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UPDATE 2-Cinda IPO unveils secrets of a Chinese bad debt factory

Monday, 25 Nov 2013 | 4:22 AM ET

* Bad loan manager says assets up 11 percent in six months

* Profit jumped over a third in first half of 2013

* Up to $2.5 bln IPO set to be Hong Kong's biggest this year

HONG KONG, Nov 25 (Reuters) - China Cinda Asset Management Co Ltd lifted the lid on how Beijing turns bad loans from its banks into profits, issuing a prospectus on Monday for an initial public offering that has reeled in some of the world's biggest investors.

The IPO, seeking up to $2.5 billion, is set to be the largest in Hong Kong this year as sovereign wealth funds join hedge funds in betting that soured loans will be a growth business in China's slowing economy.

Cinda plans to list shares on Dec. 12. It's one of four debt collectors created in 1999 by China's Ministry of Finance to process bad loans made by the country's biggest banks to a wide range of companies.

Little had been known about financial operations at the firms, known as asset management companies (AMCs), until a filing last year on a Cinda bond offering and now Monday's prospectus. Huarong Asset Management Corp is the next AMC expected to seek an IPO, hoping to raise up to $2 billion, though no timetable has been set.

Cinda's 710-page filing shows steady growth in assets and profit in recent years. Yet it also reveals a drop in return on equity, underlining the company's need to diversify its lines of business.

"We think the proceeds will be used to continue to diversify and grow Cinda's investment, asset management, insurance, and other financial services," said James Antos, banking sector analyst at Mizuho Securities Asia.

In the filing to the Hong Kong Stock Exchange, Cinda said total assets rose 11 percent to 283.55 billion yuan ($46.5 billion) as of June 30, versus the end of December last year.

That makes it a significant player in distressed debt when stacked against global peers. By comparison, Oaktree Capital Management, the world's largest distressed debt manager and also an investor in Cinda, had $79.8 billion under management as of the end of September.

Cinda said one of the main ways it conducts the distressed asset management business is by buying assets at a discount and selling them later for a profit. It also conducts debt-to-equity swaps, where Cinda ends up owning shares of companies whose debt it owns.

The total book value of Cinda's assets acquired through debt-to-equity swaps is $7.2 billion, with unlisted companies accounting for about 79 percent.

Set up to handle the bad loans of China Construction Bank , the country's No. 2 lender, Cinda said profit attributable to equity holders was 4.06 billion yuan ($667 million) for the six months ended June 30, 2013. That was up 36 percent from 2.99 billion yuan a year earlier.

But the company also said its return on average equity (ROAE) declined from 43 percent in 2010 to 30.4 percent in the six months ended June 30, 2013. Distressed asset management is Cinda's primary business, accounting for 72.3 percent of profit before tax for six months ended June 30, the company said.

CORNERSTONE INVESTORS

A group of 10 investors, including Norway's sovereign wealth fund and Och-Ziff Capital Management Group LLC, have together committed to buy about $1.1 billion of stock as cornerstone investors, Reuters reported on Sunday.

In March 2012, Cinda raised $1.6 billion by selling shares in the company to four investors, which included Swiss Bank UBS , Standard Chartered and Citic Capital, which bought less than 5 percent each.

In its IPO, Cinda is offering 5.32 billion new shares in an indicative range of HK$3.00 to HK$3.58 ($0.39 to $0.46) each, valuing the sale at up to HK$19 billion ($2.5 billion). Hong Kong's biggest 2013 IPO before Cinda was Sinopec Engineering Group Co's $1.8 billion listing in May.

With just under half of the shares on offer already assigned to cornerstone investors, retail demand for the remaining shares is expected to be strong: On Monday, trading in a small listed subsidiary, Cinda International Holdings Ltd, was halted with the stock up 38 percent.

"We think the IPO will be extremely popular among investors. The market has been starved for chunky IPOs in recent months, so there is probably pent-up demand for such a deal," said Mizuho's Antos. Until a recent batch of deals by Chinese financial companies, Hong Kong has suffered a drop in IPO volumes in the last two years.

The Cinda offering is for 15 pct of the enlarged share capital, putting a total value on the company at $16.4 billion, assuming the top of the range. The Ministry of Finance will own 69.6 percent of the company after the sale, compared with 83.5 percent before.

China's financial sector stocks trade at 1.2 times book value, in line with such stocks in the Asia Pacific region, according to data from Thomson Reuters StarMine. Research notes from investment banks handling Cinda's deal put its price-to-book ratio at between 1.1 and 1.3 times.

When the four bad debt managers were set up, the companies borrowed from the state to purchase the bad loans. At Cinda, those borrowings have yet to be repaid.

Cinda said as of June 30, 2013, the company had an amount due to the Ministry of Finance of 33.6 billion yuan, which it will pay in installments.

Beijing allowed the four AMCs to roll over the original loans in 2010. Cinda's installments - 9.7 billion yuan each - must be paid by 2016, it said, adding that it had already been granted a delay in its first payment, which was due in Feb. 2012.

As of June 30, 2013, the company's capital adequacy ratio was 17.8 percent, exceeding the regulatory requirement of 12.5 percent.

Bank of America-Merrill Lynch, Goldman Sachs, Morgan Stanley and UBS are among the 17 banks handling the offering.

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