I was in the air over the Pacific, bound for China in the dead of the night, when the pilot came out of the cockpit of our leased private jet to tell me I had an urgent call from the office. We had taken off only half an hour before after a brief refueling stop on the Kamchatka Peninsula, where I’d checked in with Julie Becht, my assistant, so I was surprised to be hearing from her again so soon.
Mike Evans and I were on our way to two days of meetings, beginning that morning in Hong Kong with the president of China’s massive state power company. It was planning to spin off its grid, which was responsible for transmission and distribution throughout the country, and we were hoping to win a piece of the business. Then it would be on to Beijing and meetings with members of the executive committee of Tsinghua University’s business school, as well as a breakfast with Zhou Xiaochuan, now heading the China Securities Regulatory Commission. Goldman Sachs was in the thick of preparations for the multi-billion-dollar restructuring of Bank of China’s Hong Kong assets, which involved the first international IPO of a Chinese bank. It was scheduled for February 2002, just under five months away, and it was meant to serve as the model for Premier Zhu Rongji’s plans to restructure the shaky banking sector. Zhou was the brains behind the financial reforms, and I was eager to discuss them with him.
I called Julie, who connected me to John Rogers, Goldman’s chief of staff, and I wasn’t on the line long before any thought of those meetings and deals went right out of my head.
“Hank,” he said. “A plane’s flown into the World Trade Center.”
Calm and precise as ever, John said he didn’t know whether it was an accident or something worse. But while I was on the line with him, I heard a loud shout in the background that I later learned had come from Goldman employees on the 22nd floor of our 85 Broad Street headquarters—a few blocks south of the World Trade Center—who were watching from our windows as a second plane crashed into the other tower. John had spent more than a decade in government service before joining Goldman in 1994. He said, “There’s no way it’s an accident now.”
I signaled to Mike. “Tell the pilots to turn the plane around. We’ve got to go back. Right away.”
The plane swung into a long curve and started flying east, but after a while it reversed course again. I asked immediately what was going on, only to be told that U.S. air space had been closed except to military aircraft. We understood just how serious matters had become. We had no choice but to proceed to Hong Kong.
The next few hours were interminable. We checked on our families—all safe—and every few minutes I called for updates, and, of course, the news kept getting worse. We learned about the collapse of the Towers, the attack on the Pentagon, the plane going down north of Shanksville, Pennsylvania, the mounting toll of death and destruction. Fortunately, we knew of no one at Goldman who had been hurt, although sadly, we would learn, a number of our staffers had lost family members. It was surreal: floating aloft in the filtered, humming quiet of a small private jet, just the pilots, Mike Evans, and I, full of questions, unable to get answers, unable seemingly to do anything useful, calling the office repeatedly with just one more thing we’d forgotten to ask about, all the while racing away from the very place I wanted to get back to as soon as I could.
We landed in Hong Kong at 7:00 a.m., having decided to go straight to our meetings. I wanted to show resolve and determination. And I wanted to lead by example. I didn’t want anyone to think we could be stopped by these attacks. In the car on the way in, I started drafting a voice mail to send throughout the firm to reassure our 23,000 employees worldwide. I knew they would be worried about family, friends, and colleagues from Goldman and other firms in New York.
My first meeting was a breakfast, at the upscale restaurant Felix on the top of Hong Kong’s Peninsula Hotel, with Gao Yan, the CEO of the State Power Corporation and a protégé of former premier Li Peng’s. I could not believe how indifferent he seemed to the news of the tragedy in the United States. When I mentioned the attack, trembling with shock and sorrow, he didn’t say a word. I mean not one word. He seemed far more interested in having the restaurant play a favorite song repeatedly on its sound system as he ate a huge breakfast. I excused myself a couple of times to get updates from John Rogers, who was still in the office, where he would spend every night until my return. I couldn’t wait for the meeting to end and free me from the presence of that self-absorbed, arrogant man. As it happened, barely a year later, Gao fled China in the wake of a $1 billion corruption scandal. He’s been a fugitive ever since.
Fortunately, Gao’s attitude was markedly different from that of the other leaders and executives I met or who called me expressing their condolences, their concerns for the U.S., our people, the markets. His rudeness was unlike anything I had ever encountered, before or since, from a senior official in China.
Mike and I rushed back to our Hong Kong office. Though I was relieved that no one at Goldman had died, I was concerned that our people were frightened and emotionally devastated by the horrific events of the day. Many were worried sick over friends and relatives who worked in New York. I made it clear that Goldman placed the highest priority on their personal safety, and I did my best to encourage everyone to look ahead and focus their energy in positive ways, contacting family and comforting friends. Mike and I had lunch with Antony Leung, the financial secretary of Hong Kong, then met with K. S. Li and C. H. Tung, who was chief executive of the Hong Kong Special Administrative Region. All had been watching the events on television, and they were shocked and saddened—and perhaps a little frightened, just as we were. The world was changing before our eyes, and no one could quite imagine what might come next.
