Equity Research | Financials
Mar 31, 2017
Distressed Asset Management Industry
Positive (initiation)
A booming industry with expanding market size
Wang Wen
SFC CE No. BGL298
[email protected]
+86 755 8826 1286
Distressed asset management companies (AMCs) in China are categorized into the Big Four
AMCs, local AMCs, and non-licensed AMCs. The Big Four AMCs are the dominant players
in the industry, and local AMCs the latest policy beneficiaries. Licensed AMCs are regulated
by the CBRC and MoF.
GF Securities (Hong Kong) Brokerage Limited
29-30/F, Li Po Chun Chambers
189 Des Voeux Road Central
Hong Kong
The Big Four AMCs acquire distressed debt assets from both financial institutions and nonfinancial enterprises. The acquisition-and-disposal model used to be the mainstream
business model for distressed debt asset management at the Big Four AMCs before their
marketization. Once they were marketized, acquisition-and-restructuring became dominant
at both China Cinda and China Huarong. However, with the sharp increase in distressed
assets from financial institutions over the past two years, the proportion of new distressed
debt asset acquisition costs attributable to the acquisition-and-disposal model has rebounded
to ~40%.
The acquisition-and-disposal model The Big Four AMCs acquire packages of distressed
assets from financial institutions through public bidding or negotiated transfers. With an aim to
maximize the recoverable value of distressed debt assets, they adopt a variety of methods to
dispose of these assets. Main characteristics of the business include: 1) market space is
expanding quickly as disposal remains consistently below distressed debt asset acquisition;
2) AMCs are maintaining stable IRRs by shortening disposal cycles as net disposal returns
drop; 3) the IRR demonstrates counter-cyclical characteristics while the ROA appears to be
pro-cyclical.
The acquisition-and-restructuring business optimizes existing debt assets through
restructuring, providing differentiated financial services for companies with temporary liquidity
issues. It is in effect the provision of financing/lending to companies with a flawed credit
profile. Main characteristics include: 1) monthly annualized returns declined to ~11% in 1H16,
reflecting pro-cyclical characteristics; 2) the NIS is still quite high despite higher-than-banks
credit cost, and asset growth is strong on high NIS and visible gains; 3) the business is
property-sector-focused with fixed assets the preferred form of credit enhancement.
Debt-to-equity swap The Big Four AMCs obtain DES assets primarily through debt-to-equity
swaps, receipt of debt repayment with stock and follow-on equity investments; they then exit
from these investments and realize profits through asset swaps, M&A, restructuring and stock
listing. DES is the distressed asset management business with the highest return and longest
disposal cycle, while there is only a small proportion of liquid assets in the business.
Thriving industry with intensifying competition Both FI and NFE distressed assets have
surged since 2013, providing support for a boom in the distressed asset management
business. Recently the government has leant significantly towards more market-orientated
industry operation, as is reflected by two major regulatory trends. First is the support for
local AMC development by relaxing restrictions on business operations and the license quota,
giving rise to competition with the Big Four AMCs. Second is the promotion of marketoriented DES business. While the Big Four AMCs’ competitive edge has been weakened, we
believe that local AMCs’ business scale will still be much smaller than the Big Four AMCs
amid a sufficient supply of distressed assets.
Asset expansion bottleneck for Big Four AMCs, full-service operation key for future
development Amid the currently strong supply of distressed debt assets, both China Cinda’s
and China Huarong's capital adequacy ratios are approaching the minimum of 12.5%,
hindering further asset expansion. The provision of a full spectrum of financial services will be
the future of industry development as: 1) By establishing their own financial service platforms,
the Big Four AMCs can reduce the cost of using external institutions and produce business
synergy. 2) The fact that the business cycles of different financial service divisions do not
move entirely in sync can help to smoothen profitability volatility and increase asset utilization
efficiency. 3) It is now the Big Four AMCs’ developmental goal to become financial holding
groups that provide high value-added financial services.
This is a translation of a report originally written in Chinese. Please contact us for more information of the original report.
The Chinese version shall prevail in the event of any discrepancy between the two versions.
Mar 31, 2017
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Different types of distressed asset management companies in China
There are mainly three types of distressed asset management companies (AMCs) in China: the
Big Four AMCs, local AMCs, and non-licensed AMCs.
The Big Four AMCs: China Huarong Asset Management, China Great Wall Asset Management,
China Orient Asset Management and China Cinda Asset Management were set up in 1999, each
to accept, manage and dispose of distressed assets that had accumulated over the years at one
of China’s big four state-owned banks, i.e. the Industrial and Commercial Bank of China,
Agricultural Bank of China, Bank of China and China Construction Bank respectively, as well as
those at China Development Bank. In 2004, the Ministry of Finance issued a set of Administrative
Measures for the Management of Risks Tied to Financial Asset Management Companies’
Business (《金融资产管理公司有关业务风险管理办法》), allowing the Big Four AMCs to make
additional investment in foreclosed assets, acquire distressed assets in a market-oriented manner,
and offer custodian and agency services. This marked the beginning of a transition towards truly
marketized diversified financial business operations at the Big Four AMCs. Since 2010, the four
companies have become fully marketized, acquiring distressed assets through market-driven
mechanisms such as bidding and assuming sole responsibility for its profits and losses from the
disposal of assets. Their business scope now covers distressed assets from banks, non-bank
financial institutions and non-financial institutions. In 2010, China Cinda took the lead in
completing its joint-stock system reform, and the company became listed in Hong Kong in 2013.
China Huarong completed its joint-stock system reform in 2012 and went public in Hong Kong in
2015. Both China Orient and China Great Wall were also converted into joint-stock financing
institutions in 2016.
Local AMCs: In 2012, the MoF and the CBRC issued the Administrative Measures for the Bulk
Transfer of Financial Enterprises’ Distressed Assets (《金融企业不良资产批量转让管理办法》),
allowing each provincial government to establish one local AMC or issue the license for one,
which is required to have a minimum registered capital of Rmb1bn and is permitted to participate
in the bulk acquisition and disposal of distressed assets from financial institutions within its own
province. Furthermore, the central government has introduced a series of supportive policies for
the distressed asset management industry since Oct 2016, including the permission for each
provincial government to add one more local AMC (i.e. each now allowed to have up to two local
AMCs) and the permission for local AMCs to dispose of distressed assets through debt
restructuring and external transfer among other methods. Five local AMCs were granted a license
in Nov 2016. Among them, Everbright Jinou Asset Management Co., Ltd. (光大金瓯资产管理有限
公司) and Shanghai Win & Shengjia Asset Management Co., Ltd. (上海睿银盛嘉资产管理有限公
司) were added as the second local AMC in Zhejiang and Shanghai respectively. By the end of
2016, there were a total of 33 local AMCs across 27 provinces and municipalities.
