Rising China defaults turn investors off bad debt factory Cinda

Wed Apr 16, 2014 5:00pm EDT

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By Nishant Kumar and Lawrence White

HONG KONG, April 17 (Reuters) - Investors have soured on prospects for China's only listed bad debt management firm, as Beijing's newfound willingness to allow struggling firms to default on loans signals a harsher environment for China Cinda Asset Management.

Cinda's shares soared on their debut last December as investors flocked to a rare chance to buy exposure to China's bad debt market, then effectively guaranteed by the government. Firms like Cinda, 25 percent-owned by China's Ministry of Finance, make money by buying up underperforming loans and slowly turning them around for profits.

Now as China Huarong Asset Management Co Ltd, the biggest of the four bad debt firms, prepares to list, investors fear the business model is at risk and many are selling Cinda stock short in a calculated gamble that it will drop. If China simply lets more loans and trust products go under, rather than allow the likes of Cinda to take them on, what once seemed a good bet will lose its lustre.

"Before, people did not think the government will allow some trust products go bankrupt. Basically, they assumed the (state-backed) banks guarantee their payments," said Cong Li, managing partner at Hong Kong-based hedge fund Zenas Capital Management.

Cinda's stock is still 17 percent ahead of its initial public offering price, largely because of the rapturous Hong Kong market welcome in its early days.

Since the turn of year, though, Cinda's shares have fallen 13 percent, a bigger drop than the 10.5 percent decline in the Hang Seng China financials index, as confidence in its prospects have drained. Investors and analysts also express concern about the opacity of Cinda's earnings model - it reports earnings only every six months - and its exposure to China's weakening coal mining sector.

That has made Cinda a target of short sellers, investors who sell stock they have borrowed hoping to profit from buying it back cheaper later.

Global hedge funds have scrambled to bet on a decline in Cinda shares after it became eligible for short-selling under Hong Kong stock exchange rules on Feb. 14. The exchange regularly offers newly listed stocks for shorting once they fulfil certain criteria.

As much as 92.8 percent of the Cinda shares that could be borrowed under Hong Kong rules were out on loan on April 14, the latest day for which data was available, up from 71 percent about a month earlier, according to Markit, indicating interest from short sellers.

That has led to the cost of borrowing the stock spiking to 9 percent of its share price per annum, compared with the less than 3 percent that investors typically pay to borrow Asian stocks, people familiar with stock lending and borrowing said.

"It went straight from zero to hero," said a Hong Kong-based head of equity finance at a bank that has lent Cinda shares to hedge funds, referring to Cinda's popularity among short-sellers.

NEGATIVE CHINA PLAY

Cinda was established in 1999 to absorb toxic assets held by China Construction Bank and is one of four such entities Beijing set up. It had 283.55 billion yuan ($46 billion) worth of assets as of June 30.

Cinda's IPO attracted a group of core backers, known as 'cornerstone investors', who put in a combined $1.1 billion into the deal. These investors, including Oaktree Capital Management Ltd, the world's largest distressed-debt investor, and Och-Ziff Capital Management Group LLC, agreed to a six-month lock-up, which expires on June 12.

Part of the build-up in short positions is on expectations that some cornerstone investors may decide to cut their holdings, putting pressure on the stock.

Cinda's pricey valuation, at 2.15 times book value, is another lure. By comparison, Industrial and Commercial Bank of China and China Construction Bank Corp trade at book value, according to Thomson Reuters data.

Analysts also fret about Cinda's exposure to China's coal sector, with coal prices falling 20 percent in the first two months of 2014 due to overcapacity and tighter anti-pollution regulations. Nearly a quarter of Cinda's non-cash assets were in the coal sector through debt-for equity swaps in mid-2013, according to Daiwa Capital Markets.

Another concern for some: Unlike most major Chinese financial firms that are listed in both Hong Kong and Shanghai and report earnings every quarter, Cinda is listed only in Hong Kong and reports every half-year.

"It's the opaqueness of the business with low frequency of financial performance disclosure ... that piles up the short trades," said Dorris Chen, an analyst at Standard Chartered in Hong Kong.

($1 = 7.7531 Hong Kong Dollars) ($1 = 6.2220 Chinese Yuan) (Reporting by Nishant Kumar and Lawrence White; Additional reporting by Umesh Desai and Shanghai Newsroom; Editing by Kenneth Maxwell and Denny Thomas)

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