Year Of The Citi In China?

Its bid for an insolvent Chinese bank could change the banking game in China in its favor -- big-time

It has been the mating of the mighty with the mighty. Some of the world's biggest commercial and investment banks, including HSBC Holdings (HBC ), Goldman Sachs (GS ), American Express (AXP ), the Royal Bank of Scotland, and Bank of America (BAC ), have spent billions buying strategic stakes in China's biggest financial institutions, including China Construction Bank, Bank of Communications, and Bank of China. The Westerners want access to Chinese depositors and their savings of $1.8 trillion. They also want to help China's biggest banks go public, and enrich themselves in the process: The initial offering of China Construction has already made a ton of money for BofA. Now, Bank of China has just gotten the government nod to raise $8 billion later this year. That will fill the bank's coffers and hugely benefit its key American partner, Merrill Lynch & Co (MER ).

But someone's missing from the dance card: Citigroup (C ), a bank with ties to China dating back to 1902 in Shanghai, and a record of making big bets in expanding markets such as Mexico. Citi has balked at signing on to big partnerships with the Chinese majors (it pulled out of negotiations with China Construction Bank last year, for example). It has always insisted on having a big managerial voice, which is something the major mainland banks are reluctant to give away. As a result, all Citi has to show for its efforts in China is about 5% in midsize Shanghai Pudong Development Bank, for which it ponied up a paltry $67 million in 2003.

Now Citi is hoping to hear in the coming weeks from Chinese authorities on a bid it made in October for another regional player, Guangdong Development Bank. Just another consolation prize? Maybe not. The unusual thing about the Guangdong bid: Citi and a group of investors including The Carlyle Group, a U.S. private-equity firm, want 85%. Acquiring outright majority control of a Chinese bank would be a first for a foreigner, and possibly prove to be a game-changer.

Citi needs a bold play. True, it has made some headway, expanding its own branded network of retail branches as well as outlets that focus on corporate lending and investment banking services. Two years ago it joined with Shanghai Pudong to launch a successful dual-currency credit card that customers can use to pay in yuan at home or in foreign currencies abroad. Last September, Citi forged a tieup with China Unionpay Co., a national bank-card association, which gave Citi cardholders access to its partner's vast ATM network on the mainland. Robert Morse, managing director and chief executive of Citi's Asia Pacific Corporate & Investment Bank, told analysts late last year that Citi's branded businesses in China are not only "highly profitable" but have delivered 39% average annual growth rates over the past three years.


Yet mainland China generates only 2% of Citi's Asian revenues, vs. 12% from Hong Kong, 14% from South Korea, and 10% from India -- all smaller economies than China's. Citi's Asian operations generated an impressive $2.6 billion in earnings in 2004 (bigger than Lehman Brothers Inc.'s (LEH ) worldwide profit) on $7.6 billion in revenues. Those numbers would be even more robust if Citi could manage to develop a sizable mainland presence.

So now Citi Chief Executive Charles O. Prince III has given the green light to a more aggressive China strategy. The New York behemoth is leading a group that wants to pay some $3 billion to acquire control of Guangdong Development, a commercial lender that's basically insolvent after years of extending credits to favored companies. On the plus side of the ledger, though, Guangdong is based in Guangzhou, right smack in the country's second-richest province, where all foreign players want to be. Better yet, it has a 520-plus branch network. To land the bank, Citi will need a special exemption from Beijing to the 20%-to-25% investment caps imposed on foreign investors, something its rivals and Western governments have long pressured Chinese President Hu Jintao's government to do.

To win its bid, Citi has launched the usual corporate charm offensive waged by Prince and Robert E. Rubin, former Treasury Secretary and Citi director and door-opener-at-large, who have personally lobbied Chinese officials. Its main argument is that someone needs to rescue Guangdong. At least 20% of Guangdong's loan book, or up to $6.2 billion by some estimates, is nonperforming. That burden is roughly four times larger than Guangdong's entire capital base. "The problems at this bank run very deep," says May Yan, vice-president and senior analyst with Moody's Investors Service (MCO ) in Hong Kong.

And while the central government has injected $259 billion into big national state-owned banks to clean them up, it has been reluctant to do costly salvage jobs on regional lenders like Guangdong. Guangdong officials don't want to touch the bank, either. That official aversion to a bailout could tip the balance in favor of Citi, even though it still faces a rival bid from Société Générale of France and domestic bidders.

If the deal goes through, Citi will suddenly have a key advantage over those globe-girdling rivals like HSBC who have bested it in China so far. It will have carte blanche in turning around Guangdong and won't have to contend with all the political considerations and institutional resistance that foreign minority investors have had to deal with at other Chinese banks. Citi would install its own management team, while a booming coastal economy would likely mean continued double-digit growth in customer deposits.

Guangdong, established in 1988, would certainly need a complete overhaul in lending practices, information technology, and customer service. But once it cleaned house, Citi could make a go of distributing its array of loan and credit-card products and build a nationwide branch network. In contrast, Bank of America doesn't have managerial control of China Construction -- and it had to abandon its ambitions for its own mainland retail strategy to secure the partnership with CCB.

The attractions for Citi aren't just on the retail front. It could also lure the bank's corporate clients to its investment banking services, which already have a track record on the mainland. Citi, for instance, scored big by providing merger advice and underwriting services for China National Petroleum's $4.2 billion buyout of PetroKazakhstan Inc.

Acquiring control of Guangdong will change the field in other ways. If Citi wins the approval it covets, other foreign banks are certainly going to demand a wholesale lifting of the 20% cap on their current and future deals. Song Guoqing, an economics professor at Beijing University's Center for Economic Research, thinks a successful turnaround at Guangdong could also give Chinese officials political cover for more such takeovers. "If this went well, other [foreign] banks might also have this opportunity," he says. It's not the biggest deal of 2006. But if Citi bags Guangdong, it could be one of the most important.

By Brian Bremner, with Dexter Roberts in Beijing

— With assistance by Dexter Roberts

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