Beijing’s latest manoeuvre to transfer the risk of the country’s crippling bad debt from banks to private investors is to mint brand new local asset managers and let them on-sell distressed debt to third-party buyers.
China’s bad loan market has long been dominated by the big four asset managers - China Huarong, Cinda, Orient and Great Wall - but on 30 January the regulator agreed to expand the number of local asset managers to 35 - two from each province - with five more in the works.
The growing financial firepower of these local asset managers, combined with big capital raising by the Big Four also point to Beijing's resolve to boost the financial capacity of asset managers.
But,according to US analyst, Jason Bedford, a burgeoning private sector distressed debt market is emerging. As such, even more important than the increase in the number of players is the removal of a rule that stopped asset managers from on-selling bad loans to third parties.
"On the positive side, we believe the regulatory relaxation increasing the number of asset managers per province - and the freedom to on-sell bad loans to private buyers - will allow banks to dispose of them more rapidly and to a much wider range of buyers at higher prices," he said.
“This will make a serious dent in bank non performing loans.”
However, some asset manger are not playing the game and using their massive balance sheets to issue new credit to dodgy corporates.
“We believe the primary objective of these firms is not NPL purchase but providing credit to distressed borrowers to repay bank debt," said Bedford. “Rolling credit via the asset managers may prolong the credit cycle and not ring-fence the banks from the underlying credit risk.”
All up, he argued the risk of a systemic credit event caused by excessive leverage may increase or decrease depending on what accelerates faster: the asset manager’s loan rollovers - which will increase system leverage - or asset managers bad loan acquisition, which will reduce leverage.
What makes it especially tough to read though is that regulatory direction is uncertain and may be subject to sudden change depending on the pace of state-owned company reforms.
“While we remain positive on the expanding and evolving infrastructure for NPL resolution and disposal, we are concerned by the changes in the asset manager’s business models," he added. "Their expanding financial clout to deal with system NPLs is positive, in our view, and leads to deleveraging as bad loans are removed from the system."
However, he argued, the non-bank distressed debt issuance appears to be the most rapidly expanding part of their balance sheets and is having the opposite effect.
“By propping up distressed corporate borrowers, they are ultimately expanding the size of the system credit and the bad debt bubble. In the short term, we think this will lead to smoother financial performance at the banks and increased profits, but in the long term systemic risks will likely continue to expand.”