Non-licensed AMCs: As distressed asset disposal becomes a large market in recent years,
some foreign and private capital has also set foot in the distressed asset management business,
acquiring and disposing of distressed assets from the Big Four AMCs, local AMCs or banks
(without being able to participate in the bulk transfer of assets from financial institutions). Some
non-licensed AMCs focus on investing in niche segments such as distressed assets in the
property or small/micro loans space. In addition, following the issuance of the Guidelines on
Market-Oriented Debt-To-Equity Swaps at Banks (《关于市场化银行债权转股权的指导意见》) by
the State Council in Oct 2016, banks began to set up or make plans for setting up their own AMC
subsidiaries with a focus on the debt-to-equity swap business.
Overall, the distressed asset management market is dominated by the Big Four AMCs. They are
the main institutions that acquire and dispose of distressed assets thanks to their significant
advantages in terms of business experience, capital strength and professional expertise.
Meanwhile, as the beneficiaries of the latest policies, local AMCs are likely to thrive on an
increasing number of licenses and the relaxation of restrictions on their business models. Besides,
while not being able to benefit from an AMC license, non-licensed AMCs are popular among
private and foreign capital as the distressed asset management market prospers and becomes
more segmented.
Policy and regulatory documents
Licensed AMCs are mainly regulated by the CBRC and the MoF. Industry-related policy and
regulatory documents issued since 2012 are listed below.
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Document
Administrative
Measures for the Bulk
Transfer of Financial
Enterprises' Distressed
Assets
《金融企业不良资产批量
转让管理办法》
MoF [2012] No.6
Notice on the Issuance
of Off-Site Supervision
Report Standards for
Financial Asset
Management
Companies (Provisional)
《关于印发金融资产管理
公司非现场监管报表指标
体系（试行）的通知》
CBRC office [2012]
No.153
Notice on Local AM Cs'
Qualifications for
Distressed Asset Bulk
Acquisition and Disposal
《关于地方资产管理公司
开展金融企业不良资产批
量收购处置业务资质认可
条件等有关问题的通知》
Key points
Quantity: 1 local AMC for
each province
Minimum package size: 10
items
Disposal: Debt restructuring
only, no external transfer
allowed
Capital requirements:
Minimum capital = riskweighted assets (including
OBS assets) * 12.5%
Leverage ratio: no less than
6%
Liquidity ratio: no less than
15%
Local AMCs are required to
have a minimum paid-in
registered capital of Rmb1bn
CBRC [2013] No. 45
Regulatory Measures
for Financial Asset
Management
Companies
The parent company shall
have a capital adequacy ratio
of no less than 12.5%
《金融资产管理公司监管
办法》
Rules related to the
replenishment of the group's
or parent company's capital
CBRC [2014] No.41
Notice on Regulating the
Acquisition of
Distressed Assets by
AMCs
《关于规范金融资产管理
公司不良资产收购业务的
通知》
《关于市场化银行债权转
股权的指导意见》
Article 3:
1. In principle, each provincial government can establish or authorize the establishment of
just one local AMC
2. A local AMC can only participate in distressed assets bulk transfers within its own
province/municipality. Bulk transfer is the transaction where financial enterprises
transfer a package of distressed assets (comprising no less than 10 separate items) to
a targeted AMC
3. Purchased distressed assets should be disposed of by means of debt restructuring
and should not be transferred by local AMCs
Five regulatory indicators are set: qualified capital, minimum capital, group consolidated
financial leverage ratio, asset company leverage ratio, and asset company liquidity ratio.
Among them:
The minimum capital for the Group is determined based on the calculation standards set
out by the Guidelines for the Consolidation of Financial Asset Management Companies .
The minimum capital for an AMC is calculated as 12.5% of its risk-weighted assets (OBS
assets included), where the weights are determined mainly based on the level of risks and
relevance to core business. The minimum capital for securities, insurance, trust and
leasing companies should be calculated in accordance with the regulatory requirements of
relevant regulatory bodies;
The leverage ratio of the Group and the asset company shall not be less than 6%;
The liquidity ratio of the asset company shall not be less than 15%.
Local AMCs shall meet the following prudent conditions:
1. Minimum paid-in registered capital of Rmb1bn
2. Having directors and senior management personnel with professional knowledge and
experience, as well as professional teams suitable for the bulk purchase and disposal of
distressed assets from financial enterprises
3. Having sound corporate governance, internal control and risk management systems
4. Having achieved solid operating results, continuously making profits over the past three
accounting years
5. Good credit quality, with no violations of any laws or regulations or any other bad records
over the past three years
1. The parent company and its subsidiary financial institutions shall meet the capital
requirements set out by their respective regulatory bodies. The Group/parent company's
capital adequacy ratio shall not be less than 12.5%.
2. Article 98: The parent company shall strengthen the prudent management of its
subsidiaries. Where the parent company holds a 20%-50% stake in a subsidiary and has
actual control of the latter, only the proportion of eligible capital in excess of the pro rata
capital requirement for the subsidiary may be used to cover the group/parent company's
own capital.