I shelved my plans for Beijing and worked with John Rogers and my office to get us home fast. Meantime, I sent out a very personal voice mail to all of Goldman’s employees assuring them that I was returning in a few hours and that “we are going to go forward as a team and a firm that is strong… [and] a force for stability in a time of crisis.”
We were among the first overseas travelers allowed to fly back, because I ran a major investment bank and it was considered a matter of vital national importance to restart the markets, closed since the attacks. Mike Evans and I jumped on a NetJets plane in Hong Kong on Friday, September 14. When we stopped in Osaka to refuel, I recorded another voice mail in which I urged everyone to come back to lower Manhattan for work, saying simply, “We are returning to normal business operations.”
I remember vividly, as we flew over Alaska, and then across America, being accompanied by an F-16 fighter jet on each wing. We landed in White Plains, New York, and were met by Alex Noreddin, my driver, who asked if I wanted to go home to my apartment on the Upper West Side of Manhattan.
“No,” I said. “Straight to the office.”
It was a dripping, overcast day, and we sped through empty roads to the city and down the FDR Drive. When we cleared the barricades at Canal Street and entered the frozen zone near Ground Zero, I was shocked by what I saw, even though I had been trying to prepare myself: debris was everywhere, a storm of ash, the streets empty except for emergency and police vehicles, National Guardsmen, and the awful stench of burning.
The next few days were extraordinary. The U.S. bond market had reopened Thursday, and the bulk of our employees had returned to our offices, joining operations and technology teams that had been working day and night. But we had to go to great lengths to get people in. A Goldman Sachs crisis management team had organized ferries from New Jersey, buses with police escorts to pass through security cordons, and fuel trucks to supply our backup generators. We had another team working around the clock with the New York Stock Exchange to be ready for Monday, when the NYSE would open again for business. I was on the floor of the exchange with the heads of other Wall Street firms for the bell ringing, then literally ran back to be on our trading floor when we executed a big trade of Walt Disney Company shares.
It was, as I had anticipated, an ugly day for the markets, as investors’ pent-up fears exploded into a selling rout that saw the Dow Jones Industrial Average plunge by more than 7 percent, or 684.81 points—still the third-largest point drop in history. As rattling as it was, I was not overly concerned. I was confident in America and the resilience of our economy and financial system. I knew we would bounce back. I was relieved to see that the markets were functioning smoothly and that our people were coping with the shock and sorrow of those awful days. I was so proud of our team at Goldman, and frankly of all our colleagues at other Wall Street firms who were working so hard under unbelievably difficult conditions. I saw that no matter how hard we competed with one another, we were united by things even more fundamental and important: love of country, surely, but also a powerful, pervasive sense of shared humanity that made us all determined to prove that terrorists would not defeat us or weaken our resolve.
That day I worked the phones hard, calling Goldman partners and clients around the world. I ended with calls the next morning to Zhou Xiaochuan and to Wang Qishan, who had moved up from Guangdong to be director of the State Council General Office of Economic Reform, the nerve center of the government’s far-reaching economic changes. I wanted them to hear straight from me that we in the U.S. and at Goldman were undaunted. They and Premier Zhu Rongji and all of China could rest assured: we weren’t going to miss a beat. Their plans for reform would stay on track—at least as far as Goldman Sachs was concerned.
In Mao’s China there hadn’t been much need for commercial banks. The Ministry of Finance funneled money to state-owned enterprises, which handed profits back to the ministry in a stultifying, closed loop. Urban workers belonged to SOEs, which provided their basic needs directly. In the countryside farmers eked out a subsistence living and had little or no money. Household savings, at just 6 percent of GDP, were low for a developing country. Today they are half of GDP. (U.S. household savings, by contrast, account for 5 percent of GDP.)
One institution dominated the financial arena: the enormous, all-purpose People’s Bank of China (PBOC). It acted both as central bank—managing the money supply, setting interest rates, and overseeing the country’s foreign exchange holdings—and as a commercial bank, making nearly all the loans in China and holding four-fifths of all deposits. A few other financial institutions existed, vestiges of the pre-Communist economy that had been folded into the Ministry of Finance and the PBOC after 1949. Bank of China, founded in 1912—and until 1928 the central bank of the Nanjing Provisional Government and the Northern Warlords’ Government—had become a bureau of the PBOC concerned with foreign exchange transactions. The Agricultural Bank of China (ABC), formed in 1951 to finance rural projects, spent most of the next three decades as part of the PBOC. The Ministry of Finance created the People’s Construction Bank of China in 1954 to disburse funds for infrastructure and construction projects.
To switch from a command and control economy to one that is more market oriented requires commercial banks and, eventually, capital markets. Banks come first. They play a crucial role in allocating capital efficiently. They make loans to businesses and individuals, help depositors safeguard and grow their savings, and provide a host of day-to-day transactions—from letters of credit and trade finance to lockbox services and funds transfer—that most people don’t think much about but that grease the wheels of commerce.
