SDB's Choice

The capital injection is welcome by SDB. The bank will "benefit from the new shareholder in several aspects, and the primary one is a rise in its capital base," the bank's Chairman Frank Newman told Caijing.

Shares in Ping An and SDB resumed trading June 15, three days after the public announcement. Although the former saw mixed price movement, the latter's stock price soared.

The private placement will boost SDB's capital pool by between 6.7 billion and 10.7 billion yuan, raising its core capital adequacy ratio as high as 8.8 percent, and its capital adequacy ratio to a range of 10.7 to 12 percent, more than 10 percent above the regulatory threshold. 
 
Over the past five years, SDB's development was hampered by a capital shortage. Newbridge's Shan said the problem led to inadequate investments in some key areas, including efforts to expand SDB's network and upgrade the IT infrastructure.

First on Newbridge's agenda after becoming a SDB shareholder was to beef up the capital pool. "It looked like the capital ratio was 2.3 percent at that time, but many hidden toxic assets made the actual capital ratio even lower," Shan said.

But Newbridge faced a funding dilemma. China's banking rules say a foreign investor cannot hold a bank stake greater than 20 percent, which gave Newbridge little room for additional investment in SDB. The rules also limit any combination of foreign investors to less than 25 percent. And Newbridge feared adding Chinese investors would jeopardize its role as largest shareholder.

Several efforts to inject extra capital into SDB failed. General Electric signed a contract with SDB in 2005 to infuse US$ 100 million by buying the latter's new issue. But nationwide shareholder reform delayed the issue for two years, during which SDB's share price rose to more than 30 yuan from 5 yuan. GE's investment was declared dead in October 2007.

A month later, SDB said it would sell 120 million shares to Chinese steelmaker Baosteel for 4.2 billion yuan. But regulators rejected the idea of an industrial firm's capital moving into banks, so the plan was abandoned in 2008.
 
SDB had another capital-raising option – subprime bonds. But capital adequacy ratio rules affected the plan. A total 9.5 billion yuan worth of bonds sold in three tranches, but even that was not enough to pump up the capital pool significantly.

The bank can't rely on the capital market, Shan said, but there has to be a "permanent, stable source of capital" for SDB's development.

Remaining Uncertainties

Ping An has a long way to go before incorporating SDB into its financial empire. Market analysts think that, sooner or later, SDB will acquire Ping An Bank, raising Ping An's stake in SDB to more than 50 percent.

Most of Ping An's subsidiaries are wholly owned, which lets the parent consolidate financial reports, improve synergy and avoid business duplication. It now holds 90 percent of Ping An Bank, and market insiders think the same thing will happen to SDB.

Ping An's Sun said the two banks will operate separately for now while sharing a back office. In the future, it can choose from several business models, including full merger, but Sun said it's too soon to consider such details.

Hu has proposed a sweeping deal in which Ping An would give a tender offer to all SDB shareholders, allowing them to choose between cash and Ping An's share. "After that," he said, "an incorporation of Ping An Bank and SDB would be very smooth."

Such a scheme would face no legal barriers in China, but precedents are rare. In addition, the size of the latest deal, Ping An's dual listing status on the Hong Kong and Shanghai bourses, as well as Newbridge's role as a foreign investor, would certainly invite controversy and prolonged regulatory review.

These realities prompted Newbridge and Ping An to compromise and choose the current takeover plan. SDB shareholders approved the private placement plan June 29.

1 yuan = 14 U.S. cents