Channel business prohibited
AMCs are required to acquire distressed assets from banking financial institutions at fair
market prices. They shall not enter any agreements with the transferor which might affect
the true and complete transfer of the assets and risks; they shall not set any explicit or
implicit repurchase terms, transfer interests in violation of regulations, or provide channels
for banking financial institutions to evade asset quality regulations
AMCs shall not acquire the performing assets of non-financial institutions
In the acquisition of distressed assets, AMCs shall not provide financing for enterprises or
projects by purchasing debt or assets that are yet to exist
Bank debt-to-equity swaps
should be realized through
executing institutions
1. Banks shall not directly convert debt into equity. Banks should first transfer the
creditor’s rights to an executing institution which will then convert the debt into equity
2. The government will not bail out in the case of any losses
3. Debt-to-equity swaps must not be carried out for "zombie enterprises"
4. The bank, enterprise and executing institution should determine the transfer of creditor's
rights, the prices and terms of the transfer with no external influence
5. Stock market trading prices are allowed to be used as reference in determining the debtto-equity swap pirces for listed SOEs; competitive market quotes or other fair prices are
allowed to be used as reference when determining the swap prices for unlisted SOEs
CBRC [2016] No. 56
Guidelines on MarketOriented Debt-to-Equity
Swaps at Banks
Highlights
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Adjustments to Local
AMC Policies
《关于适当调整地方资产
管理公司有关政策的函》
(Document No.1738)
Administrative
Measures for the Bulk
Transfer of Financial
Enterprises' Distressed
Assets (new version)
Quantity: up to 2 local AMCs
each province
Asset disposal: both debt
restructuring and external
transfer allowed
1. Each provincial government allowed to add one more local AMC
2. Local AMCs allowed to dispose of distressed assets by way of debt restructuring and
external transfer, with no geographical restrictions on the transferee
The CBRC also requires provincial governments to consider the following three factors
when adding local AMCs:
1. The local distressed debt balance is relatively high, with considerable pressure for the
disposal of distressed debt
2. Distressed assets grow rapidly with strong demand to trasfer distressed assets
3. The existing local AMC is operating normally and has played an active part
Minimum package size: 3
items
Minimum number of assets needed to make a pachage redcued from ten to three
新《金融企业不良资产批
量转让管理办法》
Notice on Announcement
of the List of Local AM Cs
in Shaanxi, Qinghai,
Heilongjiang, Zhejiang
and Shanghai
《关于公布陕西省、青海
省、黑龙江省、浙江省、
上海市地方资产管理公司
名单的通知》
Five local AMCs approved to
be set up, includign the
second local AMC for
Shanghai and Zhejiang
Shaanxi Financial Asset Management Co., Ltd., Huarong Kunlun Qinghai Assets
Management Co., Ltd., Heilongjiang Castrol Longsheng Financial Asset Management Co.,
Ltd., Everbright Jinou Asset Management Co. Ltd., and Shanghai Win & Shengjia Asset
Management Co., Ltd. permitted to participate in the bulk transfer of distressed assets
within their respective province/municipality
Among them, Shanghai and Zhejiang have been approved to set up their second local
AMC
Distressed asset management business overview based on listed AMCs
Sources of distressed assets: The Big Four AMCs acquire distressed debt assets from both
financial institutions and non-financial enterprises through bidding, public auctions, blind auctions,
and negotiations. Depending on their sources, distressed assets acquired by the AMCs can
therefore be categorized into FI distressed assets from financial institutions and NFE distressed
assets from non-financial enterprises.
FI distressed assets are mainly distressed loans and other distressed debt assets sold by large
commercial banks, joint-stock banks, urban and rural commercial banks and non-bank financial
institutions. Before becoming fully marketized, each of the Big Four AMCs focused on accepting
the distressed debt from their corresponding state-own bank. However, the proportion of
distressed debt assets acquired from joint-stock banks has risen in recent years.
NFE distressed assets In recent years, a large amount of distressed assets have come into
being in some of the non-financial industries during the course of economic restructuring and
industry consolidation, which mainly include overdue receivables, receivables expected to default
and receivables due from debtors with liquidity issues. Based on data from China Cinda (1359 HK)
and China Huarong (2799 HK), NFE distressed assets increased rapidly during 2012-2015,
contributing to more than 50% of newly acquired distressed debt.
Figure 1: Newly acquired distressed debt assets (Rmb m)
200,000
250,000
China Cinda
FI
150,000
China Huarong
200,000
NFE
FI
NFE
150,000
100,000
100,000
50,000
50,000
0
0
2010
2011
2012
2013
2014
2015
1H16
2012
2013
2014
2015
1H16
Sources: Company data, GF Securities (Hong Kong)
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Figure 2: FI distressed assets breakdown
China Cinda
China Huarong
100%
100%
80%
80%
60%
60%
40%
40%
20%
20%
0%
2010
2011
2012
2013
2014
2015
0%
1H16
Large commercial banks
Joint-stock commercial banks
Urban/rural commercial banks
Other banks
2012
2013
2014
Large commercial banks
Urban/rural commercial banks
Non-bank financial institutions
Non-bank financial institutions
2015
1H16
Joint-stock commercial banks
Other banks
Sources: Company data, GF Securities (Hong Kong)
In terms of business models, the Big Four AMCs have now established a business structure with
traditional distressed asset acquisition, acquisition & restructuring, debt-to-equity swap, and
custodian and agency services at the core. Based on China Huarong’s and China Cinda’s
revenue breakdown, distressed debt asset management and debt-to-equity swap are their most
important businesses. More specifically, distressed debt asset management consists of the
acquisition-and-disposal business and the acquisition-and-restructuring business (for Cinda,
distressed-asset-based special situations investments and property development are grouped
under the investment and asset management business).
Figure 3: Distressed asset management revenue breakdown (1H16)
China Cinda
China Huarong
Distressed debt asset
management
Debt-to-equity swap
11%
11%
Distressed debt asset
management
Debt-to-equity swap
26%
7%
1%
7%
1%
63%
Others
73%
Custody and agency
services for distressed
asset business
Distressed-asset-based
special situations
investments
Distressed-asset-based
property development
Others
Source: Company data, GF Securities (Hong Kong)
Distressed debt asset management business
The distressed debt asset management business is conducted following the acquisition-anddisposal model or the acquisition-and-restructuring model. Under the acquisition-anddisposal model, an AMC acquires a distressed debt asset at a discount to the asset’s original
carrying value, and enhances its value based on the classification of the asset; the AMC then
makes a profit by selling the asset or collecting the debt by various means. Under the acquisitionand-restructuring model, the AMC, during the acquisition, decides upon a method to restructure
the debt or asset based on the level of its risks, and then enters into a restructuring agreement
with the debtor and related parties. The main differences between the two models are as follows.
