China Economics Seminar

China's central government is paying for the AMCs

Interbank crunch, GDP slowdown, worsened rebalancing, mysterious government debt … after so much frustrating news I finally found something inspiring: the Asset Management Companies (AMCs) are paying their bond principals!

For readers who are not very familiar with the AMCs in China, this 2003 BIS paper would give you some background. Basically they are the Chinese bad banks. In the late 1990s and early 2000s, Chinese banking system had huge amount of bad loans and 4 asset management companies (AMCs) were created to purchase the bad assets of the big 4 state-owned banks at face value. In exchange of the bad loans, the banks received 10-year bonds from the AMCs. The total amount of bonds was as large as 810 billion yuan and by 2009 only about 100 billion were paid back according to a PBOC official. The Cinda bond held by China Construction Bank (CCB), Huarong bond held by Industrial and Commercial Bank of China (ICBC) and Oriental bond held by Bank of China (BOC), 720 billion in total, had not been paid by then. When those bonds were matured in 2009 and 2010, they were simply rolled over for another 10 years (see Caixin report). The reason was quite simple: the AMCs were not making enough money.

However, the payments have suddenly accelerated since 2009. According to the 2012 annual reports of CCB and ICBC, their holding of the AMC bonds have declined substantially. Actually CCB’s holding of Cinda bond has fallen every year since 2009, when it was rolled over.  

Table 1 AMCs bonds held by banks (in billion yuan)

 

2009

2010

2011

2012

Cinda bond by CCB

247.0

206.3

131.8

57.6

Huarong bond by ICBC

313.0

313.0

313.0

175.1

Oriental bond by BOC

160.0

160.0

160.0

160.0

Total

720.0

679.3

604.8

392.7

Remaining portion

 

94%

84%

55%

This is very interesting. The AMCs were not profitable enough to pay any of the bond principals in the first 10 years so that the bonds were rolled over for another 10 years, but they suddenly started to pay large amounts right after the roll-over started.

Why did the AMCs suddenly start to pay their bond principals after 2009? Logically there are only three possibilities and let me go through them one by one.

1.      They successfully recycled cash from the bad assets so that they had enough money to pay the bonds.

2.      They used their retained earnings to pay the bonds.

3.      Someone else helped them pay the bonds.

The financial situation of the AMCs is not very transparent but it was said that Cinda was the only AMC who was able to pay the bond interests (5.56 billion yuan per year) on time and its net profits were only 4.4 billion yuan in 2009. Therefore there is no way that Cinda can pay bond principal as much as 190 billion yuan unless it suddenly made tremendous progress in selling those bad assets. What’s more, since Huarong and Oriental could not even pay interest on time,  tremendous progress would be required for Huarong to pay 140 billion in a single year. They did make some progress - Cinda’s net profits in 2012 rose to 7.27 billion yuan while Huarong’s net profits increased to 6.96 billion yuan - but this number is still too small.

Can they use retained earnings to pay the bond principal? Given that Cinda's net profits were 7.27 billion yuan in 2012, even under the most optimistic estimation its retained earnings can hardly reach 100 billion yuan. So it is impossible for them to pay 190 billion principal with retained earnings. Since Huarong is even less profitable than Cinda, it is even more unlikely that it will pay 140 billion yuan in a single year.

 There leaves the third option: someone else is paying for Cinda and Huarong. But who?

In August 2010, CCB announced:

China Construction Bank Corporation (“the Bank”) has recently received a notice from the Ministry of Finance (“MOF”) that the MOF and China Cinda Asset Management Co., Ltd. (formerly known as China Cinda Asset Management Corporation) (“Cinda”) have established a jointly managed fund to secure the payment of the principal of a bond issued by Cinda to the Bank with a book value of RMB247 billion (“Cinda Bond”). The MOF continues to provide support for the repayment of the interest under the Cinda Bond.

The term of the jointly managed fund is from 1 July 2009 to 21 September 2019. The jointly managed fund is owned by the MOF and jointly managed by the MOF and Cinda during its term. The funding sources of the jointly managed fund include, among others, enterprise income tax payable by the Bank during the term and other appropriations made by the MOF.

According to the announcement, the fund jointly-managed by MOF and Cinda will pay the bonds and the capital of this jointly-managed fund is from the enterprise income tax payable by CCB and other appropriations made by the MOF. We do not exactly know what the other appropriations are but it is reasonable to argue that it is from the fiscal revenue and the amount of appropriations could be quite large. CCB paid 57.8 billion as enterprise income tax in 2012 and even if all of it went to the joint-managed fund it would not be enough to cover all the bond payments. The MOF still had to add at least 16.4 billion to the fund.

For Huarong we do not even know how its was paid because ICBC never publicly announced that a joint-managed fund was set up. But since it was impossible for Huarong to pay 138 billion in a single year by itself, the government must have stepped in as well. And the amount paid by the government here would be even larger.

