Non-performing loan asset-backed securities resurface in China with BOC debut
The Bank of China on Friday successfully debuted 301 million yuan (HK$356 million) worth of asset-backed securities instrument made up of 1.25 billion yuan worth of dud loans carved out from the bank’s non-performing loan book, 1 per cent of its total NPL.
The move is China’s first in eight years, restarting the nascent NPL securitisation market that had been halted during the global financial crisis. The last deal by China Cinda Asset Management dates back to 2008, a “bad bank” manager that raised 2.8 billion yuan before the government shut it down.
The bookbuilding results were announced after market close. In April, investors reacted poorly when another NPL-associated move in the form of a debt-equity swap valued at one trillion yuan in which BOC was a leading participant together with China Development Bank was disclosed to the market.
But BOC has priced its virgin NPL asset-backed securities attempt at a deep discount relative to the face value of the underlying loans. The securities instrument was therefore three times oversubscribed on Friday with popular response from other mainland national, joint-stock and city commercial banks, as well as securities companies and fund management companies.
BOC is already on the lookout for a new batch of asset-backed securities and has sent out a notice for rating agencies to submit bids to rate for the next project.
In the latest issue, christened “Zhong Yu 2016”, BOC had diced the asset-backed securities in two tranches. Three quarters of the bond came in a senior AAA-rated portfolio paying a fixed coupon of 3.42 per cent, higher than the 2.9 per cent level of 10-year Chinese government bonds at the moment; the remainder was in a subordinated portfolio to tranche A that does not pay a fixed rate, but rather tracks and pays the price of the risks of the underlying default risk.
Tranche A will mature in 2019. The B tranche matures in 2021. Industrial Securities was the trust adviser while China Merchants was the lead manager.
“This is a ‘water-testing’ move. Whereas previously the Big Four [asset managers] were the only channel banks could sell their NPLs to, banks have now acquired a new channel to resolve the NPL issue and see a faster turnaround in their cash recovery,” said Shujin Chen, research director at DBS Vickers.
“But this [asset-backed securities] has been priced at a very low rate. It will be difficult to see better pricing than this in the issues to come, given that everyone currently holds harsh expectations on the economy.”
Chen calculated that BOC had discounted its loan portfolio at a rate of about 24 per cent in Zhong Yu, which is lower than the average 27 to 29 per cent level BOC would get if it sold the loans to Big Four asset management companies.
Until the latest asset-backed securities relaxation, Big Four asset managers such as Cinda and Huarong made up the only group of qualified buyers for banks’ distressed assets in a market where sellers far outweigh available buyers.
Chen said the asset-backed securities move was a good one overall, noting that reopening the market would now help diversify the market for distressed assets and encourage wider bank transparency in providing information about their troubled portfolios which otherwise was not available.
“Once out of BOC’s loan book, these are bond investments on other banks’ balance sheet. The senior tranche is well-collateralised – it only needs to generate about 240 million yuan in recovery flows and it will pay interest. There is already quite some cash that has been recovered and that’s why it was AAA-rated and has been well received in the market,” Chen said.“I’m more interested in the results with the subordinated tranche.”
Chen added that this was where the actual risks of the underlying NPL would be denominated.
“The main buyers of this tranche were hedge funds, private funds. I have heard overseas distressed funds which previously wouldn’t be able to get into the Chinese distressed market expressing interest. To me, that will give a view as to what are investors’ beliefs on where China’s balance sheet actually stands in quality.”
This story has been corrected to remove 240 billion yuan in the 13th paragraph.