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Exhibit 4: Acquisition-and-disposal vs acquisition-and-restructuring
Source of acquired
asset
Acquisitionand-disposal
Primarily from
financial
institutions
Acquisitionandrestructuring
Both from
financial
institutions and
NFEs
Changes in legal relationships
Profit-making model
All elements of the original creditor-debtor Price spread between the acquisition
relationship remain unchanged, except that cost and disposal proceed for the
of the creditor
distressed asset
New contractual rights and obligations
established through a three-party
agreement between the AMC, the orignial
creditor and the debtor
Restructuring income and date of
payment set in restructuring
agreement
Source: Wind, GF Securities (Hong Kong)
Relative size of the two models The acquisition-and-disposal model used to be the mainstream
business model at the Big Four AMCs before their marketization. Once they were marketized,
acquisition-and-restructuring became the dominant model for newly acquired distressed debt
assets at both China Cinda and China Huarong. However, as the Big Four AMCs accelerated the
pace of asset acquisition and disposal amid a sharp increase in distressed assets from financial
institutions over the past two years and the diversification of downstream AMCs (e.g. local and
non-licensed AMCs), the proportion of new distressed debt asset acquisition costs attributable to
the acquisition-and-disposal model has rebounded to ~40%.
Figure 5: Acquisition costs of newly added distressed assets, acquisition-and-disposal vs acquisition-and-restructuring
China Cinda
China Huarong
100%
100%
80%
49%
77%
60%
94%
100%
86%
80%
56%
59%
60%
79%
40%
94%
88%
86%
74%
40%
51%
20%
23%
6%
0%
2010
2011
2012
Acquisition-and-disposal
14%
21%
2013
2014
41%
0%
2015
44%
20%
1H16
Acquisition-and-restructuring
6%
12%
14%
2012
2013
2014
Acquisition-and-disposal
26%
2015
1H16
Acquisition-and-restructuring
Source: Company data, GF Securities (Hong Kong)
The acquisition-and-disposal model
As the major players in the primary market for distressed debt assets, the Big Four AMCs acquire
packages of distressed assets from financial institutions through public bidding or negotiated
transfers. With an aim to maximize the recoverable value of distressed debt assets, they adopt a
variety of methods to dispose of these assets, which include: short-term operations, asset
restructuring, debt-to-equity swap, individual transfer, packaged transfer, discounted repayment
by debtors, bankruptcy, liquidation, collection through litigation, repayment in kind, and debt
restructuring. The core competitiveness of the acquisition-and-disposal business lies in an AMC’s
acquisition pricing power and asset disposal capabilities.
Based on data from China Cinda and China Huarong, the distressed debt asset acquisition-anddisposal business has demonstrated the following characteristics in recent years.
1) Market space expanding quickly as disposal remains consistently below distressed debt
asset acquisition Prior to 2012, the cost of distressed debt asset acquisition and the gross
amount of distressed debt asset disposal were roughly the same at China Cinda and China
Huarong. After 2013, however, the size of the distressed asset disposal market had grown amid
the economic downturn, with Cinda and Huarong recording a significant increase in the cost of
distressed debt asset acquisition. The gross amount of distressed debt asset disposal did not start
to pick up considerably until mid-2015, and has remained lower than the amount of newly
acquired distressed debt assets in the same period. This means the pace at which distressed debt
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assets are disposed of has lagged that of their acquisition, and that the earnings growth of the
business has been achieved mainly through increasing input in asset acquisition. The regulatory
requirement for a minimum net capital ratio of 12.5% has been a bottleneck for business growth at
the Big Four AMCs. In view of this, China Cinda significantly reduced its cost of distressed debt
asset acquisition in 1H16, whereas China Huarong has expanded its business even more
aggressively.
Figure 6: Disposal consistently lower than newly acquired distressed debt assets (Rmb m)
China Cinda
China Huarong
100,000
100,000
80,000
80,000
60,000
60,000
40,000
40,000
20,000
20,000
0
0
2010
2011
2012
2013
2014
1H15
2015
1H16
2012
2013
2014
1H15
2015
1H16
Acquisition cost of newly added distressed debt assets
Acquisition cost of newly added distressed debt assets
Gross amount of distressed debt assets disposed of
Gross amount of distressed debt assets disposed of
Source: Company data, GF Securities (Hong Kong)
2) AMCs maintaining stable IRR by shortening disposal cycles as net disposal returns drop
The disposal IRR is the discount rate that makes the net present value of all cash flows from
acquisition-and-disposal projects completed in a given period equal to zero. Meanwhile, the net
return on disposal is calculated as, in China Cinda’s case, “(net gains from acquisition-anddisposal distressed debt assets - unrealized fair value changes) / cost of distressed debt assets”,
or, in China Huarong’s case, “realized disposal gains from distressed debt assets / gross value of
distressed debt assets disposed of”. The main difference between the IRR and the net return is
that time cost is factored in in the former but not the latter.
Net disposal returns have plunged since 2011, dropping from 145.5% in 2011 to 6.6% in 1H16 for
China Cinda, and down from 26.4% in 2012 to 3.2% in 1H16 for China Huarong. That said, the
disposal IRR (which captures time cost) has remained stable for both companies, staying in the
range of 15%-20% from 2012 to 1H16, which has been achieved mainly by shortening the
disposal cycle. By using the equation (1 + IRR) n = 1 + net disposal return (where n = disposal
cycle), we can roughly calculate the changes in the disposal cycle at the two listed AMCs. Cinda’s
disposal cycle shortened from 4.24 years in 2013 to 0.42 years in 1H16, while Huarong’s
shortened from 1.71 years in 2012 to 0.21 years in 1H16. Shorter disposal cycles can not only
help maintain a relatively stable IRR for the acquisition-and-disposal business amid declining net
disposal returns, but it also means the Big Four AMCs can benefit from the existence of other
types of AMCs, as they can now transfer relatively tricky projects to other AMCs quickly after a
preliminary review of the value of the asset packages.
Another explanation for the relatively stable IRR might be that policy-driven distressed debt assets
acquired at low costs before the Big Four AMCs were marketized have generated high returns
over the past few years. However, this explanation cannot be widely applicable: in China Cinda’s
case, a disposal cycle of 4.24 years in 2013 meant that most of the disposable assets were
acquired around 2009, but the company has not acquired any policy-driven distressed debt assets
since 2000.
