ICBC formula may well work in restructuring of Agricultural Bank

Encouraged by the success of Industrial and Commercial Bank of China's record US$19.1 billion initial public offering, the mainland authorities are now pressing ahead with plans to restructure and sell shares in the last of the Big Four state-owned commercial banks.

Bailing out Agricultural Bank of China will not be cheap. Although it is smaller than ICBC by assets, its finances are even shakier. Altogether, restructuring could cost as much as US$100 billion, roughly equal to the annual economic output of the Philippines.

With 31,000 branches and hundreds of thousands of staff, Agricultural Bank is an even bigger, more sprawling organisation than ICBC, which boasts 18,000 branches. And the credit quality of its borrowers - mostly farmers and agricultural industries in depressed rural areas - is even worse. At first, China's banking authorities appeared to despair at the prospect of getting Agricultural Bank into shape for a share sale. For a while they toyed with splitting its diffuse banking network into some combination of its 32 provincial businesses.

Another suggestion was to break it up into 'good' and 'bad' banks; the good portion to pursue a stock market listing and a future as a commercial business, the bad part to take over the lender's job of extending loss-making but politically expedient loans to rural borrowers.

Now, however, following the roaring success of ICBC's stock offering, it seems China's bank regulators have resolved to restructure and sell shares in Agricultural Bank as a single unit. Managers are expected to present their plans before the end of the year for relaunching and recapitalising the bank as a joint stock company. A bailout will follow.

It will be a big one. At the end of last year, 26 per cent of the bank's loan book was classified as non-performing. Management hailed that as a reduction from the previous year, but the claim was disingenuous. The ratio was flattered by rapid expansion of the lender's overall loan book. In reality, bad loans grew by 48 billion yuan to 740 billion yuan, or US$92 billion.

If listing a bank so riddled with bad loans sounds a tall order, compare it with ICBC. At the end of 2004, ICBC sported a similar non-performing loan ratio of 21.6 per cent with bad loans worth 658 billion yuan on its books. Just 12 months later, after several injections of government cash worth about US$80 billion, the bad loan proportion had been reduced to 4.7 per cent. Now, after another 10 months, the bank has successfully pulled off the world's biggest-ever IPO.

It is likely Agricultural Bank's restructuring will follow a similar path. First, the Ministry of Finance, its owner, will write off the relatively slender 80 billion yuan of equity it holds in the bank. Then it is likely the central bank will inject some of China's vast foreign exchange reserves through state holding company Huijin. ICBC got US$15 billion, and Bank of China and China Construction Bank US$22.5 billion each. About US$25 billion should be sufficient to rebuild Agricultural Bank's tier one regulatory capital base.

Next, the bank's largely worthless non-performing loans will be sold at their face value to a state asset management company in return for 700 billion yuan or so of bonds backed by an implicit government guarantee.

Finally, a handful of reputable foreign strategic investors will be invited to buy in at above book value, and - presto! - from an absolute wreck, Agricultural Bank will suddenly be transformed into a well-capitalised lender with solid international backers sporting a non-performing loan ratio of less than 5 per cent. No doubt investors will flock to the subsequent stock offering.

Of course, behind all the make-up, Agricultural Bank will remain a very troubled institution. But if that did not bother investors in ICBC's stock offering, it is hard to see why it should deter this lender's suitors either.

Jake van der Kamp is on holiday