CITI'S RICHARD STANLEY ON GDB AND BANKING IN CHINA

C O N F I D E N T I A L SECTION 01 OF 05 SHANGHAI 007112 SIPDIS E.O. 12958: DECL: 11/30/2031 TAGS: EFIN ECON PREL PGOV PINR CH SUBJECT: CITI'S RICHARD STANLEY ON GDB AND BANKING IN CHINA REF: A. SHANGHAI 5625 B. SHANGHAI 1354 CLASSIFIED BY: Mary Tarnowka, Political/Economic Chief, U.S. Consulate Shanghai, State Department. REASON: 1.4 (b),(d) ¶1. (C) Summary: On December 1, Citibank China CEO Richard Stanley updated a visiting Federal Reserve Bank (FRB) delegation led by Governor Kevin Warsh on the status of Citi's efforts to purchase a minority stake with management control in the Guangdong Development Bank (GDB). According to Stanley, the deal, signed on November 16, needed to be finalized no later than December 18, and could potentially be part of the deliverables for the December 14-15 Strategic Economic Dialogue (SED) meetings in Beijing. To meet this deadline, Guangdong Province, responsible for removal of about USD 7 billion in bad loans, would need to sell its stake in Southern Grid and deposit the cash in GDB by December 10. Stanley also described Citi's China business strategy and, with his usual candor, outlined Citi's views on some of the challenges facing foreign banks in China, including the new banking regulations. He encouraged USG officials participating in the SED to take a "publicly accommodating, privately tough" stance in convincing China to continue to open up it is market to the world. End summary. ¶2. (SBU) As part of a recent visit to Shanghai to assess macroeconomic and financial sector development, FRB Governor Kevin Warsh, San Francisco FRB President Janet Yellen, and VPs Rueven Glick and Teresa Curran, accompanied by P/E Chief and Econoff, met with Citibank China CEO Richard Stanley and VP Christie Ho on December 1. -------------- Citi's Three-Pronged Strategy for China -------------- ¶3. (SBU) Stanley outlined Citi's three-pronged strategy for continued growth in China. He identified these as: 1) Citi's own organic growth; 2) its relationship with the Shanghai Pudong Development Bank (SPDB); and 3) its efforts to acquire a minority stake with management control in GDB. -------------- -- Citi's Organic Growth as the American-flag Bank -------------- -- ¶4. (SBU) Stanley said that Citi's top priority would be to continue to enlarge its organic (independent Citibank) growth, and take advantage of its 104-year history in China using its well-known brand, which in Chinese meant "American-flag Bank" (Huaqi yinhang). According to Stanley, Citi had 3,000 employees located in six cities across China. He expressed continued frustration with the obstacles Citi had encountered opening up new branches, noting that other countries' foreign banks seemed to be allowed to expand more rapidly, and said that the approval of "a branch or two" of a Chinese bank in the U.S. would help Citi's approval process here in China. Warsh and Yellen smiled, noting that had heard similar suggestions in their meetings with People's Bank of China (PBOC) and China Banking Regulatory Commission (CBRC) in Beijing. -------------- Citi's Stake in SPDB -------------- ¶5. (C) Stanley said Citi's second priority was to develop its "synthetic joint venture investment" in SPDB. Stanley explained that Citi's initial 4.9 percent stake, acquired in 2002, had been reduced to a 3.2 percent stake, due to non-tradable share reform. The main business of the investment was a joint credit card operation, which had 700,000 cardholders. Stanley explained that the business was doing well now, but had been delayed at the outset. Apparently former CBRC Chairman (now Tianjin Mayor) Dai Xianglong had approved the credit card JV, but Liu Minkang tried to stop the deal, resulting in the business not being launched until 2004. Stanley said that while he sat on the board of directors and Citi had employees seconded to the SPDB as advisors, the day-to-day management was done by SPDB. Stanley noted SPDB was already listed on the Shanghai Stock Exchange and planned another listing, and said Citi had the option to increase its stake to 19.9 percent, and would do so likely when the price dropped. -------------- Citi's Efforts to Acquire a Stake in GDB -------------- ¶6. (C) Stanley was most excited by the third part of Citi's growth strategy, the contract to acquire a 20 percent stake in GDB, signed on November 16. According to Stanley, the deal would give Citi an option to purchase up to a 65 percent stake, exercisable "the minute the law changes." Stanley said, although the Central Government clearly wanted to retain a majority stake in the Big Four or Big Five Banks at least for the medium-term, it had expressed an intent to raise the ownership caps on foreign ownership in other Chinese banks. Stanley's conversations with National Development and Reform Commission staff led him to believe that 3-5 years out, the cap still might be around 49 percent, but that eventually majority foreign ownership would be allowed. Once Citi had more than a 50 percent stake, it would merge GDB into Citibank China, and possibly list it, as it had done with similar acquisitions in other counties. Under a worst case scenario, it would just list and take its money out. From Stanley's perspective, however, GDB was "a long term investment" in building Citi's penetration into China's market. According to news reports, GDB had 500 branches, 12,000 employees and USD 48 billion in assets. Stanley said GDB had about USD 100 billion in loans and about USD 40 billion on its balance sheet. -------------- Citi and GDB: Anatomy of the Deal -------------- ¶7. (C) Expressing thanks for continued strong USG support, from Treasury Secretaries Paulson and Snow, Commerce Secretary Gutierrez and Ambassador Randt, Stanley said that Citi and GDB signed the take-over contract on November 16 and were scheduled to close the deal by December 18. He said there had been some discussion of including the signing in the SED meetings and he was certainly supportive. He recollected spending the prior Christmas holiday in negotiations and said he did not want to repeat that experience. He commented that someday, he and Christie Ho, would write a book about their negotiating experience, a la "Beijing Jeep." He noted that Citi, unlike its two competitors for the GDB deal, continued to be a tough negotiator. Societe General was ready to sign whatever was offered and Ping An had offered an additional USD 800,000 after bids were closed. Stanley said he thought China's financial leaders were willing to accept Citi's terms because 1) they wanted to do something for the United States, and 2) they wanted a capable partner who could turn the bank around as a showcase. ¶8. (C) Stanley explained that Citi, and its consortium partners, agreed to purchase 85.6 percent of GDB for about USD 3.1 billion. Citi would own 20 percent and International Business Machine (IBM) would own 4.7 percent. Stanley commented that CBRC had raised some concerns about Citi's financing of a portion of IBM's stake, but he didn't think they were serious since Citi had always been very transparent about this and IBM was also obtaining some financing from unrelated parties. According to reports in Caijing, an influential Chinese business periodical, Citi's other partners include China Life Insurance Company (20 percent share),National Electricity Net (20 percent share),Puhua Investment Company (8 percent share),and Cititrust (12.8 percent share). ¶9. (C) The deal was scheduled to close by December 18 after GDB resolved the issue of 58 billion RMB (about USD 7 billion) in nonperforming loans (NPLs),what Stanley referred to as "the core cancer." The adjusting entry to handle the write-off was supposed to occur by December 10 to allow GDB's auditor, KPMG, time to review the financial statements. Stanley said that Citi already had a 100-person transition team in Guangzhou working with GDB. He said that business had basically been frozen this year but that the transition team now had the opportunity to review any new big loans before they were issued. ¶10. (C) Stanley also indicated that, what he had once termed "the worst Bank in China" (ref B) was actually in better condition than he had expected. He said although there were "legacy problems" in Guangdong, the branches in Shanghai, Hangzhou and Nanjing were relatively well-run. KPMG had been auditing GDB for three years and was ready to give it a clean opinion -- provided the cash came in to write-off the NPLs. Stanley told Warsh that Citi had actually been hoping for a more conservative classification. Nonetheless, he said that after KPMG and Citi had gone through GDB's books, there were only "a few hundred million RMB" in loans that they could not agree on. He said this was "really amazing" given GDB's reputation. ¶11. (C) Under the terms of the agreement, GDB's board would elect Citi's Michael Zink, currently Citi Korea Senior Executive VP for Corporate and Investment Banking, as President