China Merchants Bank has been put on review for a credit-rating downgrade by Standard & Poor's.

The rating agency is considering the impact on the bank's core capitalization that acquiring Wing Lung Bank will have.

Standard & Poor's Rating Services (S&P) said that it has placed its "BBB-" long-term counterparty credit rating and "A-3" short-term rating on China Merchants Bank (CMB) on CreditWatch with negative implications.

China Merchants Bank's acquisition of Wing Lung Bank in Hong Kong is expected to have a far-reaching impact on the bank's core capitalization. Bloomberg

"The acquisition will have a far-reaching impact on CMB's core capitalization - depending on the bank's future capital plan, targeted asset growth and internal capital-generation capacity," said Liao Qiang, a credit analyst with S&P.

Earlier this week, CMB agreed to buy 53.1 percent of Hong Kong-based Wing Lung for HK$19.3 billion, and the price is equivalent to about 2.91 times the net book value of Wing Lung. The bank needs to make a general offer to buy the rest of the shares, S&P said, and the whole deal leads to a total cash consideration of 32.4 billion yuan.

If funded by a subordinated debt issuance, CMB's ratio of adjusted total equity (ATE) to adjusted assets will significantly decline to 3.39 percent, down from 5.12 percent at the end of the first quarter, mainly because of a goodwill charge of about 21.22 billion yuan.

CMB's rating could be lowered if it simply relies on internally generated capital to restore its capital strength, and if the pace of restoration is slow.

Shares in CMB lost 1.42 percent to close at HK$27.85.

HSBC said in a research report that the acquisition via sub-debt financing will lead to higher interest expenses for CMB, diluting its net interest margin (NIM) and lowering its return on equity (ROE).

As the deal is expected to be completed in the third quarter, the financial impact on CMB will be limited this year. HSBC has reduced the NIM by 19 basis points to 3.16 percent in 2009. It also forecasted the medium-term ROE to drop from 32 percent to 29 percent, reflecting the lower returns and higher book value. The target price of CMB was reduced by 9 percent, from HK$36 to HK$32.85.

Merrill Lynch said in a research report that CMB will need to raise capital by debt issuance, and the interest expenses will largely offset Wing Ling Bank's contribution to CMB's earnings per share.

(HK Edition 06/05/2008 page2)