With the start of Reform and Opening Up in 1978, China’s leaders set out to build a set of banks that would compete to provide a wider range of needed services. Bank of China and Agricultural Bank were separated from the PBOC and became stand-alone commercial banks operating directly under the State Council. In October 1979, the People’s Construction Bank was spun out of the Ministry of Finance (it would later be renamed China Construction Bank). In 1984 the State Council put through a series of reforms to make the PBOC act more like a traditional central bank. Its commercial activities were shifted to the newly created Industrial and Commercial Bank of China (ICBC), which immediately became China’s biggest bank, with more than 20,000 branches and offices and nearly half of all bank lending.
The idea was that the newly minted Big Four commercial banks—ABC, Bank of China, ICBC, and People’s Construction Bank—would provide financing for the SOEs as they grew out of the state economic plan. The banks would gradually exert greater discipline on the loans they made and the companies that borrowed from them. The approach proved to be flawed. The banks were created but the discipline was not. The 1984 financial reforms decentralized decision making, giving considerable discretion to local branch managers with scant training and no experience in operating profit-making enterprises. These executives were, moreover, under the thumb of local government and Party leaders, who were hell-bent on financing growth at all costs: their political futures—and personal well-being—depended on it.
The Big Four banks grew quickly, scooping up deposits from households made increasingly prosperous by burgeoning entrepreneurial activity and lending these funds to SOEs. This propelled breakneck growth and helped fuel the inflationary spiral that contributed to the unrest underlying the Tiananmen Square protests of 1989. Eventually, the feverish expansion would lead to mountains of bad loans.
Along the way, to gradually increase competition, a dozen joint-stock banks of modest size were created or reconstituted from prerevolutionary institutions like the Shanghai-based Bank of Communications, and in 1995 the State Council authorized another new class of banks, so-called city commercial banks that were owned by municipal governments. But the power of the banking system remained concentrated in China’s Big Four.
As he tackled inflation and introduced fiscal and tax initiatives, Zhu Rongji moved to reshape the banking system, aiming, among other things, to halt local government intervention in bank-lending decisions and to reform the central bank, whose departments had overlapping and conflicting responsibilities. Too frequently, provincial branches of the decentralized PBOC came under pressure to cover the losses at local branches of the Big Four banks. (The government would go on to introduce measures that shifted authority from local bank branches back to headquarters in Beijing, while a new central bank law revamped and strengthened the PBOC. Beijing would replace the 31 provincial PBOC offices with nine regional ones, whose presidents would be appointed by the central bank instead of local authorities.)
The government also created three new banks—the State Development Bank of China, the Export and Import Bank of China, and the Agricultural Development Bank of China. They were meant to finance government projects: roads, bridges, power plants, and the like. Such “policy” lending typically had higher default rates and had previously accounted for a third or more of the loans made by ICBC, the People’s Construction Bank of China, Bank of China, and ABC, which were now directed to focus strictly on making commercial loans.
Some of these well-intentioned moves fell flat. The new policy banks soon wanted to make commercial loans of their own, while the big commercial banks continued to have to contend with political pressure to prop up faltering industries, which led inevitably to poor credit decisions. The vast majority of their loans went to struggling state-owned enterprises, which increasingly used the money to pay operating expenses, while China’s dynamic but fledgling private enterprises went begging for credit.
Moreover, while the reforms were meant to improve future credit decisions, they did not address the problems already festering on the banks’ books, and the bill for these was rapidly coming due. Borrowing freely while hemorrhaging money, the SOEs had run up enormous debts, crippling the banks and threatening to derail economic growth and undermine China’s standing in world markets. By 1997 the government calculated that a staggering 25 percent of the Big Four’s bank loans were nonperforming. Later it would turn out that even this figure was a gross understatement: when the government began using stricter methods of loan classification, the proportion of bad debts rose to closer to 50 percent of loans.
The Asian financial crisis laid bare the problem. Countries in the region fell victim to a nasty mix of weakening exports and plunging currencies that accompanied the collapse of speculative property lending, widespread bank failures, and the specter of panicky global investors withdrawing their money. The shakiness of China’s banks led many to question whether the country would stumble, too. China was hit by the recessionary fallout of the crisis, and GDP and export growth slipped sharply, but China’s leaders vowed to stand strong. Zhu Rongji refused to devalue the renminbi, which would have made China’s exports more competitive but would have led to beggar-thy-neighbor devaluations throughout the region. Instead, he embarked on a vast program of infrastructure spending to stimulate the economy and moved to revamp the banking system.
In 1998 the government injected 270 billion yuan (roughly $32.5 billion), or more than 3 percent of GDP, into the Big Four banks to bring their capital levels up to the international minimum standard of 8 percent of assets. But bad loans still threatened the system, and the problem was too big for a simple fiscal solution. The total value of nonperforming loans (NPLs) far exceeded the government’s annual revenues as well as the country’s foreign reserves of $145 billion.
