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UPDATE 2-Cinda IPO to test investor appetite for China's bad debt

Gabriel Wildau and Elzio Barreto
Friday, 8 Nov 2013 | 3:08 AM ET

* Sources say IPO could raise up to $2 bln

* IPO set to provide insight into China's bad loan problems

* Cinda the most profitable of four China bad loan managers

SHANGHAI/HONG KONG, Nov 8 (Reuters) - China Cinda Asset Management gained approval for a Hong Kong IPO that sources say could raise up to $2 billion, kickstarting a deal that will offer clues as to whether the company - created for a government bailout - can transform into a profit-driven entity.

Investors are eagerly awaiting forthcoming details from the bad loan manager, whose fundraising is part of China's broader efforts to recruit private capital to help clean up rising bad debts in the financial system.

Cinda is one of four asset management companies that Beijing established in 1999 to absorb toxic assets held by the China's four biggest banks. It is the most profitable and the first of the four to seek a public listing, with company disclosures showing large and steady growth of its operations.

Fund managers and investment bankers positive about the deal say demand for the company's services will rise in sync with the increase in non-performing loans across the country. One banker involved in the underwriting said investing in Cinda can also be a hedge against China's banks, whose profit growth is slowing.

Other financiers are more bearish on the offer, pointing to a lack of clarity about Cinda's bad loan pricing policies, its recovery rates, and its effort to diversify into other financial services.

They also worry that a company set up by Beijing to clean up financial messes may not be able to deliver steady profits. Cinda's largest shareholder is the finance ministry, which owns 83.5 percent while the national pension fund holds about 8 percent.

"With state-owned companies there's always the risk they'll be asked to do national service," said Chris Ruffle, portfolio manager at Open Door Capital Group, a Shanghai-based hedge fund.

When the bad loan firms were created, they borrowed money from the banks they were assigned to, using the cash to buy the debt. Cinda was set up to take on the bad loans at China Construction Bank, the country's No. 2 lender.

Hiving off the non-performing loans allowed China's Big Four banks to restructure, with Industrial and Commercial Bank of China becoming the first to list in 2006.

AN INTERESTING PROSPECTUS

Cinda has said its asset management business made a net profit of 7.2 billion yuan ($1.2 billion) in 2012, a rise of 6 percent over the previous year.

It has stakes in a raft of companies obtained through debt-to-equity swaps, including holdings in Aluminum Corporation of China (Chalco) and China Gezhouba Group , the main construction firm in charge of the massive Three Gorges Dam project. It has property holdings worth at least 2.3 billion yuan, mostly seized from companies that failed to pay their loans.

"This is going to be a really interesting prospectus to go through," said Mike Werner, a Sanford Bernstein analyst who covers China's banks. "There seems to be a lot of mis-information about the company. I think Cinda has changed what it does over the years, but until we see the listing documents, it's hard to say for sure."

In March of 2012, Cinda raised $1.6 billion by selling shares in the company to four investors, which included Swiss Bank UBS and Asia focused bank Standard Chartered .

For the IPO, Bank of America-Merrill Lynch, Goldman Sachs, Morgan Stanley and UBS are among the underwriters on the deal, according to people familiar with the matter.

A LOT OF BAD DEBT

Official data shows that non-performing loans at Chinese banks stood at 540 billion yuan, or 0.96 percent of commercial bank loans outstanding, at end-June, but most analysts believe the true ratio is between 2 and 5 percent.

China's banking system could produce around 3.86 trillion yuan in bad loans over the next five years, UBS banking analysts estimated in a June 6 research report.

In disclosures related to a bond issuance last year, Cinda promoted itself has having "deep experience in the disposal of non-performing assets, including best-in-class pricing ability and innovative disposal tactics via diverse channels." It declined to comment for this article.

Since the government required Cinda to purchase most of its bad loans at above-market prices, it remains unclear whether the firm possesses genuine expertise in pricing the debt.

"There was never a fair and open market (for bad loans). I'm not convinced they're particularly great at it," said Fraser Howie, director of brokerage Newedge Financial in Singapore and co-author of Red Capitalism, a book about China's financial system.

Cinda purchased 2.6 trillion yuan in non-performing loans between 1999 and 2005, with the initial tranche worth 1.2 trillion yuan purchased at 100 percent of face value. A second tranche in 2004 to 2005 was bought at between 26 and 50 percent, according to Trevor Kalcic, Asia financials analyst for CIMB in Hong Kong.

Kalcic and other analysts estimate that recovery rates for non-performing loans acquired in that period averaged around just 20 percent. He also notes that since 2010 new bad assets purchased by the four asset management firms include bank loans, corporate receivables and trust loans that have been purchased at market rates.

All four asset management firms have gained licenses to engage in a broad range of financial services but it is also not clear to what extent they will develop their non-performing loan operations.

Cinda alone has licenses for investment banking, securities brokerage, fund management, trust, private equity, insurance, real estate development, and financial leasing.

Cinda has said it held 7.2 billion yuan in bad loans at the end of 2011 but has not disclosed any breakdown, causing some analysts to worry that it still may be saddled with legacy debts taken on between 1999 and 2005.

"That's my question if I'm investing: 'What am I actually buying? What exposure am I getting here?"' posed Howie, the Red Capitalism author. "That's not clear to me."

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