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Figure 7: Net disposal return
160%
140%
Figure 8: Disposal IRR
22.0%
145.5%
123.9%
112.5% 111.3%
120%
20.4%
19.30%
20.0%
18.6%
19.2%
20.2%
18.0%
100%
80%
62.1%
60%
14.0%
26.4% 23.2%
40%
16.7%
9.9%
20%
8.1% 6.6%
4.2% 3.2%
11.8%
0%
2010
2011
2012
2013
2014
China Huarong
16.2%
16.0%
1H15
2015
17.0%
15.7%
16.0%
2013
2014
16.2%
14.7%
12.0%
10.0%
2012
1H16
1H15
China Huarong
China Cinda
2015
1H16
China Cinda
Sources: Company data, GF Securities (Hong Kong)
3) Counter-cyclical IRR vs pro-cyclical ROA The distressed asset disposal industry is generally
perceived to a counter-cyclical industry, given that the supply of distressed debt assets tend to
increase with greater acquisition discounts amid an economic downturn, leading to increased
opportunities for the acquisition-and-disposal business. However, only during an economic
upcycle when the price of distressed asset disposal rises, can disposal profits be maximized,
which still shows pro-cyclical characteristics. While Cinda and Huarong have achieved relatively
stable IRRs by accelerating the disposal cycle, the ROA of the acquisition-and-disposal business
is still decreased in a weakening economy if the substantially increased input in acquiring new
distressed debt assets is considered (ROA = net disposal gains/average net amount of distressed
debt assets).
Figure 9: Distressed asset disposal cycle (years)
Figure 10: ROA of acquisition-and-disposal business
4.24
4.50
80%
4.00
70%
3.50
60%
2.83
3.00
50%
37%
40%
2.00
1.00
61%
50%
2.50
1.50
67%
30%
1.71
0.88
0.42
0.50
0.00
2012
2013
0.64
0.71
2014
1H15
China Huarong
14%
20%
1.43
0.22
2015
0.42
0.21
1H16
10%
7%
9%
8%
1%
6%
4%
0%
China Cinda
2010
2011
2012
2013
China Huarong
2014
2015
2%
1H16
China Cinda
Sources: Company data, GF Securities (Hong Kong)
The acquisition-and-restructuring model
The acquisition-and-restructuring business optimizes existing debt assets through restructuring,
providing differentiated financial services for companies with temporary liquidity issues. It seeks to
discover and enhance asset value by re-pricing credit risk, redeploying distressed debt assets
with going-concern value, restoring the debtor’s corporate credit profile, and assessing the price
and operational value of the debtor’s core assets. The revenue from the business comprises
restructuring gains and asset appreciation gains, as well as financial advisory fees. It is in effect a
business that provides financing/lending services to companies with a flawed credit profile (or
those with sound asset quality but unable to gain access to normal financing due to regulatory
reasons, such as property companies). The ability to discover, reassess and enhance overall debt
asset value is key to the business.
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Mar 31, 2017
Sector report
Based on data from China Cinda and China Huarong, the acquisition-and-restructuring business
has demonstrated the following characteristics in recent years:
1) Monthly annualized returns declining to ~11% in 1H16, reflecting pro-cyclical
characteristics The decline in the return on distressed debt assets under the acquisition-andrestructuring model was mainly due to the combined effect of the economic downturn and falling
interest rates. As a de facto financing/lending provision business, its revenue (except financial
advisory fees) is mainly driven by market interest rates and customers’ risk premiums. During the
latest economic downturn, the Big Four AMCs have adopted a more prudent business strategy in
their selection of customers and projects. Meanwhile, the bargaining power of quality customers
has also increased amid such a market environment. The monthly annualized return on distressed
debt assets under the acquisition-and-restructuring model declined to ~11% in 1H16, though the
pace of decline was much slower than the ROA decline in the acquisition-and-disposal business.
Figure 11: Monthly annualized return on acquisition-andrestructuring distressed assets
Figure 12: Total amount of acquisition-and-restructuring distressed
assets (Rmb bn)
25.0%
250
19.4%
20.0%
17.9%
200
167 169
15.0%
17.2%
13.1%
12.9%
12.5%
11.2%
11.7%
16.0%
13.5%
10.0%
222
212
12.2%
11.9%
168
148
150
99 92
100
10.6%
5.0%
156
236
49 55
50
0.0%
0
2011
2012
2013
2014
China Cinda
1H15
2015
China Huarong
1H16
2012
2013
2014
China Cinda
1H15
2015
1H16
China Huarong
Source: Company data, GF Securities (Hong Kong)
2) NIS still quite high despite higher-than-banks credit cost; strong asset growth on high
NIS and visible gains Cinda and Huarong have maintained relative stable ratios of distressed
asset impairment provisions over the past two years. Based on our estimates (credit cost =
distressed debt asset impairment losses / average amount of distressed debt assets under the
acquisition-and-restructuring model), the credit costs of Cinda and Huarong are higher than the
average level at commercial banks, in line with the level of risks associated with the acquisitionand-restructuring business (unusually low data in 1H16 were probably due to impairment losses
mostly being recognized towards year-end). That said, deducting the credit cost and 5% cost of
funds from the restructuring return, AMCs still manage to earn a 3.5-5% NIS. In addition,
acquisition-and-restructuring gains are more visible compared with the acquisition-and-disposal
model. As such, the gross amount of distressed debt assets under the acquisition-andrestructuring model has increased rapidly given higher NIS and more visible gains. However, it is
worth noting that the NIS, which is dependent on the restructuring return, credit cost and cost of
funds, has narrowed in recent years, a trend which is mirrored by a slowdown in the growth of
acquisition-and-restructuring distressed debt assets over the past two years.
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Mar 31, 2017
Sector report
Figure 13: Impairment ratio of acquisition-and-restructuring
distressed assets
Figure 14: Credit cost of acquisition-and-restructuring distressed
assets
6.0%
3.0%
5.0%
2.70%
2.0%
1.60% 1.60%
1.5%
1.0%
4.6%
5.0%
2.5%
1.2%
1.2%
1.0%
0.8%
1.78%
1.52% 1.50%
1.82%
4.0%
1.70%
3.0%
3.3%
2.0%
2.1%
2.0%
1.0%
0.90%
0.5%
4.1%
4.6%
1.0%
0.3%
0.1%
0.2%
0.0%
0.0%
2011
2012
2013
2014
China Cinda
1H15
2015
2011
1H16
2012
2013
China Cinda
China Huarong
2014
2015
1H16
China Huarong
Sources: Company data, GF Securities (Hong Kong)
3) Property-sector-focused with fixed assets preferred form of credit enhancement Based
on Huarong’s data, the proportion of to-be-restructured distressed debtors from the property
sector has declined in recent years, but remained above 60% in 1H16. The high proportion is
partly due to the fact that property companies are forced to seek alternative financing channels as
lending supply for the sector has long been restricted by policies. In addition, properties have
proven to be highly effective in preserving and enhancing value as a collateral. The rising debt-tocollateral ratio of distressed assets in the acquisition-and-restructuring business reflects the Big
Four AMCs’ preference for fixed assets.