Goldman bankers, including Jerry Corrigan—a former president of the Federal Reserve Bank of New York, who served as co-chair of both our risk committee and our global compliance and controls committee—had begun conferring with the government on various solutions. They flew regularly to Beijing to share their experience and advice with government and banking leaders like Zhou Xiaochuan, who had been tasked by Zhu Rongji with taking the lead in devising a pilot for bank restructuring. The premier wanted a systematic plan that would address nonperforming loans, capital issues, and corporate governance across the industry. With Goldman’s help, the government studied various international models—including bad-loan workouts in Sweden, bank restructurings in Central and Eastern Europe, and the efforts of the Resolution Trust Corporation to deal with the U.S.’s savings and loan crisis in the 1980s.
Zhou designed a plan to move bad loans off China Construction Bank’s balance sheet and into a specially created asset management company that would try to recover what it could by selling assets, using debt-equity swaps, reorganizing the operations of defaulted borrowers, and employing other loan workout practices. In October 1999 the three other big banks set up their own asset management companies. By the end of 2000 the four AMCs had acquired more than a fifth of the loan portfolios of the big banks, or $170 billion, a whopping 15.5 percent of China’s 1999 GDP. This move shrank the nonperforming loans on the banks’ balance sheets, though it didn’t eliminate the problem.
Dealing with these staggering sums required some fancy financial engineering. To pay for the $32.5 billion recapitalization in 1998, the government resorted to the expedient of having the central bank lower the reserve requirements of the big banks, freeing up funds the banks could use to buy bonds issued by the Ministry of Finance. The Ministry of Finance then injected the funds back into the banks as capital. A similar circularity was used to deal with the nonperforming-loan problem. The asset management companies were capitalized with equity from the Ministry of Finance. They paid for their purchase of the bad loans by borrowing from the central bank and issuing low-coupon bonds that the banks themselves purchased.
The plan, which ultimately succeeded, was inspired if flawed. The asset management companies acquired the bad loans at face value but hadn’t a prayer of recovering anything on that order. Most of the loans were dreadful, and loan recovery rates would run closer to 20 percent, foretelling massive losses for the AMCs. The AMCs were empowered to swap debt for equity and take stakes in debtors, but they lacked the clout to force operating changes at the politically connected SOEs. Crucially, however, the asset management companies were not meant to wind down for ten years, and that allowed the Chinese to buy time, putting off any financial reckoning until they were better able to afford it.
The architect of the banking sector restructuring, Zhou Xiaochuan, had been on the front lines of reform for two decades and would go on to become, in 2002, the head of China’s central bank, where he still serves today. I first got to know Zhou in early 1998, soon after he had taken the reins at China Construction Bank. We had a lively discussion inspired by the IPO of PetroChina, which we were vying to lead-manage alongside China International Capital, CCB’s investment banking joint venture with Morgan Stanley. Tall and graceful, Zhou is a man of many talents: fluent in English, he learned to play a crack game of tennis in the 1980s, and he nurtures an abiding love of Western classical music, opera, and Broadway musicals (at one point, he compiled a guide to Western musicals with the help of graduate students).
A penetrating thinker, Zhou was also exceptionally well connected, always a huge plus in China. His father, a powerful official in the postrevolution First Ministry of Machine Building, had been an early mentor of Jiang Zemin’s, when the future Communist Party leader was a young official at the same ministry. Both of Zhou’s parents studied in the Soviet Union in the 1950s. They were central planners—his mother worked as an official in the Ministry of Chemicals—who developed a deep skepticism of the ability of central planners to effectively manage such a sprawling economy. Zhou’s graduate research would dissect, with mathematical models, the practical challenges of the command and control economy, analyzing what kind of information could be collected and correctly reported to the State Planning Commission, comparing resource allocation in planned and market economies, and examining incentive structures—or lack thereof—in top-down planned economies.
Zhou, his parents, and three siblings were scattered across China during the Cultural Revolution—all in different remote locations. He spent four years as a farm laborer in Heilongjiang Province in Manchuria, where the brutal winters last from October to May. Zhou found time to read and cultivate his love of music, listening to a 5-foot-tall stack of records that he managed to collect. As he told me once: “During the Cultural Revolution they tried to stop people from listening to classical music, but in the countryside, no one cared!” Most important, Zhou used those frigid sent-down years for introspection, to examine what was right and wrong in his country, and how people’s lives could be improved.
Beijing in the early 1980s was a fervid laboratory of experimentation, and Zhou, working toward his Ph.D. in automation and system engineering at Tsinghua University, emerged as one of a group of energetic young reformers, alongside his contemporary Wang Qishan. While Wang focused on rural reform, Zhou delved into pricing, trade, and foreign exchange issues, working with Zhu Rongji, then vice minister of the State Economic Commission, on plans for comprehensive reforms in these areas. After earning his Ph.D. Zhou began working in 1986 as deputy director of the Institute of Chinese Economic Reform Research and became a commissioner of the State Commission for Restructuring the Economy later that year. Along with Wang Qishan, Zhou was involved with the group of scholars and returnees from overseas who tried to set up a stock exchange in Beijing in 1988.
