Cinda's bond debut heralds more issuance as China slows

Tue May 13, 2014 11:01pm EDT

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* Longer time to realise returns indicate funding needs to grow

* Move signals desire to step away from interbank markets

* Distressed debt assets have grown ten times in three years

By Umesh Desai and Saikat Chatterjee

HONG KONG, May 14 (Reuters) - Cinda, China's toxic debt manager, may become a frequent visitor to debt capital markets following a debut bond issue this month, as a slowdown in the economy offers rich pickings and the state-backed entity transitions to a commercial model.

Cinda's entry into the international debt capital markets last week with a $1.5 billion bond issue signals its growing use of leverage to buy distressed assets, especially in the well-founded expectation that policymakers would not let economic growth drop sharply below 7 percent.

Business prospects will also be boosted by Beijing's attempt to rein in its massive shadow banking sector, with the rise in corporate stress and defaults that could be expected to follow.

"We expect more controlled failures after the first onshore bond default to take place in order to remove moral hazard," said Aidan Yao, an economist at AXA Investment Management which manages $700 billion in assets.

"This poses great opportunities for distressed debt managers as long as they assess the risks properly."

China recorded its first domestic bond default in March when loss-making solar equipment producer Chaori Solar missed an interest payment, establishing a landmark for market discipline in China.

Yao noted Cinda was in a "sweet spot" as the economic slowdown presented buying opportunities, but intervention by Chinese authorities would prevent distressed debt from snowballing into a systemic problem.

But a slowing economy also means Cinda's funding needs will only rise as it takes more time to realise returns, despite its acquisition costs being the lowest in the growing distressed debt industry.

Its current holding period for distressed assets is about two years while Cinda's cost of acquiring bad debts is estimated by analysts at around 30 cents to the dollar, some of the lowest in the industry thanks to the backing of China's Ministry of Finance.

"Cinda's requirements for funds will go up, as there will be consolidation among the providers of capital," said a Hong Kong-based partner at a distress fund.

He said the pull-back of China's trust sector would increase institutional participation in lending to small and mid-cap companies, which could provide more accurate debt pricing.

"Consumers are currently financing these companies via trust products. They are not the right investor base because of their lack of sophistication in terms of conditions or pricing."

Gross distressed debt assets at Cinda have grown dramatically to 117 billion yuan ($19 billion) at end-2013 from 17 billion yuan in 2011, according to a bond prospectus.

On the financing side it has tried to reduce its reliance on interbank financing and on central banks.

"It makes more sense to raise funds offshore than to fund non-performing loans (NPL) purchased from banks with financing from the very same banks, to reduce conflict of interest," said Oscar Chow, head of Asian credit research at Mitsubishi UFJ Securities, Hong Kong. For a related story, see

Cinda's borrowing from central banks has fallen sharply to just 2 percent of total financing from 11.4 percent in 2011 - in keeping with the government's objective of imposing market-driven pricing.

At the end of 2013, banks funded about 60 percent of Cinda's total liabilities with about 52 percent of these obligations bearing a maturity of less than a year.

"There is moral hazard in that the government can't keep supporting all entities while they want more market discipline," said David Marshall, a Singapore-based analyst at independent research firm CreditSights.

While Cinda's desire to gather more funds at market rates and expand its balance sheet in a slowing economy is good business sense, market watchers agree Cinda will continue to benefit as long as it doesn't wade deeper into the murky waters of non-financial debt - capital provided to entities outside the financial sector.

"The business model has evolved from a government-funded entity to one that is bank-funded. It is now moving away from commercial banks and the goal is to buy assets relatively cheap and generate a return on equity for shareholders," said Chow.

"It will benefit from the distress cycle and the economic slowdown as long as it prudent and acquisitions are made at a decent price." ($1 = 6.2375 Chinese Yuan) ($1 = 6.2291 Chinese Yuan) (Editing by Eric Meijer)

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