Figure 15: Sector breakdown of China Huarong’s acquisition-andrestructuring distressed debtors
100%
Figure 16: Debt-to-collateral ratio of acquisition-and-restructuring
distressed assets at China Huarong
37.0%
80%
36.2%
35.7%
36.0%
35.0%
35.8%
34.2%
34.0%
60%
33.0%
40%
75.7%
67.2%
62.6%
65.8%
32.0%
61.2%
20%
31.0%
30.2%
30.7%
30.0%
29.0%
0%
2012
2013
2014
2015
1H16
Property
Manufacturing
Construction
Services
Infrastructure
Mining
Transportation
Others
28.0%
27.0%
2012
2013
2014
1H15
2015
1H16
Sources: Company data, GF Securities (Hong Kong)
Debt-to-equity swap
The Big Four AMCs obtain DES assets primarily through debt-to-equity swaps, receipt of debt
repayment with stock and follow-on equity investments; they then exit from these investments and
realize profits through asset swaps, M&A, restructuring and stock listing. The revenue of the
business mainly comes from equity disposal income, dividend income, financial service income,
restructuring income (equity swaps) and follow-on investment gains. DES assets acquired from
the MoF at low costs make up the bulk of the Big Four AMCs’ DES asset pool.
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Mar 31, 2017
Sector report
Distressed asset management business with the highest return… Based on the formula for
calculating the exit multiple (exit multiple = [net gains on DES assets disposed of + corresponding
acquisition cost of DES assets] / corresponding acquisition cost of DES assets), the following can
be derived: exit net return = (exit multiple - 1)*100%. A DES asset net return range of 90-420% at
Cinda and Huarong makes DES asset management the most profitable distressed asset
management business.
…and longest disposal cycle The majority of DES assets at the Big Four AMCs had been
converted from distressed debt assets acquired from large and medium SOEs before the AMCs
were turned into joint-stock companies, which means most of the DES assets disposed of by the
Big Four AMCs have been in their possession for at least a decade. Except in 2013 when there
was a liquidity crunch, the number of DES companies disposed of by China Cinda and China
Huarong each year has accounted for less than 20% of the total number of companies in their
existing DES asset pool; the same proportion calculated in terms of the amount of assets has also
been lower than 20% in general. This means it will take at least five years for the Big Four AMCs
to completely dispose of all the existing DES assets in their possession with reasonable returns.
Figure 17: High exit multiples for DES business
6.0
Figure 18: Proportion of DES assets disposed of
50%
5.2
40%
5.0
3.7
4.0
3.7
30%
3.8
20%
3.3
2.9
3.0
2.1
3.0
2.7
2.0
2.3
2.2
1.9
1.9
1.0
10%
2.7
0%
2010
2011
2012
2013
2014
2015
1H16
Cinda: (cost of DES assets disposed of + net gains)/gross DES assets
0.0
2010
2011
2012
2013
2014
1H15
2015
Huarong: (cost of DES assets disposed of + net gains)/gross DES assets
1H16
Cinda: No. of DES co. disposed of/total No. of DES co.
China Cinda
China Huarong
Huarong: No. of DES co. disposed of/total No. of DES co.
Source: Company data, GF Securities (Hong Kong)
A small proportion of liquid assets It is worth noting that time cost and realization cost are not
reflected in the calculation of the exit multiple and net return on DES assets. Listed shares are the
most highly valued and liquid of DES assets given the existence of a liquid secondary market and
easily accessible fair value information. However, listed companies represent just a small
proportion of companies in the Big Four AMCs’ DES asset pool: below 15% at Huarong and Cinda.
In addition, considering that most of the Big Four AMC's DES assets had been transferred from
the MoF with many of these SOEs being key beneficiaries of government support, and
considering that these assets have been under the AMCs’ management for more than a decade,
only a very small proportion of these DES assets are likely to eventually become listed.
Figure 19: DES asset classification, listed vs unlisted (No. of companies)
China Cinda
300
250
200
26%
10%
250
27%
8%
12%
11%
200
9%
150
China Huarong
300
10%
11%
14%
12%
13%
13%
2014
Unlisted
1H15
Listed
2015
1H16
150
100
100
50
50
0
16%
0
2010
2011
2012 2013
Unlisted
2014 1H15
Listed
2015
1H16
2012
2013
Sources: Company data, GF Securities (Hong Kong)
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Mar 31, 2017
Sector report
As of the end of June 2015, Huarong had DES assets worth Rmb26.6bn from 221 companies. By
asset value, industrial companies accounted for the largest proportion of assets (56%), followed
by materials (23%), energy (7%) and information technology companies (5%). As of the end of
June 2013, Cinda had on its book Rmb43.65bn worth of DES assets from 249 companies. Coal
companies accounted for the largest proportion of 61.5%, followed by chemical (16.2%) and metal
companies (9.1%). 13 of the top 20 unlisted companies with the largest amount of DES assets on
Cinda’s book were coal companies, which accounted for 81% of the total DES asset acquisition
cost for these 20 companies. Overall, through DES asset management Cinda had equity interests
in 21 of the top 50 largest coal companies by output in China in 2011, and it has benefited
significantly from the upcycle of resource prices.
Figure 20: DES asset sector breakdown (China Cinda, as of end-June
2013)
Figure 21: DES asset sector breakdown (China Huarong, as of endJune 2015)
9%
13%
5%
9%
Coal
Manufacturing
7%
Raw materials
Chemical
Energy
Metal
16%
62%
Others
56%
23%
IT
Others
Sources: Company data, GF Securities (Hong Kong)
Thriving industry with intensifying competition
Expanding market space
Both FI and NFE distressed assets have surged since 2013, providing support for a boom in the
distressed asset management business.
