Temasek to Buy BofA's CCB Rights - Analyst Blog

Temasek Holdings, Singapore's state investment firm, said on Thursday that it will purchase Bank of America Corporation's (BAC) entire entitlement in China Construction Bank's (“CCB”) upcoming 61.6 billion yuan ($9.3 billion) rights issue, Reuters reported.Temasek, the third largest shareholder in CCB with a 5.65% stake, is taking the step in an effort to increase its investments in emerging markets.

On the other hand, BofA is selling its rights to Temasek as it intends to raise funds to fortify its balance sheet. Besides, BofA's participation in the rights offering would have made the company feel the rage of the U.S.taxpayers, who have paid hundreds of billions of dollars to bail out the bank, as a subscription to the rights issue will drain the money out to China while lending to national consumers is the chief necessity for the U.S. economy.

BofA, the second largest shareholder in CCB after the Chinese government, currently owns a 10.95% stake in the Chinese bank. CCB is China's second-largest lender by assets after Industrial & Commercial Bank of China Ltd. However, in order to avoid a dilution of its stake, BofA would need to pay roughly $1.0 billion.

As of September 30, 2010, CCB's capital-adequacy ratio was 11.64%, almost in line with the regulatory minimum requirement of 11.50% for major lenders in China. Following the rights issue, CCB's capital-adequacy ratio will increase to about 12%. According to CCB's vice president Pang Xiusheng, the proceeds from the rights offering would be sufficient to meet the bank's capital demand over the next two years.

Chinese banks plan to raise a total of more than 320 billion yuan through rights issues and convertible bond sales this year. Like CCB, many other domestic lenders are in the process of strengthening capital level by initiating rights issues and selling bonds.

One could say that the sale of rights to Temasek is the better course for BofA to follow as it is an existing shareholder of CCB, and this way it will be able to protect its capital adequacy ratios (CAR) to comply with the upcoming tougher banking regulations (Basel III). However, we think its participation in the CCB rights issue could have significantly improved its financials in the long term with the growth of the Chinese banking major in the emerging markets, especially in the fast-growing Asian economies.

BofA's third quarter 2010 earnings came in at 27 cents per share, substantially ahead of the Zacks Consensus Estimate of 16 cents. This also compares favorably with the loss of 26 cents in the prior-year quarter.

Earnings for the quarter leave out a non-cash, non-tax deductible goodwill impairment charge of $10.4 billion. Considering this charge, BofA reported a net loss of $7.3 billion or 77 cents per share, compared with a net loss of $1.0 billion or 26 cents per share in the year-ago quarter.

Lower credit costs, higher net interest income and increased mortgage banking and card income were primarily responsible for the better-than-expected results. However, higher non-interest expense, pressure on trading income, lower service charges and reduced insurance income were the primary offsetting factors.

The BofA stock maintains a Zacks #3 Rank, which translates into a short-term ‘Hold' recommendation. Also, considering the company's business model and fundamentals, we have a long-term “Neutral” recommendation on the stock.