In 1991 Zhou Xiaochuan became vice president at the Bank of China, and his hand became increasingly evident in banking sector reforms after Zhu Rongji took direct control of the central bank in 1993. He co-authored a paper recommending the separation of commercial and policy-based lending before taking charge of China’s foreign exchange regulator, the State Administration of Foreign Exchange (SAFE), in 1995 and joining the People’s Bank of China as deputy governor the following year. The PBOC was in the process of being revamped into a more tightly managed operation modeled after the U.S. Federal Reserve System.
In 1998, after Zhu Rongji had dispatched Wang Qishan to clean up the financial mess in Guangdong, Zhou Xiaochuan took over China Construction Bank. The move positioned Zhou to implement the reforms he had helped design, since Construction Bank’s investment banking arm China International Capital Corporation would act as the lead or co–lead manager on China’s major restructurings and IPOs in the late 1990s. Relations with Morgan Stanley were tidied up, and the premier’s son, Levin Zhu, was appointed to the management committee of CICC.
Zhou continued to work on broader reform themes. In 1999, at Zhu Rongji’s behest, Zhou wrote a paper outlining a long-term plan for comprehensive bank reform detailing how the banks should restructure—improving their management and lending practices by upgrading their accounting, technology, and transparency—and then incorporate as stockholding companies and prepare for IPOs. To sell their shares successfully, the banks would need to assure prospective investors that legacy loan problems had been resolved and mechanisms had been put in place to prevent any reoccurrence.
Zhou originally suggested reducing government ownership to 30 percent, enough to maintain control while raising plenty of capital, but the premier told him that proposal would never get past other senior leaders. Instead, the paper called for government to maintain a majority share of the banks. At Zhu Rongji’s insistence, Zhou published the paper in the People’s Daily in 2000, the same year he would move to head up the China Securities Regulatory Commission (CSRC).
Bank of China (Hong Kong) was chosen to be the guinea pig for Zhu Rongji’s plan. The bank, it was thought, would be in better shape and better run than those on the mainland. After all, it had competed for decades with major international institutions like HSBC Holdings and Standard Chartered in the sophisticated Hong Kong market, where it operated under the supervision of the Hong Kong Monetary Authority, a stricter and more highly regarded regulator than the PBOC at the time. These factors would make Bank of China (Hong Kong) the bank with the greatest attractiveness to international investors and the least baggage as a Communist institution.
Concluding that BOC(HK) was in better shape than its mainland brethren wasn’t saying much. To begin with, it was not a single institution, but rather a motley collection of a dozen or so banks that included the 84-year-old Hong Kong branch of Bank of China itself, as well as the Hong Kong branches of seven mainland banks that the People’s Republic of China government had nationalized after coming to power, plus two additional banks the PRC government had established in Hong Kong. In the 1980s BOC had tried to rope them together as part of a newly formed Bank of China Hong Kong Group, but apart from a common ATM network and some shared software, the effort was largely window dressing. Though jointly headquartered in the bank’s stunning I. M. Pei–designed tower by the Hong Kong waterfront, the banks were run independently, with their own brands, back offices, and information technology systems. Their books were not consolidated. There was no chief financial officer or chief risk officer for the group. All in all, this was an unusual set of deficiencies in a modern bank.
Not surprisingly, group results were underwhelming. In 2001 it had earned $355 million pro forma, a meager return on assets of $98 billion. Problem loans were modest compared with mainland banks but still substantial by Hong Kong standards. At the end of 2000, nonperforming loans stood at 10.19 percent, compared with 3.3 percent for a local competitor, the Hang Seng Bank.
For most of the 1990s Bank of China had been run by Wang Xuebing, whom everyone called HP after the Cantonese pronunciation of his given name. A graduate of the Beijing Institute of Foreign Trade, he had worked for Bank of China in London and New York, where he took over U.S. operations in 1988 after a stint as a trader. He returned to Beijing in 1993 to head the bank. I’d first met with him in the winter of 1996. He was a man of medium height who wore prominent dark glasses, and with his very big smile, boisterous personality, and command of English, he was popular with foreign bankers. He had recently sought advice from our old friend Fang Fenglei at CICC, who in turn enlisted our help.
In October 1999 Fang arranged to meet one Saturday at the Kunlun Hotel in Beijing with Ziwang Xu, our lead China banker, and Tracy Wolstencroft, who ran our Asia financial institutions practice and was co-head of Japanese banking. On arriving, they were surprised to be directed to the hotel’s steam room, where Fang awaited them, draped in a white towel with a cold orange washrag on his head. They were the only guests in the room; two associates of Fang’s guarded the entrance. He’d chosen the rendezvous so that he could describe, with utmost confidentiality, a specific plan for bank reform. Focusing on Bank of China, Fang sketched a “one bank, two systems” strategy that drew on Deng Xiaoping’s “one country, two systems” formula for reincorporating Hong Kong. He outlined a plan to create two separate legal entities (one for mainland China and one for the international assets) that would be incorporated under a parent holding company that would straddle both.