FI distressed asset acquisition As commercial banks write off or package transfer distressed
debts that are unable or difficult to be recovered each year, the actual increase in commercial
banks’ total NPLs is the sum of newly added NPLs as disclosed by the banks and NPLs disposed
of or written off during the year. For distressed loans that are difficult to be collected, a commercial
bank can choose to transfer them to an AMC through public bidding or negotiated batch transfer,
of which the latter is currently the prevalent channel. Since 2014, with the deterioration of asset
quality, commercial banks have stepped up the transfer of distressed assets off their balance
sheets, resulting in an actual NPL ratio that is much higher than the reported figure. Accordingly,
the acquisition costs of newly added FI distressed debt assets at the Big Four AMC’s increased
significantly in 2015, and continued to rise in 1H16. Cinda and Huarong acquired FI distressed
debt assets with a combined value of Rmb158.4bn during 2015, up 58% YoY. Full-year FI
distressed asset acquisition would have grown 42% YoY in 2016 if the amount of acquisition in
1H16 was maintained in 2H16. Based on 2016 data from commercial banks, the proportion of
“special-mention” loans came down in 4Q16 but remained high, and these loans will subsequently
turn into NPLs. As such, the supply of distressed assets from banks is expected to remain high in
2017.
NFE distressed assets mainly come from enterprises’ receivables. Net receivables in China
have continued to increase as the economy grows. That said, amid ongoing industrial
restructuring and upgrade, receivable growth has mainly been driven by slower receivable
turnover, which has led to strengthening demand among companies to revitalize their assets and
restructure their debt. Cinda and Huarong collectively acquired NFE distressed debt assets worth
Rmb233.3bn during 2015, a figure which has grown at a three-year CAGR of 94%. Meanwhile,
net receivables at industrial companies in China have continued to increase, up 10% YoY to
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Mar 31, 2017
Sector report
Rmb12.6trn at the end of 2016. Continuously growing receivables will give rise to a large supply of
distressed debt, providing room for the development of the distressed debt asset management
business.
Figure 22: Acquisition cost of newly added FI distressed debt assets
(Rmb m)
180,000
Figure 23: Acquisition cost of newly added NFE distressed debt
assets (Rmb m)
250,000
160,000
200,000
140,000
120,000
150,000
100,000
80,000
100,000
60,000
40,000
50,000
20,000
-
0
2012
2013
2014
China Cinda
2015
1H16
2012
China Huarong
2013
China Cinda
2014
2015
1H16
China Huarong
Source: Company data, GF Securities (Hong Kong)
3.0%
2.6%
2.5%
2.0%
1.5%
1.6%
1.7%
1.6%
2.3%
1.9%
1.6%
0.8%
ICBC
601398
CH
1398 HK
CCB
601939
CH
939 HK
CMB
CMBC
600036 600016
CH
CH
3968 HK 1988 HK
SPDB
600000
CH
BoNJ
601009
CH
Reported NPL ratio
NPL ratio with write-offs & OBS transfers added back
14,000
30%
12,000
25%
10,000
Rmb bn
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
Figure 25: Net receivables from industrial companies continue to
rise
20%
8,000
15%
6,000
10%
4,000
2,000
5%
0
0%
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Figure 24: NPL ratios become much higher with write-offs and OBS
transfers added back (end-2015)
Net receivables from industrial companies
YoY
Sources: Company data, GF Securities (Hong Kong)
Industry becoming increasingly market-oriented
Previously the distressed asset management business has been highly policy-driven. Over the
years, the Big Four AMCs have accumulated relevant business experience by accepting
distressed assets at cheap prices from their designated state-owned banks, and have benefited
greatly from preferential policy and licensing treatments amid an economic upcycle. However,
recently the government has leant significantly towards more market-orientated industry operation.
This is reflected in two major regulatory trends. First is the support for local AMC development
by relaxing restrictions on business operations and the quota of licenses, giving rise to
competition with the Big Four AMCs. New policies issued in 2016 allow each provincial
government to set up or authorize the establishment of up to two local AMCs, while local AMCs
are now allowed to conduct both acquisition-and-restructuring and acquisition-and-disposal
businesses (the latter of which used to be prohibited); the minimum number of items in a package
of distressed assets for transfer has also been lowered from ten to three, effectively enabling local
AMCs with less capital strength to participate in the bidding for distressed asset packages.
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Sector report
Mar 31, 2017
The second regulatory change is the promotion of market-oriented DES business. Previously
DES transactions were entirely orchestrated by the government, while the Big Four AMCs had
little say in company selection and asset pricing. In the Guidelines on Market-Oriented Debt-toEquity Swaps at Banks (《关于市场化银行债权转股权的指导意见》) issued in 2016, marketization
was identified as a guiding principle for the DES business, under which the bank, debtor company
and executing institution should determine the transfer of creditor's rights, the prices and terms of
the transfer through negotiation with no external influence, while the government will not bail out in
the case of any losses. In addition, in view of the potentially high returns of the DES business,
several state-owned banks and joint-stock banks have shown interests in setting up fully or
partially owned subsidiaries to participate in the business. CCB took the lead by launching the first
market-driven DES project ever launched by a bank. At the early stage of their development,
AMCs (DES executing institutions) established by banks might focus on DES projects coming
from their parent banks due to personnel and capital constraints. However, as part of large banks’
diversified financial service platforms, bank-affiliated AMCs will inevitably set foot in a broader
scope of distressed asset management businesses in the long run, and might eventually become
important players in the industry.
Local AMCs’ business scale much smaller than Big Four AMCs despite policy support So
far there are 32 local AMCs officially in operation, including 28 provincial AMCs and four municipal
AMCs. Every province in China now has a local AMC of their own except Xinjiang, Guizhou,
Hainan and Yunnan. Most of these local AMCs are predominantly owned by local state-owned
capital such as local fiscal bureaus, local SOEs and local financial holding groups, though privatesector shareholders, listed companies, the Big Four AMCs and other financial institutions are also
found among quite a few local AMCs’ shareholders.