Table 2 Bond payments and enterprise income tax in 2012 (in billion yuan)

 

CCB

ICBC

Enterprise income tax

57.8

70

Bond payment received

74.2

133

Net profits

193.6

238.7

There is still one last question: why does the MOF help pay AMC bonds? When the AMCs were not able to pay the bonds before 2009, the MOF offered no help and the bonds were simply rolled over for another 10 years. If the AMCs still cannot pay, the bonds can either be rolled over again or the banks can write them off from their balance sheets. Why is the government (the taxpayers in fact) bailing them out now?

To be honest, I don’t know the exact answer because it must involve with a lot of inside information and secret talks that I do not have access to, but I can make some guessimates based on the public information. There is a piece of news this morning on the Wall Street Journal saying that:

China Cinda Asset Management Co. has invited bankers to submit proposals for its initial public offering in Hong Kong, which could raise about US$2 billion, people familiar with the situation said Wednesday. The IPO is expected to come in the fourth quarter at the earliest, with many of the banks that handled the IPOs of China's big lenders vying to run the offering.

Cinda has planned for an IPO in Hong Kong for a long time, but if a company has 247 billion payable bonds that have been rolled over for 10 years, it is hard to imagine that investors won’t challenge the financial status of the company and make the public listing very difficult. Therefore, it is in Cinda’s interest to get rid of the 247 billion bonds as soon as possible and the MOF who owns Cinda decided to offer the help.

The commercial banks also want to get paid as soon as possible, because they do not want to hold hundreds of billions in bonds with an annual return of only 2.25% while the benchmark lending rate is 6% and even the yield 10-year government bond is above 3.5%. Everyone seems happy with the solution, and it tells us again that central government will bail out large financial institutions when they are in trouble.

Given that the AMCs are the legacies of the last banking crisis in China, I would be curious to know if the solution can be used again in the next one. 

 

Central Banking Seminar
Chen Long

Comments

0

Hi Chen,

Good writeup!

Just a few points:

In all likelihood Huarong follows a similar model since it has been explicitly stated that Cinda is the pilot agency for a reform of all four. So it is reasonable safe to assume that the method used for Cinda is used for Huarong. Also besides the bonds, the PBOC debt is also said to have been voided/written off or in some fashion make to vanish.

What has to be remembered is that the AMC were not originally supposed to make money. They were not really financial institution but off balancesheet budgetary bailout vehicles. It is not clear that they even had official balancesheets before 2008. By buying debt from the banks at face value (including accrued interest) they were effectively recapitalizing the banks.

The really interesting question is what have the AMC have done with their bailout. If we look at Cindas balancesheet, it is striking that it went from a 80 billion yuan balancesheet in 2008 to a 300 billion one last year. So where did all this growth come from and what is this new business the AMCs are getting into?

Whatever it is it is very profitable. The AMC have the highest ROA of any financial institution covered by bankscope (admittedly not close to a full sample) except for the trusts.

We can say what it is not: buying NPLs from the banks. The banks, both the big four and the smaller have long ago stopped selling NPLs to the AMCs. They have found ways of working them out themselves.

What then is their business?

Well, they could buy non-performing assets from other financial institutions than banks such as trust or securities companies.

According to my information the new business is basically buying up real estate related loans and failed trust products. This is of course not verifiable, but this seems to have been the view of several sources.

Now not all the AMC are equally aggressive. Cinda has some good legacy assets (old equity from D2E swaps or land recovered from the policy NPLs) that they have been allowed to keep in exchange for a MOF payable they have on their balance sheet. And Huarong has good subsidiaries (one of which is, ironically, a bank). The most aggressive of the four on the "new business" is said to be Orient.

This also fits with the high earnings. If the AMCs are buying real estate related assets and other high risk/high yield assets it would explain both their growth and they earning. Of course we do not know exactly what they are buying since they do not tell us the industry they are investing in on they balance-sheets.

If this is the case, then they cannot really be used for bailing out anything, since they are themselves exposed to the same risk as the rest of the financial system and will not be part of a solution but rather part of the problem.

0

Tomas, 

Great to hear your comments! 

I also agree that Huarong is probably following Cinda's model too, but it is weird that ICBC said nothing about how Huarong bond was paid, isn't it? What's more, the corporate tax by banks isn't enough to cover the bond payment and I looked into the fiscal budget report but I did not find anything related to this. How untrasparent it is!

What new business are they doing?

The AMCs have started to do non-performing asset management for many institutions as it is shown on their websites. Moreover, they all become "financial supermarkets" with trust, brokerage and a lot other stuff. They are doing everything to make money. However if the 273 billion debt was not taken away they still cannot make anything but pay bond interests...

0

Good insights. Keep it up.

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