Tracy worked through that Christmas with Fang hammering out a plan for restructuring Bank of China (Hong Kong), and in January, over lunch, Wang Xuebing reviewed the details with me and the Goldman team. The approach—to clean up bad loans and broaden ownership from the state to multiple shareholders, then raise capital through a public offering—would morph over time, but it became the basis for the Bank of China (Hong Kong) offering and the blueprint for future IPOs as each of the four major state-owned banks was restructured.
HP wouldn’t be around to see the plan through, however. Not long after our lunch, in one of the frequent, mystifying leadership round-robins in the Chinese hierarchy, he was transferred to China Construction Bank, replacing Zhou Xiaochuan, who moved to the CSRC. HP was succeeded by Liu Mingkang, the chairman of China Everbright (Group) Company, a Hong Kong red-chip conglomerate, who had previously served as deputy governor of the People’s Bank of China.
Zhu Rongji knew the key to success was getting the right person in the right job. We concluded that the Chinese had foreseen that Liu Mingkang would be the right person to drive the Bank of China IPO forward and wanted him to work with Goldman Sachs, following our success on other big deals.
By May we had signed a cooperation memorandum, and Liu Mingkang, whom I had taken to calling by his Western nickname, LMK, pronounced himself impressed with our teamwork and “knowledge, skills, and experiences.” It had helped that our work in the Guangdong Enterprises restructuring in 1998 and 1999 had built credibility with members of Liu’s management team; their bank had been significantly exposed to Guangdong Enterprises, and they had appreciated our transparent workout process. We also received high grades for taking heat in the market—and politically—during the PetroChina IPO.
In October 2000 I met with LMK, who confirmed that the State Council had settled on the two-stage strategy to take Bank of China (Hong Kong) public first, followed in time by the mainland bank. John Thornton signed a technology transfer agreement with LMK under which Goldman would help train BOC personnel in best practices. By the time John and our bank team made our formal pitch for the IPO on January 2, 2001, the deal was ours to lose. We would be lead underwriters with Switzerland’s UBS and Bank of China’s investment banking arm.
The bank faced a huge task in restructuring Bank of China (Hong Kong), especially on the timetable Zhu Rongji had initially set: to list by the fourth quarter of 2001. For all the preliminary work we had done, we were in some ways starting from scratch—at least when it came to the bank leadership. Tracy Wolstencroft attended the first board meeting after the mandate was awarded to walk the directors through what they should expect during the restructuring process. One asked what multiple of book value we thought the bank should be priced at. A banker from one of the other underwriters said, flatly, “2.8 times book.” That was a high, even mischievous, valuation, given that the best banks in the world were then trading between two and three times book value—which measures the value of a company’s assets minus liabilities and intangible assets. Liu Mingkang asked Tracy his opinion.
“We have no idea,” Tracy answered forthrightly. “For the next six months, the exercise is precisely to find out what the book value is. Only then can we tell you what’s the right multiple.”
To find out what the book value was meant we would have to dig through the nonperforming loans and see how much they impaired capital and whether the government was willing to take over the bad loans. The reorganization of the bank, already under way, would take another year and a half to wrap up. During that time we would play a combination role of policy adviser, management consultant, and investment banker, pushing hard to accelerate changes. I made it clear at an April 2001 meeting with LMK that a successful IPO depended on a thorough restructuring.
This was not just about selling shares. It was about building a good bank. A successful IPO would signal to the world that China’s banks had arrived on the global financial stage. But the IPO would fly only if the new shareholders owned a piece of a successful bank, and that would be possible only if BOC was restructured. LMK assured me that he understood, and wanted and needed, the same outcome I did—a good bank. The 2001 restructuring involved a total of 15 subsidiaries with assets of $105 billion that made Bank of China (Hong Kong) the second-biggest bank in Hong Kong after HSBC. It cut several hundred workers, put most of the banks under one brand name, consolidated their books, management, and IT, and established uniform lending criteria. BOC became the first Chinese bank to implement a more stringent loan classification system. The banks were officially merged in October 2001. By then, however, the world had been shaken to its core by the events of September 11, 2001.
The attacks disrupted markets worldwide, and the Chinese government continued to dawdle in finalizing the size of its nonperforming-loan position and in determining how much of the losses from those loans it was prepared to absorb. This caused the IPO date to be pushed back. When we’d won the mandate, the offering had been scheduled for year-end 2001. That had become February 2002, and then even later. Keenly aware of the time pressure, I had stressed to LMK at a December meeting in Beijing that his team had to speed up its decision making if it wanted to have a successful offering in the first half of 2002.
