Bad debts offer opportunity for asset management firms

As nonperforming loans creep up in China, the situation is presenting opportunities for at least one sector - asset management companies - to benefit from the opportunity to acquire NPLs cheaply from troubled lenders and sell them at a profit.

Any decline in the property market, which many analysts have warned is likely to cool or even slump, will provide even further chances for the AMCs to gain as loans to developers sour.

Chinese commercial banks' NPLs stood at 563.6 billion yuan ($93.2 billion) as of late September, up 14 percent from the end of 2012.

The NPL ratio, which remained at about 1 percent at that point, means the banks look pretty safe, at least on paper.

"Investors believe that the actual NPL ratio is much higher than just 1 percent, because the off-balance sheet businesses are not factored in," said Lucy Feng, regional head of bank research at Nomura International (Hong Kong) Ltd.

"I had commercial bank managers coming to me and asking why their stock prices remain weak while their quarterly reports consistently show good results. I told them that shareholders no longer buy into what they write on paper."

China Cinda Asset Management Co Ltd is so far the biggest beneficiary of the bad asset buildup. Its shares have performed strongly since it went public in Hong Kong in December.

"Asset management companies tend to grow when the economy slows down," said Feng.

"Nomura was the first securities company to write a report recommending Cinda to investors. We continue to see great opportunities ahead for AMCs' performance in the stock market."

NPL disposals contributed 53.8 percent of the company's net profits in the first half of 2013, far more than the other two sectors - investment asset management and financial services - in its portfolio.

The volume of NPLs purchased by Cinda will grow to more than 50 percent of the company's portfolio, according to Goldman Sachs Group Inc.

The company is betting on China's ever-growing NPLs, which are expected to soar from an estimated 593 billion yuan in 2013 to 1 trillion yuan by the end of 2015, said Goldman Sachs.

Cinda was originally one of the four AMCs established in 1999 by the State Council to deal with 1.4 trillion yuan in bad assets then held by the "big four" State-owned banks. The banks' finances were being cleaned up to pave the way for their own IPOs.

Cinda outperformed the other three in terms of both revenue and net profit in 2010 and 2012.

Cinda's success story was partly built on the foundations of the "golden decade" of the real estate industry, which ended in about 2010. As of June 30 last year, 60.4 percent of Cinda's NPLs were related to real estate.

"Cinda was assigned to take over the NPLs of China Construction Bank Corp and China Development Bank Corp" in 1999, said Mei Xingbao, external auditor of Bank of China Ltd.

"Since CCB's bad assets were mostly generated by infrastructure construction and real estate projects, they could rise exponentially in value with careful management, thanks to soaring land and housing prices."

However, the boom times for real estate may soon end. Ye Tan, a Shanghai-based economist, said that the property market is now going through a "silver decade" as China continues to tighten its grip on the housing market.

Home prices will fluctuate only within a limited range in the future, rather than soaring by double-digit amounts, Ye said.

Andy Xie, an independent economist, has even forecast a 50 percent fall in housing prices this year.

If that were to happen, Cinda's profitability could be dragged down - but not because of fundamental changes in the way it handles bad loan disposals.

Rather, Cinda and the other AMCs would lose their dominance in the business of NPL resolution as Chinese regulators seek other ways to dispose of a rising volume of soured assets.

Those methods could include write-offs, sales on asset exchanges and setting up local "bad asset" banks. That would mean more competition to acquire bad loans.

The Ministry of Finance recently relaxed its restrictions on small loan write-offs. Loans of less than 10 million yuan to small and medium-sized enterprises that are more than one year delinquent could be written off, compared with a previous threshold of 5 million yuan.

Also, banks can write off the loans that have not been settled within two years after a borrower starts bankruptcy liquidation, compared with three years previously.

There are 20 exchanges around the country that handle NPL sales.

Bank of Tianjin Co Ltd has put more than 900 million yuan worth of NPLs for sale on a local exchange. Agricultural Bank of China Ltd has put more than 20 billion yuan in bad debts up for sale on exchanges in Tianjin, Beijing, Chongqing and Shandong. Most of those loans pre-date its 2010 IPO in Shanghai and Hong Kong.

The Ministry of Finance and the China Banking Regulatory Commission set a quota last February of one "bad asset bank" per province to purchase loans from local companies. So far, though, only Jiangsu province in the eastern region has set up such a bank.

"I believe that the government should open up the AMC market to the private sector," said Chen Zhiwu, a finance professor at Yale University. "That way, the methods of handling NPLs will become more diversified and flexible."

"The government should no longer adopt a one-size-fits-all approach to bad asset management like it did in the late 1990s," said Hu Jiye, a finance professor at the China University of Political Science and Law.

"AMCs' purchase of NPLs should be a pure business transaction among individual market players. The government and regulatory authorities should refrain from intervening."