Dealtalk: China financials pressured as lock-ups expire

HONG KONG (Reuters) - Chinese financials face mounting pressure in the coming weeks as lock-up periods on an estimated $35 billion worth of stock expire, potentially unleashing a flood of shares into a market wary of swelling bad debts and slowing growth.

The success of such large block sales from cornerstone investors will hinge largely on timing of the sale, especially given the volume of stock coming out of expiry from just one sector.

Among the big block of shares that could potentially hit the market include $6 billion worth of Agricultural Bank of China (1288.HK), about $7.7 billion of insurer AIA Group Ltd (1299.HK) and some $2.6 billion in China Pacific Insurance Group Ltd (2601.HK) from Carlyle Group CYL.UL.

"It will be a hard sell given the negative sentiment for Chinese bank stocks," said Mike Werner, an analyst with Sanford Bernstein.

The sales overhang are putting further pressure on financial stocks which have already been underperforming the broader market this year, partly on concerns of slowing loan growth and mounting worries about bad debts.

The Hang Seng Composite Index of 13 financial companies .HSHFI is down 5 percent on the year, underperforming 1.1 percent fall in the broader market .HSI, pushing valuations close to the troughs last seen during the financial crisis of 2008.

On average, Chinese bank shares have underperformed 8.5 percent their peers in the four weeks leading up to the lock-up expiry, according to Werner's calculations.

STAY OR GO?

For cornerstone investors, the dilemma is whether to take some money off the table or hang in there to see if the underperforming bank stocks will rebound. Inevitably, a potential hangover will keep the pressure on stocks.

Cornerstone investors commit to investing in an initial public offering before its price determined but they get firm allotment and in exchange they agree to a lockup - usually six to 12 months. The dominance of mutual funds in the U.S. and European IPO markets precludes the need for cornerstones there, so this kind of early investor is unique to Asia.

Singapore state investor Temasek Holdings TEM.UL this week underscored the importance of moving quick and first by selling $3.6 billion of shares in China Construction Bank (CCB) (0939.HK) and Bank of China (3988.HK), outmaneuvering other large investors in the process.

Its move may have stymied plans by Bank of America Corp (BAC.N), which is widely expected to sell at least part of its $22 billion holding in CCB and might have been looking at the Singapore state fund as a possible buyer of the stake.

BofA's lock-up in CCB shares expire in August end, while some cornerstone investors in AgBank will be free to sell their holdings on July 15. A BofA spokeswoman declined to comment on its shareholding in CCB.

Other foreign banks have sold their IPO and pre-IPO stakes in Chinese lenders over the past two-and-half years. Goldman Sachs (GS.N) has partly exited from Industrial and Commercial Bank of China (1398.HK), while UBS (UBSN.VX) and Royal Bank of Scotland (RBS.L) sold their holdings in Bank of China.

The prospects of massive block deals have spurred the equity capital market desks of investment banks into action, as they scramble to win the next big deal.

"Now is a great opportunity," said a banker whose firm participated in several large block sales in Hong Kong in recent months. "There will be a large supply of IPO paper and other selldowns in the second half, so the ability to get the best pricing may not be that good."

The question is whether big sovereign wealth funds, such as Qatar Investment Authority and Kuwait Investment Authority, hang in the for stocks to rebound.

"The expiration of the lock-ups will create a lot of uncertainty in many of those shares," said Adrian Lim, senior investment manager at Aberdeen Asset Management's Asia Pacific ex-Japan. "The natural reaction is that the share prices will fall, but that's more of a short term thing," he added.

But bankers pitching for such block deals are confident that the market can absorb more sales. They cite the sector's cheap valuation as a strong reason to buy the stocks. To top it, most block deals are offered at 4-5 percent discount to the market price, making the purchase more attractive, they argue.

BofA's potential sale of CCB stake is of particular concern for investors as reflected by a 10 percent fall in the stock this year. That makes it the worst performing bank stock this year among China's top four lenders.

CCB now trades at 7.1 times forward earnings, a 43 percent discount to its historical levels.

Even at such depressed levels, any sale would represent a healthy return for BofA, which paid just $3 billion for its entire holding in 2005.

Investors are betting that BofA will sell part of its holding to boost its core capital. Cornerstone investors in banks and insurers have no such compulsions, though the worry for them is the deteriorating macro economic environment in China. Moody's last week threatened to cut Chinese banks' ratings amid worries about their exposure to local government debt.

Given all that, a 23 percent rise in AgBank's Hong Kong shares since listing and a 43 percent surge in insurer AIA could tempt some investors to book profits. But institutions deciding to pare exposure will have to make a quick decision.

(Additional reporting by Vikram Subhedar; Editing by Lincoln Feast)