Less toxic than before, but Cinda still isn't a great buy
Amid suspicion over bad-debt warehouse Cinda’s balance sheet, it seems to have been repaying its bonds, presumably with help from Beijing
I am grateful to the reader who wrote in response to yesterday's Monitor, drawing my attention to the note concerning "debt securities classified as receivables" on page 133 of China Construction Bank's 2012 annual report.
I know that doesn't sound exactly thrilling, but bear with me here. This gets interesting.
In case you missed it, yesterday's column looked at the HK$15 billion initial public offering being lined up for China Cinda Asset Management.
One of the four bad debt warehouses set up by the mainland authorities 14 years ago to shift trillions of yuan in non-performing loans off the balance sheets of state banks, Cinda has been restructured over the past few years.
When the deal hits Hong Kong's market in the coming months, the company will be sold to investors, not as a dump for toxic financial waste, but as a profitable universal financial services group with a robust balance sheet.
Monitor, however, doubted how clean Cinda's balance sheet really is. Although its worst assets were spun off into a separate fund in 2010 in return for Finance Ministry IOUs, yesterday's column questioned the value of these IOUs.
In the absence of an explicit government guarantee, Monitor worried that Cinda's capacity to repay 247 billion yuan (HK$312.8 billion) in bonds it sold to China Construction Bank in 1999 to fund the acquisition of CCB's bad loans will still be tied to its ability to recover value from the fund's near-worthless assets.
For years CCB carried Cinda's bonds on its balance sheet as "debt securities classified as receivables". Then in 2009, with Cinda unable to repay the bonds' principal as they matured, they were rolled over for another 10 years.
Now we come to the interesting bit. Although the bonds are not due to mature until 2019, suddenly in 2010 Cinda began to repay the principal. According to notes tucked away in the back of CCB's annual reports, Cinda repaid 41 billion yuan in 2010, 75 billion in 2011 and 74 billion last year.
As a result, at the end of 2012, CCB carried just 58 billion yuan of Cinda's bonds on its books, down from 247 billion three years before.
That's encouraging news for potential investors in Cinda's offering, but it does raise the question: where did Cinda get the money?
Certainly the funds did not come from Cinda's income. The company claimed an operating profit last year of 14 billion yuan - a record, but insufficient to fund even 20 per cent of the principal it repaid.
The company raised an additional 10 billion yuan by selling a 16.5 per cent stake to a clutch of strategic investors. But even with this sum added to its entire operating profit, Cinda would still have covered only a third of its repayment.
Nor can Cinda be drawing down retained earnings to make the payments, considering that in recent years it has struggled even to make the interest on its outstanding bonds.
As a result, it looks as if the mainland's Finance Ministry must be dipping into its coffers to repay Cinda's bonds, wiping out the company's liabilities ahead of its listing.
A 2010 filing to the Hong Kong stock exchange by CCB hints at a possible source of the funds. In it, CCB declares that the Finance Ministry might use CCB's corporate taxes to repay the principal of Cinda's bonds.
If that is what's going on, it means in effect that Beijing is giving CCB a massive tax break to write down the bad assets it accumulated in the 1990s.
And not just CCB; a glance at the latest annual report from Cinda's counterpart, China Huarong Asset Management, shows that last year Huarong managed to pay down a thumping 138 billion yuan of its own bonds held by state banking giant ICBC (see chart). That's a remarkable achievement for a company which made an operating profit of just 12 billion yuan.
Clearly the authorities are working hard to make sure mainland asset management companies are solvent ahead of their Hong Kong offerings.
But that doesn't necessarily mean their shares will make good investments.
There is an abiding suspicion among many observers that the reason Beijing is cleaning up the asset management firms and rushing to sell their shares now is that it wants to raise the funds to help finance a fresh bailout of the mainland's big banks - a bailout that will become increasingly urgent as the economy slows and more of the loans made during the massive credit boom of 2009 and 2010 begin to turn bad.