later that afternoon. There would be 17 total directors -- 14 executive and three independent. Citi could nominate six directors, five executive and ONE independent. The three executive directors would include Zink, a tough-talking Citi risk management expert from North Carolina, and a consumer banking expert from Citi's Singapore operations. ONE of the independent directors Citi would bring on was Y.S. Wong, who had retired after 35 years of experience with Citi as a risk management expert. Stanley said Chinese officials openly admitted that Citi would have management control. The President would have the ability to appoint a new management team, and hire and fire staff. While Citi could nominate the bank's chairman, it currently planned to retain GDB's chairman for the next ONE and half years to see through the transition process. ¶12. (C) Stanley said that at the working level, GDB employees were "welcoming Citi like the arrival of the Savior." He estimated that it would take Citi ONE year to implement basic compliance and anti-money laundering policies and a more-robust audit process. Stanley observed that the biggest challenge was human resources. He said that all of GDB's branch managers located in Guangdong were "political appointees," many of whom were responsible for the bad loans. Stanley said the Guangdong Deputy Party Secretary had advised Citi to "go in and fire two branch managers on the first day to show who is boss." -------------- -- Guangdong Province Has to Clean Up its Own Mess -------------- -- ¶13. (C) According to Stanley, GDB, the PBOC and the CBRC agreed that 58 billion RMB worth of NPLs would be resolved in a "pre-closing adjustment" prior to Citi's final signature. Stanley said these loans were too politically sensitive to ever see the light of day since he understood they were largely channeled to Guangdong's current and former leaders and their friends. In the end, the question came down to who would pay. Guangdong Government had tried to place the responsibility on the PBOC, but Chairman Zhou Xiaochuan had made clear that PBOC would only take care of the Big Four banks. CBRC acknowledged that the NPLs needed to be removed to make the sale, but had no money of its own. Eventually, PBOC told Guangdong's political leaders that they needed to clean up their own mess. The current plan was that Guangdong Province would sell its stake in Southern Grid and parts of the Guangdong Electricity Group to a State Grid and China Life consortium. The sale of these provincial assets was due to bring in roughly 50 billion RMB. The Citi-lead consortium would be responsible for the other 8 billion RMB. -------------- Stanley Never Sleeps, Wen is Weak; Hu is Sick -------------- ¶14. (C) An obviously exhausted Stanley described the hectic pace he had maintained over the past several months conducting his own brand of shuttle diplomacy in order to resolve the business and regulatory issues surrounding the GDB acquisition. He said he tried to start and end each week at the office in Shanghai, and traveled to Guangzhou and Beijing for meetings from Tuesday to Thursday. Part of the problem he encountered was that "PBOC and CBRC don't like each other" and kept asking Citi to relay messages and information back and forth. ¶15. (C) Stanley said that in his discussions in Beijing, he had heard that Huang Ju was sick with cancer and resided in Shanghai; Huang was "technically retired" and would probably be officially retired in March 2007. He also had heard that Hu Jintao was also "not healthy" and that the Party had begun the process of looking for the next generation of leaders. Stanley added that, compared to Zhu Rongji, Wen Jiabao was "a weak premier" and not effective in leadership circles. ¶16. (C) Stanley said that he had seen "radical political change in the last eight months" and a "general backlash against foreign investment." He mentioned that Huijin Investment Company CEO Xie Ping had come under a lot of criticism for pricing the China Construction Bank (CCB) sale of stock to Bank of America too cheaply (after BofA made large paper profits from the CCB listing on the Hong Kong exchange) and many other Chinese officials began to question why they should be so open to investment after the failure of the CNOOC and Dubai Port deals. Stanley said "hard line communists" now had more say in the governing process and the media had become "increasingly vocal in opposing foreign encroachment" in China's economy. He said China's