Return To Cinda: What Does Its IPO Say About China's Financial Reform?

Posted: Dec 20 2013, 2:21pm CST | by , in News


What to make of the recent IPO in Hong Kong by one of China’s so-called “bad banks”? Cinda Asset Management Company raised US$2.5 billion on an offering 161 times oversubscribed by Hong Kong retail investors and, according to reports, “several times” by global institutional investors. Its shares popped 26 percent on the first day of trading; a real blow out reminiscent of the IPOs by China’s major banks several years ago. The market’s reaction, however, is less interesting than what Cinda’s deal says about the prospects for Chinese financial reform.

This deal, and any for its bad bank brethren that may follow, cannot be compared to the major bank IPOs several years ago. China’s Big 4 state banks were and are still the pillar of the government, its state enterprises and the national economy. When the Asia Financial Crisis broke out in late 1997, China’s political leadership moved rapidly not simply to strengthen the banks balance sheets, but also to bring bank management practices in line with international practice. The asset management companies (AMCs) were simply a tactic in this larger strategy and were designed to be closed when their job had been done or at most after 10 years. The fact that their shelf lives were extended illustrates how reform strategies in China can become hostage to the greater strategy of social stability.

Closure would have meant finding over 12,000 staff of the four AMCs new employment … in 2009! The big four banks were not eager to have these staff back; they had already with great difficulty reduced their own ranks by over 250,000 as part of their restructuring. For its part, the Ministry of Finance, the actual equity owner of the AMCs, would not have enjoyed the thought of enduring the protests of laid off staff that had been a common sight at bank headquarters. But sustaining the now purposeless and profitless AMCs was a burden; the MOF had to find a solution.

Contrary to common belief, the MOF does not itself dispose of limitless amounts of money; budgetary funds are earmarked. It could not (and cannot) use state funds in support of the illiquid AMCs without the approval of a higher authority, the State Council or, in some cases, the National People’s Congress. While the ministry is a powerful player in the panoply of state entities, it is not the same as the government. But within its own circle of authority it could provide the AMCs with a policy lifeline and, if things worked out, raise money by selling off stakes or through an IPO.

To lighten its burden the MOF had to identify investors with real money; in China this can only mean the big state banks. What would make these illiquid entities attractive? The key was to allow the AMCs to retain their controlling equity ownership in bankrupt financial companies they had taken over as trustees during the great stock market collapse of 2004-2005. The investment story was that the AMCs were “universal” financial institutions at a time when the bank regulator ruled out this strategy for the big state banks.

Cinda, for example, controlled 12 entities including securities, insurance, trust, leasing, investment and real estate development. These companies were bankrupt and without management, but their business licenses were extremely valuable. In the aftermath of 2008 when the Western model China had been following was discredited, China Construction Bank sought to break into the forbidden area of universal banking by acquiring these financial licenses. As one senior banker commented, “No one knows what the new banking model will be so it’s better to grab all the licenses we can.” The AMCs provided the opportunity for regulatory arbitrage.

By the end of 2009, the Construction Bank’s submission to take a 49 percent stake in Cinda had been approved by the State Council (thus trumping the bank regulator). The price tag was outrageous, US$3.5 billion! This valued Cinda at US$7.1 billion vs. the Ministry of Finance’s original investment of US$1.2 billion. It meant that Cinda had not taken a loss on problem loan workouts over its decade of operation, but instead had made a fortune. This was nonsense. In the end common sense won out and the deal failed to materialize, leading the then chairman of China Construction Bank to comment, “… the hardest thing about asset management companies is their valuation.” This may have been the understatement of the decade.

Having failed to catch the state banks, the MOF had no choice but to pursue IPOs for these bad banks and why not, at the time, the big four state banks had been viewed as hopeless and their IPOs extremely problematic.  What did the government do then? It invited major foreign financial institutions to lend their reputations as “strategic” investors. Cinda, with the ministry’s help, likewise sought out and attracted a few domestic and foreign “strategic” investors. Like the banks, Cinda was restructured with the MOF assuming its historic liabilities and the resulting investment opportunity was then offered to “cornerstone” investors in the run up to the Hong Kong IPO. The rest is history.

What does this story say about China’s prospects for financial reform? First, a tactic that was used to further real financial reform eight years ago has now nearly become the strategy; the point is that it is the Ministry of Finance’s strategy not China’s; whether Cinda can be sustained depends entirely on the ministry’s ability to manage further government support. The various “strategic” and “cornerstone” investors cannot rely on the Chinese government to secure their profit as was the case with the big banks.

Secondly, the bad bank technique that a decade ago strengthened China’s banks has ended up adding excess credit capacity to the system; Cinda is totally reliant on bank lending to grow its own credit business (and bottom line). This excess financial capacity is supporting redundant, non-competitive manufacturing and real estate businesses. The tail end of financial reform seems to be wagging the dog.

True financial reform would have had the MOF sell off a majority stake in Cinda to non-state investors, which most certainly could have succeeded. This would have been a big step toward reducing China’s financial leverage. This cannot happen, however, until there is political agreement as to what constitutes non-performing loans. And this cannot happen until there is awareness among China’s leadership that mounting financial risk can and will lead to real social instability. Until that time, parochial bureaucratic interests will play the financial reform game and Cinda will remain a disguised form of social security and not a sustainable commercial proposition.

Source: Forbes

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