The 32 local AMCs have a combined registered capital of Rmb71.6bn, equivalent to an average of
Rmb2.2bn for each. Based on the 12.5% minimum capital adequacy requirement, these existing
local AMCs together can accept distressed assets worth up to Rmb573.2bn. Assuming another 28
local AMCs are added under the relaxed policy with each to have registered capital at the
minimum threshold of Rmb1bn, the total distressed asset undertaking capacity of local AMCs
could thus be increased by Rmb224bn; the additional distressed asset acquisition capacity would
increase to Rmb492.8bn if we assume that the new AMCs had an average registered capital of
Rmb2.2bn. Meanwhile, China Cinda and China Huarong reported equity of Rmb104.3bn and
Rmb108bn respectively at mid-2016, translating into a combined maximum distressed asset
acquisition capacity of Rmb1.7trn under the 12.5% capital adequacy requirement. Assuming that
the yet-to-be-listed China Orient and China Great Wall each had equity of Rmb80bn, meaning
maximum capacity of Rmb640bn each, the total distressed asset acquisition capacity of the Big
Four AMCs can be estimated at around Rmb3trn at mid-2016.
In this simple estimation, it should be noted that the newly established local AMCs are unlikely to
be brought into operation at fully capacity immediately, while there are also likely to be fewer of
them than estimated. In addition, the Big Four AMCs’ upcoming financing plans have not been
taken into consideration: China Huarong’s plan for an A-share listing was accepted by the CSRC
for review in Dec 2016, while China Great Wall and China Orient have also finished their jointstock system reform and are actively seeking listing. In a bull case scenario, the combined
distressed asset acquisition capacity of local AMCs might be equal to the average of the Big Four
AMCs. As such, while the Big Four AMCs’ competitive edge has been weakened, we believe that
local AMCs’ business scale will still be much smaller than the Big Four AMCs amid a sufficient
supply of distressed assets.
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Mar 31, 2017
Sector report
Figure 26: AMC industry size estimates
Registered capital (Rmb bn)
Maximum distressed asset
acquisition capacity (Rmb bn)
71.6
572.8
Min registered capital Rmb 1bn
28
224
Avg registered capital Rmb2.2bn
61.6
492.8
32 existing local AMCs
Total acquisition capacity
- local AMCs (Rmb trn)
28 local AMCs to be set up
0.8
1.1
Total acquisition capacity
- Big Four AMCs (Rmb trn)
China Huarong
108
864
China Cinda
104
835
China Orient
80
640
China Great Wall
80
640
3.0
Source: Wind, GF Securities (Hong Kong)
Big Four AMCs facing asset expansion bottleneck, full-service operation key for
future development
Asset expansion bottleneck for Big Four AMCs Both the acquisition-and-disposal and DES
businesses involve purchasing and holding assets for value appreciation, while the acquisitionand-restructuring business can essentially be seen as the provision of financing/lending to
enterprises with less convincing credit profiles. All three are asset-heavy businesses with revenue
growth dependent upon asset expansion and are subject to net capital restrictions under the 12.5%
minimum capital adequacy requirement. Amid the currently strong supply of distressed debt
assets, both China Cinda’s and China Huarong's capital adequacy ratios are approaching 12.5%,
meaning their current pace of asset expansion might not be sustainable at their existing capital
levels. In response to this situation, China Huarong is actively seeking A-share listing, and as are
China Orient and China Great Wall. In addition, China Cinda has freed up some capital by
transferring a 41% stake in Cinda P&C Insurance.
Big Four AMCs as full-service financial firms
The Big Four AMCs have all turned themselves into full-service financial firms covering banking,
securities, trust, fund management, financial leasing and insurance businesses. Thus, financial
services and investment & asset management have become two other key business segments for
the Big Four AMCs alongside distressed asset management. We see the following benefits of a
full-service operation.
First, the management and operation of distressed assets typically require coordinated services
from different financial institutions. By establishing their own financial service platforms, the Big
Four AMCs can reduce operating costs originating from using external institutions’ services and
produce business synergy. For example, an AMC’s banking division can serve as its account
management and cross-selling platform, helping to expand its distribution channels; an investment
banking function can enhance its distressed asset pricing ability, and provide financial,
restructuring, M&A and listing advisory for distressed debtors under the acquisition-andrestructuring model.
Second, the fact that the business cycles of different financial service divisions do not move
entirely in sync can help to smoothen the profitability volatility in the distressed asset management
business and increase asset utilization efficiency. For example, China Huarong recorded
annualized average pre-tax ROE of 26.3%, 23.6% and 20.6% from its distressed asset
management, financial service, and investment & asset management segments respectively in
2014 (annualized average pre-tax ROE = annualized pre-tax profit / average of beginning and
ending net asset balances); in 2015, the percentages changed to 20.2%, 25.1% and 23.4%
respectively. For both distressed asset management under the acquisition-and-disposal model
and the DES business, AMCs mostly realize profits when asset prices are high. However, it is also
more costly to acquire new distressed assets at such times. If the funds recovered from the asset
disposal are instead allocated to other business divisions (e.g. banking, leasing, other
investments), a better overall return might be achieved.
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Mar 31, 2017
Sector report
Third, it is now the Big Four AMCs’ developmental goal to become financial holding groups that
provide high value-added financial services. Previously the Big Four AMCs’ profitability had mainly
derived from the monopolistic market position brought by their business licenses. However, with
the marketization of the distressed asset management business, intensified competition will
continue to eat into the industry profit margin. As a response, the Big Four AMCs can maintain
their market dominance by providing high value-added services relying on their extensive
professional expertise and leading technical skills.
Figure 27: Asset expansion hindered by net capital restrictions
25.00%
20.96%
45%
21.58%
40%
18.08%
20.00%
16.11%
15.00%
13.70%
13.45%
Figure 28: China Huarong’s segment annualized average pre-tax
ROE
13.58%
14.75%
35%
15.63%
13.71%
30%
25%
20%
12.50%
10.00%
15%
10%
5%
5.00%
0%
0.00%
2012
2012
2013
2014
China Huarong
2015
China Cinda
1H16
2013
2014
Distressed asset management
1H15
2015
1H16
Financial services
Asset management & investment
Source: Company data, GF Securities (Hong Kong)
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Mar 31, 2017
Sector report
Rating definitions
Benchmark: Hong Kong Hang Seng Index
Time horizon: 12 months
Company ratings
Buy
Stock expected to outperform benchmark by more than 15%
Accumulate
Stock expected to outperform benchmark by more than 5% but not more than 15%
Hold
Expected stock relative performance ranges between -5% and 5%
Underperform
Stock expected to underperform benchmark by more than 5%
Sector ratings
Positive
Sector expected to outperform benchmark by more than 10%
Neutral
Expected sector relative performance ranges between -10% and 10%
Cautious
Sector expected to underperform benchmark by more than 10%
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