China’s local bad-asset management companies are following the “big four” national bad banks in diversifying away from their policy mandate but, facing stiff competition, many have to rely on some shadow banking activities. Local bad-debt managers proliferated in China after the banking regulator last October eased rules on the sector and allowed a second asset management company, known as an AMC, in each province to help unload non-performing assets. They are also allowed to transfer the bad assets en bloc to other buyers, in contrast to previous rules that a single AMC for each province took on the debts and disposed of them throughrestructuring or liquidation. However, that rule didn’t help provincial AMCs, as about 50 such entities across China faced greater competition. The “big four” bad-asset managers have taken up over 90 per cent of distressed assets, according to interviews with industry insiders by the Post . Facing the conundrum, these AMCs increasingly turned to new businesses such as lending to companies that were unable to get bank loans in a traditional way, or act as “channels” for banks to temporarily park their assets off balance-sheet. “We do these businesses not for making big money, but merely for surviving,” said an executive with a central province’s AMC who would only give his surname Wang. Because local AMCs are not publicly traded there are no financial statements showing their revenue structure. In some of the financial statements from China Huarong Asset Management and China Cinda Asset Management, the only publicly-traded national AMCs, the underlying businesses are veiled behind confusing and difficult to understand accounting titles. For example, a major revenue stream of listed bad banks is “income from distressed debt assets classified as receivables”. In fact, most of these are not real bad debt assets, but what the industry called “restructured distressed assets”. AMCs are willing to take over the receivables from a non-financial company, often without repayment problems, and collect interest from the borrowers. Richard Huang, a partner at McKinsey & Co, said during 2012 to 2015 the rising property sector boosted the value of real estate, making AMCs willing to take over asset packages with real estate pledged as collateral. Such business accounted for up to 50 per cent of AMCs’ so called “bad asset disposal revenue”. In recent years the ratio has reduced in general, with the decline differing from individual companies. Another important revenue stream is “channel business”, which refers to when AMCs temporarily take over banks’ assets and later sell them. Because AMCs do not bear real risk, they usually collect a management fee of 0.2 to 0.5 per cent. In essence they are acting as a special-purpose entity no different than a trust or private fund in China. Wang said one can tell the “channel” business from the sale price. In a bad asset sale, the AMCs buys assets at a big discount, while in “channel” business assets are sold at par value and expected to repurchased by banks a short time later. He said AMCs earn slim returns in these instances, but it is relatively safe, albeit with policy risk. The banking regulator cracked down on such business beginning last March. Facing greater regulatory uncertainty, most AMCs have cut their exposure to the business. A third growing business is to participate in fundraising that makes equity investments in companies that is essentially debt. “Debt disguised as equity investment” loophole has been widely used by banks to skirt regulations Another reason some AMCs are avoiding bad-asset disposals is because they lack the necessary financial capacity. A McKinsey report noted that some AMCs are struggling to secure stable cash flows to tide them over during the lengthy asset disposal and debt resolution process. Banks are also less keen to sell-off their assets cheaply, as asset quality is improving amid the economic rebound. In this regard, these weak bad-asset managers are justified in their attempts to develop multiple businesses, experts said. “There are some global alternative investment, such as Oaktree Capital and Lone Star Funds, that derive from distressed investors. They set precedence for local AMCs,” said Huang. “Besides private equity, they can also conduct alternative investment such as real estate trust funds, private investment via public equities. ” “These nascent local AMCs were born just a few years ago and are still exploring. It may not be fair to compare them with the big four, which have much longer history,” Huang added. The big four bad banks snapped up 90 per cent of the 513 billion yuan of bad-asset packages banks sold in 2016, according to an internal survey by China Orient Asset Management. It said selling the asset packages was the last resort for banks as they developed ways to recover value.