A new set of problems emerged that threatened to delay the offering even further—and turned our relations with the bank testy. The immediate issue was an eruption of bad publicity related to allegations of fraud and corruption at the bank. Liu Mingkang’s predecessor, Wang Xuebing, had been deposed in January as chairman of the rival China Construction Bank, after barely a year in charge. The reason: alleged illicit activity that had taken place at Bank of China’s New York and Los Angeles branches when he had been in charge of those activities at the bank. Separately, press outlets had revealed that a group of Bank of China executives had pilfered almost half a billion dollars through just one branch in Guangdong Province over a nine-year period ending in 2001. (Wang would subsequently be expelled from the Communist Party, tried, and sentenced to 12 years imprisonment for taking bribes.)
Under any circumstances, this was bad news. On the eve of an IPO, it spelled a potential disaster. Bad timing compounded matters. In December 2001 Enron had imploded in the then biggest-ever U.S. bankruptcy amid revelations of accounting fraud. The stunning collapse of the U.S. energy conglomerate dominated headlines for weeks, triggering intensified scrutiny of company accounting practices and heightened concern over the adequacy of market oversight. (These would lead to the July 2002 passage of the Sarbanes-Oxley Act, which put in place much stricter standards for financial governance in U.S. markets.) Enron captured the interest of investors, corporate executives, and government leaders the world over. Not long after the Enron news broke, I’d met with Vice Premier Wen Jiabao, who was expected to take over the reins of the economy from Zhu Rongji. He quizzed me extensively about the company, how such a collapse could have happened, and what it meant for the U.S. and global economies.
The fallout in the U.S. capital markets had reached LMK and his colleagues. We had been planning for listings in New York and in Hong Kong. Now the Chinese wanted to skip the New York Stock Exchange and issue shares only in Hong Kong. They were concerned that increased market vigilance and demands for wider disclosure in the States would delay their offering, especially now that the bank’s dirty laundry had been aired. Our equity markets team disagreed. Its members believed that an NYSE listing would help generate demand and that the Big Board seal of approval would lay the groundwork for the parent company, and other Chinese banks, to come to market.
The Chinese were adamant and became increasingly frustrated with our position. They wanted their first bank deal to succeed, and they were eager to press ahead as quickly as possible. Zhu Rongji wanted bank reform well under way before he left office the following year, and he wanted to ensure that China’s banks were ready when the financial sector was scheduled to be opened fully to foreign competition in 2006 in keeping with the newly struck WTO accession agreement.
I was hoping to iron out our differences with LMK. Although I had known him for only a couple of years, I considered him a friend and enjoyed working with him on the Tsinghua SEM international advisory board. He maintained close relations with a number of Goldman bankers and had been very supportive of our efforts. He seemed to appreciate the way our team pushed his to produce results. He saw the process as a way to train his people.
LMK himself fascinated me. I could see in him the grit and ingenuity so many of the Chinese leaders of his generation had used to survive the Cultural Revolution and then thrive in its aftermath. He was a smart, determined man of high character who knew banking well but was always eager to learn more. He had grown up in Shanghai, and after graduating from high school in 1965, had been sent down to do manual labor on a farm in Jiangsu Province, where he taught himself flawless English in secret, studying tattered BBC textbooks and on long winter evenings listening clandestinely to Voice of America’s Special English program. In 1979, at 29, he was one of just two people in Jiangsu Province, population nearly 57 million, to pass a civil service exam aimed at identifying sent-down youths who could go straight to work without a college degree. By 1984 he was working at Bank of China’s branch in London, where he got an eyeful of Margaret Thatcher’s privatization efforts. Returning to China, he was tapped in 1993 as vice governor of Fujian Province. He subsequently took increasingly powerful jobs at the China Development Bank, the People’s Bank of China, and China Everbright Group, which he ran for a year before joining Bank of China.
I was scheduled to meet with LMK in February 2002 for breakfast at Beijing’s Grand Hotel, which was close to where I was staying. Though I appreciated the pressure that LMK must have been under, I wasn’t looking forward to seeing him. LMK was always courteous and considerate, but it was clear we were stretching him to the limit by insisting on our position. In the end, he was a loyal Party member, and a very efficient bureaucrat, who needed to get this deal done without delay for the very demanding head of his government.
I got into the car with Tracy Wolstencroft for the short ride. Tracy, a tall Massachusetts native who had superb people skills, summed it up for me: come hell or high water, Liu Mingkang was going to complete this IPO. We’d have to be flexible or risk getting fired.
I had time to think things over, because what should have been a 15-minute drive took twice as long in the heavy Beijing traffic. And the more I thought, the more I saw things very clearly, and simply. Essentially, we were saying, “This is how we have done things before; it worked then, so we should do it the same way again.” I wondered if we were just being obstinate or, as Mike Evans would say later, “bloody-minded.” After all, we were turning blue in the face with our arguments, but LMK wasn’t buying any of them. The imperative for him was timing. Yes, he wanted to get the deal done right, but he couldn’t wait, and it was going to be easier to issue out of Hong Kong. Delay would affect not just Bank of China, but also the entire banking sector reform effort.
