China's insolvent toxic-waste dump Cinda for sale
Let's wait and see the prospectuses, but investors would be wise to think carefully before buying in to the IPOs of China's asset management firms
At some point in the next few months, China Cinda Asset Management is likely to list on the Hong Kong stock exchange, in a mega deal that could raise HK$20 billion or more.
Meanwhile, Cinda's counterpart, Huarong Asset Management, is busy lining up strategic investors ahead of an offering some time next year.
The two companies will be sold to investors as universal financial services giants, with businesses on the mainland that range from banking and insurance, through asset management and leasing, to securities broking and commodity trading.
In reality, they are toxic waste dumps. Worse: by any sensible standards they are insolvent.
Both Cinda and Huarong, along with potential listing candidates Great Wall Asset Management and Orient Asset Management, were set up in 1999 to shift bad loans off the balance sheets of China's Big Four state-owned banks.
Over the next five years, the four asset management companies bought some two trillion yuan in non-performing assets in three successive waves. Most of these assets were purchased at face value, with the asset management companies paying for their purchases by issuing bonds - bonds which were bought by the state banks.
Under the original plan, the asset management companies were meant to recover the value of the assets over 10 years, repaying the principal on their bonds at maturity in 2009.
It was never a realistic idea. Actual recovery rates on the first 1.4 trillion yuan-round of bad loans were as low as 20 cents on the dollar, barely enough for the asset management companies to cover their operating expenses and to pay the coupons on their bonds.
In Red Capitalism, a 2011 study of the mainland financial system, Carl Walter and Fraser Howie estimated that by 2008 the asset management companies were sitting on nearly 1.5 trillion yuan in unrecognised write-downs.
Reluctant to acknowledge the losses, which would blow a huge hole in the state banks' capital base, in 2009 the authorities extended the asset management companies' bonds for another 10 years.
With little prospect of the bonds being repaid even then, in 2010 the authorities began a fresh restructuring programme, under which the government assumed nominal responsibility for their worst assets, which were spun off into "co-managed accounts" in return for IOU notes from the Ministry of Finance.
In the meantime, instead of disposing of many financial company assets acquired during the clean-up's third wave in 2005, the asset management companies kept them on, retaining their licences to set up a range of subsidiaries. Cinda now owns more than a dozen, including insurance businesses, securities brokers, trust companies and fund managers.
As a result, today China's four big asset management companies look on the surface like respectable universal financial services groups, with solid balance sheets and handsome earnings. In February, Cinda announced profits for last year of 14 billion yuan (HK$17.6 billion), while Huarong made 12 billion yuan.
Sceptics claim these profits are illusory, produced by the companies trading assets among themselves at artificially inflated values.
For potential investors, however, earnings quality should be only a minor concern compared with the enduring doubts that surround the strength of the asset management companies' balance sheets.
Offsetting the liability of their bonds, their assets now consist largely of what amount to IOUs from the Ministry of Finance. These are not sovereign bonds, but merely a vague promise to pay at some point in the future.
If these IOUs are comparable to similar IOUs held by state banks, then their eventual repayment is to be funded by recoveries from the bad assets injected into the "co-managed accounts".
In short, it appears the recent restructuring of the asset management companies was nothing more than a cosmetic exercise, which still left them exposed to their original portfolios of worthless loans.
If so, their liabilities far outweigh the true value of their assets; they are insolvent. Hopefully, Cinda's prospectus will shine some light into the dark recesses of its balance sheet. But at this stage, potential investors should be asking what is likely to become of any offering's proceeds.
Rather than being funding for the expansion of a legitimate business, there is a clear risk that the money will go towards plugging the hole on the asset management company's balance sheet.
Alternatively, the funds could be used to acquire yet more bad loans from China's state banks following their government-mandated lending binge of 2009 and 2010.
Either way it will amount to the same thing: investors in Cinda and the other asset management companies will be bailing out Beijing by buying into its toxic financial waste.