leadership, to its credit, had taken a more populist tack in addressing issues such as the wealth gap, and environmental degradation. However, in the process, it had dismantled the more business-oriented polices of the previous government and tried to address these economic problems by "pouring money into fixed asset investment" through the hands of local party bosses. -------------- China's Financial Services Advisory Committee -------------- ¶17. (C) Stanley said that with Huang's sickness and Wen's weakness, all decisions about China's exchange rate, monetary policy, and interest rates were made by a twelve-person Financial Service Committee headed by State Councilor Hua Jianmin. He said that Hua was "a very mysterious guy" who Citi executives had never met, despite having previously employed his daughter, Hua Qin. PBOC Zhou Xiaoquan and CBRC Liu Minkang also sat on this committee. Stanley added that Zhou was quite open about the constraints on his power, sometimes stating, "If I was an independent Central Bank Chairman..." -------------- The Dribbling Pace of Banking Reforms -------------- ¶18. (C) Stanley said the November 28 regulations requiring foreign banks to incorporate locally to carry out RMB business were "not bad" and that Citi had undertaken local incorporation in other markets around the world. Citi looked forward to being able to conduct RMB business with Chinese citizens. The "dribbling out" process of releasing the regulations had caused lots of heartburn, but there had been many opportunities for Citi and others to provide comment. He noted that the new banking rules benefited banks, such as Citi, that were already established in China with capital. If a new bank wanted to open up in China, he said, it would be "virtually impossible to get in." "How could a bank be profitable for three sequential years if it couldn't do RMB business?" he added. ¶19. (C) Stanley said China was engaged in an ongoing process of de-politicizing its banks, but still had a long way to go. The FRB participants were delighted to hear Stanley note the increased teeth CBRC had gotten in requiring Chinese banks to reclassify loans, a process he had observed at SPDB. While generally optimistic on the reform path Chinese banks had taken, Stanley said that the "Big Four" Chinese banks would never entirely get out of the business of making "political" loans. He discussed the difficulty that Small and Medium Enterprises (SMEs) had in securing loans, despite CBRC policy support, quipping: "A bad loan to an SOE is patriotic -- a bad loan to an SME is idiotic." Banks, he said, have no incentive to make loans to SMEs and no real experience in making the forward-looking valuations necessary to effectively differentiate between good and bad companies. -------------- Less Progress on Capital Market Reforms -------------- ¶20. (C) Stanley said the security market was "still totally closed" except for investment banks profiting from cross-border listings in Hong Kong. He said the current stock market boom was "ridiculous." He observed that the high domestic stock and real estate prices merely reflected the excess liquidity caused by the failure of monetary policy and the limited types of assets available to soak it up, noting that bond market yields were zero. -------------- --- SED: Be Soft on the Outside, Tough on the Inside -------------- --- ¶21. (C) In response to a question by Governor Warsh, Stanley advised that U.S. officials coming to participate in December's SED adopt a posture that is "publicly accommodating, but hard behind the scenes." In his experience, he had found that it was never useful to "publicly beat them up," but that the USG should be "tough" on such issues as market access. He said it was in China's own interest to adjust its currency policy to manage its excess liquidity. Market access was the real problem, and if China didn't open up, its unchecked enormous trade surplus would increase the potential for U.S. or EU trade retaliation. Stanley said it was important that SED participants made clear that "We, in the Cabinet, are your friends, but we are getting fed up as well." He believed that Chinese officials "had the feeling that they need to be friendly to Americans," and would be receptive to such tough talk so long as it was presented privately and couched in terms of steps taken being in the mutual interests of both China and the United States. ¶22. (U) The FRB delegation did not have an opportunity to clear on this cable. JARRETT