The auction of Guangdong Development Bank, set to be the first sale of a majority stake in a Chinese bank, isn't likely to be completed until the first quarter of 2006 as the local government plans to re-capitalize the State-owned institution first, said people familiar with the situation.

But the stake sold in the bank could be well over 75 percent, as regulators make an exception to the 25 percent cap on foreign holdings in local banks to allow the Guangdong lender to improve its capital adequacy ratio.

In its plans earlier this year, the Guangdong Provincial Government was aiming to sell 51 percent to foreign investors.

"This will be a two-step transaction, with the local government first re- capitalizing the bank and then new capital being put in from the winning consortium of bidders," said one source.

"The stake the winning bidders will buy and the ultimate valuation of Guangdong bank depends on how much the government is putting in, and at the moment, the government has decided not to put in as much capital as originally planned, so the consortium could end up with more than the 51 percent originally planned," he added.

Guangdong Development Bank is the 11th largest in China in asset size with 344.5 billion yuan in assets last year and is a major lender in China's affluent Guangdong Province.

Unlike other major banks that have obtained Hong Kong listings, such as Bank of Communications Ltd. (BoCom) and China Construction Bank Corp., Guangdong bank is selling its strategic stake to foreign investors without disposing of its bad assets.

"The bank is under water, but the government plans to relax the rules for foreign ownership for Guangdong, although it will definitely be an exception," said another source. "It wouldn't want HSBC, for instance, to gain control of BoCom, which is China's fifth-largest bank."

Last year, HSBC Holdings acquired 19.9 percent of Shanghai-based Bank of Communications, with an agreement that its stake could double after 2008 if regulations change.

The Central Government currently limits a single foreign investor to 20 percent ownership of a Chinese bank, and total foreign holdings to no more than 25 percent, according to the China Banking Regulatory Commission. If the combined foreign stake exceeds 25 percent in an unlisted Chinese bank, then that bank is treated as a foreign bank, with restrictions on its ability to lend and take deposits in yuan.

Former frontrunner for Guangdong Development Bank, DBS Group Holdings, has pulled out of the bidding because its bid was too low, leaving three bidders, Citigroup Inc., ABN Amro Holding and Societe Generale SA to vie for a stake in the bank through joint ventures with Chinese partners, the sources said.

"But DBS could come back in if it wants to bid higher," said a source.

Citigroup is planning to partner with a Chinese State-owned company. ABN Amro is in a consortium with Ping An Insurance (Group) Co. of China Ltd., China's second-largest life insurer by revenue after China Life Insurance Co., and Societe Generale is eyeing a tie-up with China Huawen Enterprises Development Corp., an investment company owned by the People's Daily.

China's regulators have been eager to bring in foreign investors to allow the Guangdong lender to improve its capital adequacy ratio, sources said.

As it stands, in order for Guangdong bank to increase its capital adequacy ratio to the minimum requirement of 8 percent, it would have to sell up to 50 percent of its share capital, and a month ago, sources said the bank was thinking of selling 51 percent.

"Now depending on what the local government puts in, the stake could be much higher, and the bank will likely even issue new shares," said a source.

At the moment, the sole Chinese bank with foreign management control is Shenzhen Development Bank, which is 17.89 percent-owned by Newbridge Capital Inc.

Guangdong bank was founded in 1988 and has 26 branches across China. It had total assets of 344.5 billion yuan at the end of 2004, according to its Web site.

Editor: Donald