profile

In March, Shenzhen Development Bank priced a RMB6.5 billion lower tier two bond issue. It was a significant deal – the bank’s debut in the subordinated debt markets, the largest Asian bank capital transaction for a year, and launched in a tough market – but it held particular importance for its bookrunner, underwriter and ratings advisor, UBS Securities.

UBS Securities is the joint venture that came about from the restructuring of Beijing Securities after UBS took a 20% stake, and management control of the company’s operations, in 2006. The revamped subsidiary was formally launched last year, and this is its debut in the domestic renminbi market. It is, too, the first offshore institution to sole lead a renminbi domestic bond.

The deal itself was important for SDB, since it brought the bank’s capital adequacy ratio over 8%. That, in turn, allows it to open more branches and be more aggressive in building its asset base. Newbridge Capital holds a 16.7% stake in the bank.

The deal took a 10-year non-call five structure, with two tranches: a fixed RMB6 billion tranche with a 6.1% coupon, with a step-up of 3% on the fifth anniversary if not called; and a RMB500 million floating rate tranche, priced at Shibor 3M (the Shanghai interbank borrowed rate, three month duration) plus 140 basis points, with the same step-up terms as the fixed tranche. Along the way the issuer secured a AA+ rating from a local agency, with a AA rating given to the bond itself.

It’s the biggest ever bank capital issue for a Chinese bank outside the big five, and attracted equal attention from banks and insurers (except for the floater, which went only to banks). It was widely noted in the market that a deal of this size would have been impossible in the international markets at the time, which underlines the growing importance of domestic credit markets in Asia.

The deal was representative of the growing popularity of sub-debt structures among China’s largest banks. By the time SDB launched, only one of the 14 Chinese banks that are listed in Hong Kong, Shanghai and Shenzhen had not tapped the subordinated or hybrid bond markets since the 2003 announcement by the China Banking Regulatory Commission (CBRC) allowing banks to use sub-debt funding. That bank, Bank of Ningbo, is expected to follow this year. Chinese banks need the funding for two reasons: to get over the 8% capital adequacy minimum set by the Basel II standards, and to grow in a market of vast opportunity. The SDB deal was followed by a RMB6 billion raising for China Everbright in May, led by CICC and China Everbright Securities.

While this approach is not new – each of Bank of China, Industrial and Commercial Bank of China and China Construction Bank did such issues before their IPOs to boost their capital adequacy ratios – it is certainly not expected to draw to a close any time soon, with many unlisted commercial banks likely to do the same thing before their own IPOs. Hangzhou Commercial Bank, Zheshang Commercial Bank and Wenzhou Commercial Bank have already done so.

And after agreeing to buy a majority stake in Wing Lung Bank for HK$19.3 billion, China Merchants Bank is also being closely watched. Since the purchase is likely to end in a general offer pushing total costs to HK$36 billion, and since international credit markets remain largely closed, CMB is very likely to go to the sub debt markets – with speculation it could aim for as much as RMB18 billion.

The next step is likely to be hybrid issues, because regulators cap sub debt at 50% of core capital, which some listed banks have hit already. Hybrid issues are not considered part of that 50%. Industrial Bank, Hua Xia Bank and Minsheng Bank have already launched hybrids and Shanghai Pudong Development Bank is expected to do likewise. SDB itself has approval for a hybrid raising.

Insurers, too, are discovering the sub debt markets. People’s Insurance Group raised RMB7.81 billion of 10-year non-call five subordinated bonds in April, the largest sub debt issue by an Asian insurer. UBS Securities was financial advisor on this too, which was a private deal to institutional investors; the arranger was PICC Asset Management. Chinese insurers have been permitted to issue sub bonds more recently than banks, since October 2005.

Another insurer, Union Life Insurance, has approval to issue up to RMB1.1 billion of sub debt, and Min Sheng Life Insurance is believe to be working on a similar deal.

China Railway Construction deal profile

The China Railway Construction IPO hit the headlines in March for its vast retail oversubscription and its success in the teeth of hopeless market conditions. But in the long run its greater significant is likely to be the way it approached the combination of A and H share listings – that is, a domestic and international listing of a Chinese company.

By any measure, China Railway was a big deal. Between the A and H share listings it raised US$5.7 billion, with US$2.6 billion of it coming in the Hong Kong listing. As one of the largest providers of railway construction services in China, with a major presence in highway construction too, investors liked it as a method of gaining exposure to Chinese infrastructure development – and because it represented a sector largely unaffected by sub-prime and the credit crunch.

Consequently, it attracted vast demand. Citi, one of the bookrunners (Macquarie and Citic Securities were the others, with Citic handling the domestic deal on its own), says the total demand reached HK$1.1 trillion (US$140 billion); the retail tranche, generating US$68.7 billion of demand from 800,000 people, was 293 times oversubscribed, attracting the highest retail subscription in history. While that looks frothy, institutions bit too, oversubscribing their tranche 80 times over.

From an execution point of view, one of the key considerations was that the seller – the Chinese state – wanted to conduct A and H share offerings at the same time. Clearly this had been done before, for ICBC and Citic Bank, but the lessons from those deals suggested a change of structure might be in order. “One of the issues we encountered on Citic Bank concerns the price setting mechanism,” says Willy Liu, managing director in the capital markets origination group at Citi. In the domestic deal, the China Securities Regulatory Commission typically asks institutional investors what the price should be and uses the responses to help calculate the launch price, the result being that Chinese institutions tend to suggest low figures – having no incentive to do otherwise – which in turn usually results in a low A share launch price and then a steep climb. “The problem we encountered, which is disadvantageous to the government and the seller, is that with the H share having to price at the same level, you forgo quite a lot in proceeds.”

So with China Railway, the decision was made not to price the two deals simultaneously, but with the H share launch following quickly after the A share, with the instruction that the H share launch must be at least as high, if not higher, than the A share. This way, the H share deal priced at a 10% premium to the A share.

The volatile global markets may have helped the deal in some ways. “Because of the tough markets, there were not a lot of other IPOs around,” says Mark Warburton, head of equity capital markets for Asia at Macquarie in Singapore. “Also it was a business that people knew and understood pretty well, and in uncertain times it represented a safe haven.”

On Macquarie’s numbers, demand came 58% from Asia, 17% from the US, 18% from Europe, and 7% from the Middle East. Citi’s numbers show 73% demand to Asia, and much less from the US and Middle East. Nine cornerstone investors came into the deal – 11 had expressed interest – including Temasek and Yale University’s endowment fund. “That strong line-up of cornerstones got the momentum rolling,” Warburton says.

The demand meant that the deal priced at the top of the range at HK$10.70, representing 28.7 times 2008 earnings. Doing so was unusual at the time. “There was a sudden and drastic change in November when deals started getting priced at the low end or the middle of the range,” says Liu. China Railway bucked the trend. It went up 12% on the day of launch, when the Hang Seng index lost 1000 points, and has stayed up ever since, having risen 15% by early June. That’s in stark contrast to, for example, the other behemoth IPO from Asia this year, for Reliance Power, which at the time of writing was well down on its launch price.