It dawned on me then that this was a classic case of not listening to what our client really needed. I turned to Tracy and said, “Tracy, you and I are just going to have to forget about the equity capital markets people. We’re just going to say ‘fine’ to LMK, ‘we can do the time schedule, and you don’t have to list in the U.S.’ ”
I made the snap decision out of instinct—and good judgment. I had a ton of faith in Mike Evans and his people in capital markets. I knew somehow they’d get the deal done.
Now, I’m not naïve. We could have stood our ground and insisted on the New York listing, and I’m sure LMK would have been perfectly gentlemanly and understanding and then gone out and found another bank to replace us.
“I agree,” Tracy said. “But won’t New York think we’ve caved on a matter of principle?”
I told Tracy I’d stand on a principle all day if that meant opposing something that was immoral, illegal, bad for investors, or not right for the client. But that wasn’t the case here. The judgment we had to make was this: Are the Chinese going to make this a successful deal? Is it basically a clean company? Are they honorable people?
My conclusion was yes to all.
Moreover, I reasoned, they couldn’t afford to try to sell a problem bank to international investors.
When we got to the hotel and caught up with LMK, he told me he had been pleased to see me the previous night on TV. I had met with President Jiang Zemin the day before about creating national parks in Yunnan Province, and the nightly news shows had covered the meeting at some length. LMK had many interests aside from banking—he was a talented artist whose work decorated the cover one year of the China Banking Regulatory Commission (CBRC) annual report after he took that agency over—and he was deeply interested in the environment and clean energy. He said he had been touched by our conservation efforts.
“I am confident that with you in charge,” he said, “Goldman Sachs is focused on China’s best interests with both your minds and your hearts.”
I told him we were also focused on the best interests of the Bank of China (Hong Kong).
Tracy may have been the only one in the room not surprised when I told LMK that we had changed our mind and decided to go with his plan. I explained that skipping the NYSE meant we would have to press for greater transparency and disclosure, particularly about the nonperforming loans, and LMK agreed. He was so delighted and relieved that he might have agreed to anything at that point. LMK had been working hand in glove with our bankers for two years and wanted to proceed with us. Switching bankers also might have delayed the deal.
In the end, the choice I made was practical and considered. I had to decide whether the bank was serious about dealing with its problems and had the management capability to do so. I concluded that the Chinese had more to lose than anyone if they failed to get these problems under control. Another blowup or scandal at Bank of China would set back all the other bank IPOs and bank reform, and the government wouldn’t want to risk that. A New York Stock Exchange listing would have given them more time to make sure everything was in order, but I decided that if LMK and the government wanted to go ahead, then they must have had things under control. If I did not trust them on that score, an NYSE listing and another three to six months were not going to make a difference in any case.
I staked the firm’s future in China on LMK’s abilities and the government’s sincerity. Neither one let me down.
The offering itself came to market five months later, in July 2002. Bank of China (Hong Kong) raised about $2.8 billion, slightly below some expectations, but Liu Mingkang and the Chinese leadership were thrilled with the results. It was the biggest Chinese IPO since Sinopec had raised $3.3 billion in October 2000, and the largest Hong Kong–only IPO ever. Most important, Bank of China was the first Chinese state-owned bank to sell shares outside of the mainland, and it helped turn around the negative views many international investors had held about the country’s banks.
The offering would generate some $18 billion in global demand. Most of that was Hong Kong retail, whose strong buying made BOC(HK) the second most widely held company in Hong Kong behind the local Mass Transit Railway Corporation. It was not an easy sell, for a number of reasons. The markets, shaky since 9/11, continued to be soft and erratic. The bank had gotten the government to take an additional $1.5 billion in bad loans in June and place them in an off-balance-sheet workout vehicle. This brought the NPL ratio down to a still worrisomely high level of about 9 percent, which caused some institutional investors to shy from the deal. They have no doubt kicked themselves several times over since then: BOC(HK) shares have more than tripled in value.
The key to our success, as bankers in this new market, was a willingness to look beyond short-term problems and make a bet on China and its leadership. A number of corporate investors, such as K. S. Li’s Cheung Kong and the Kwok family’s Sung Hung Kai Properties, took that same bet and invested in the IPO. As with PetroChina and China Telecom, we also brought in a strategic investor, Standard Chartered, which purchased a 1 percent stake for about $50 million, with a 12-month lockup. It was important to Liu Mingkang that Bank of China (Hong Kong)’s share valuation be competitive with other Hong Kong banks, and the final pricing reflected a price-to-book ratio of more than 1.6, compared with Standard Chartered’s price-to-book ratio at the time of 1.8. LMK was delighted, as were his colleagues.
More important, the process of bank restructuring and reform in China had begun.