Temasek eases exposure to Chinese banks

It would be misguided, however, to read too much into this confluence of events. “Temasek is very commercial,” says one private equity source with first-hand experience of the fund’s operations. “It is a self-funding portfolio and so if they identify something that will generate a lot of return, they wouldn’t hesitate to cash out elsewhere. The question isn’t why they are selling but what do they want to buy.”

On this basis, Temasek may just have looked through its portfolio for assets that were liquid, well covered by equity analysts, and had limited near-term upside. The fund did much the same thing in 2007, selling of portions of its stakes in BoC and CCB ahead of its investment in Merrill Lynch. It then bought back in when the banks were trading at around half their current valuations in early 2009, shortly after Royal Bank of Scotland and Bank of America sold stakes.

Priced to sell

There is no question that the fund’s BoC and CCB holdings were priced to shift quickly. Fullerton Financial Holdings, a unit of Temasek, is said to have offered 5.19 billion shares in BoC at HK$3.63, a 6% discount on the day’s closing price. Two other Temasek vehicles, Cairnhill Investments and Crescent Investments, reportedly offered 1.5 billion shares in CCB at HK$6.26, a 3.4% discount on the stock’s previous close.

Temasek raised $2.4 billion through the BoC sale and Dow Jones estimates that its stake in the lender now stands at 6.2%, down from more than 12%. CCB said that, after recouping $1.2 billion from the sale, the sovereign wealth fund has been left with a 2.2% holding, down from 6.76% at the start of the year.

Shares in BoC and CCB have slipped 11.6% and 12%, respectively, in 2011 amid concerns about a tighter monetary policy. For some time, ratings agencies have also warned that China’s state banks could be weighed down by a spate of non-performing loans (NPLs) arising from the massive, government-mandated credit expansion that saw the country through the 2009 downturn.

Late last month the National Audit Office released a report stating that local government debt totaled $1.6 trillion, of which $1.3 trillion is funded through bank loans. According to Moody’s, this estimate is $541 billion too low and the banking sector’s NPL exposure could be 8-12% of total loans. 
Moody’s said the most likely outcome is banks being left to manage NPLs that are not recognized as government obligations. “We expect the banks to refinance or restructure a fair amount of bank loans, and prolong the loss-recognition timeline to enable them to provision and charge off bad loans over time,” the ratings agency said. “Whether or not the banks can successfully absorb the losses through earnings will depend on the sustainability of strong economic growth.”

Song Seng Wun, an economist at CIMB in Singapore, refuses to pin the sales to a loss of faith in China’s leading banks; rather, he sees them in the context of a changing investment landscape. “They got into these banks very early [2005]. Now we are entering a more mature stage and it is a case of eking out growth rather than just having it come along,” he says. “Temasek could also be preparing to invest in China’s smaller second-tier banks.”

Such a strategy appears to be in keeping with the overview of future plans the fund gave as part of its annual review. Suppiah Dhanabalan, chairman of Temasek, highlighted the opportunities presented by mid-sized cities and middle income populations in the emerging markets, and the key role played by urbanization in spurring demand for new services.
There is little doubt that the fund will remain interested in China and its banks. The decision to shift portfolio weight toward Asia since 2002 has delivered returns of 21% over the last nine years, compared to 11% for pre-2002 investments; the portfolio reached a record high of $158 million at the end of March. But Temasek’s holdings have also become heavily skewed toward financial services, which accounted for 36% of total assets at the end of March. 

“It’s way too high – and that’s because it was very profitable,” says the private equity source. “The exposure used to be 10-15%.”

Diversification strategy

Aside from last week’s BoC and CCB sell downs, Temasek does appear to be attempting to redress the balance. Stakes picked up in Barclays and Merrill Lynch during the financial crisis have long since been exited and last October a 9.6% holding in Korea’s Hana Financial was sold for $603 million. In February, Temasek reduced its stake in ICICI Bank.

The focus now appears to be more on energy and natural resources, which only accounted for 3% of the portfolio as of March, although this is up from 2% the previous year.  Temasek spent $494.5 million on a 14.2% stake in Canada’s Inmet Mining Corp. last May and participated in the $3.5 billion buyout of Frach Tech Services this April, according to AVCJ Research. Last year, it was also part of a consortium that invested $1.5 billion in Chesapeake Energy Corp., bought India’s GMR Energy for $200 million, and subscribed to Huaneng Renewables’ IPO.

“The paring down of stakes here and there is one way of ensuring that they have enough in hand to pick and choose from new opportunities,” Song says. 

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• Topics
• Exits
• PIPEs
• Financing
• Greater China
• Southeast Asia
• Temasek Holdings