HONG KONG: Bank of China (BoC) has found a clever way to plug a looming hole in its balance sheet. It is issuing capital at what looks like a good price now, and leaving room for its majority shareholders to buy new shares at a favorable price later.

The mainland lender said on Friday it plans to issue a $5.9 billion convertible bond, and would ask shareholders for approval to issue new shares worth $29 billion at current prices. The convertible alone should push up the bank's capital adequacy ratio, the measure the regulator focuses on most, from last September's 11.6 percent to 12.5 percent.

BoC was already ahead of the official minimum ratio of 11 percent, behind peers ICBC and China Construction Bank. The new capital will allow BoC to contribute to the $1.1 trillion of loans the government wants banks to issue in 2010. Indeed, BoC could take on 10 percent of that - roughly in line with its current market share - and keep its capital ratio close to 11 percent.

The lender has cleverly exploited a price discrepancy too. Its Shanghai shares traded at a 22 percent premium to the Hong Kong variety, at Friday's close. By pegging the convertible to the more expensive of the two, it can issue 18 percent fewer shares. The coupon, set at a maximum of 3 percent, is cheaper than previous issues of subordinated debt.

Huijin, the State-owned fund that owns 67 percent of BoC's shares, does well too. Even if it puts in no new cash, the convertible will dilute its stake by no more than 2 percentage points. A premium strike price and incomplete conversion could mean no dilution at all.

Moreover, if BoC later issues equity through a top-up rights issue in Hong Kong, Huijin might pick up enough shares to restore its stake on the cheap. That option is not open to most mainland investors. Recent purchases of BoC shares below the current price show Huijin has an eye for a bargain; BoC's capital raising may show it to be a pretty shrewd trader too.

Bank of China revealed plans to raise $5.9 billion through the issue of a convertible bond, convertible into the Shanghai-listed shares. It also said it would request shareholder permission to increase its equity in Shanghai and Hong Kong by 20 percent.

Holders could exercise the convertible from six months after it was issued, and it would have a maturity of six years. The conversion price would be set no lower than the twenty-day average price, and or the previous day's average price - with a maximum coupon of 3 percent.

The majority of BoC's shares are listed in the mainland. The remaining 29 percent listed in Hong Kong. Huijin, a state-backed fund, owns 96 percent of the A-shares, giving it a total stake of 68 percent. Huijin would have no pre-emptive right to buy into the convertible issue.

Reuters

(HK Edition 01/26/2010 page4)