China Banks Sector:More AMCs to manage problem assets

ABC and ICBC have established special AMCs to manage DES transactions, other state-owned banks are likely to follow their lead

    We have concerns over banking AMCs operating DES due to the selection of proper clients, pricing and exit mechanism

    Reiterate Negative stance on the China Banks Sector; BoCom is our top pick

    What’s new: Agricultural Bank of China (ABC) and ICBC announced plans to establish asset management companies (AMC), “ABC AMC” and “ICBC AMC”, on November 22 and December 8, respectively, to manage their debt-to-equity swap (DES) businesses.

    What’s the impact: The institutionalisation of DES. ABC AMC and ICBC AMC are both wholly-owned subsidiaries of banks with registered capital of CNY10bn and CNY12bn, respectively. This is the first time that China commercial banks have established wholly-owned AMCs. Other state-owned banks, CCB, BOC and BoCom, are all likely to follow suit. These bank AMCs would carry out all DES related business on behalf of banks, including debt acquisition, distressed debt restructuring, and equity holdings and disposals. According to our calculations, CCB leads its peers and has already announced at least 8 DES transactions of more than CNY100bn. The size of major DES transactions announced from August until now has reached almost CNY200bn, which equals around 13% of the NPL balance in China’s banking system as of end-3Q16.

    Pace of new NPL generation may slow down. The institutionalisation, and recent policy easing on local AMCs, emphasises the banking regulator and banks’ determination to resolve the problem of distressed assets. We expect the banks’ pace of DES implementation to accelerate in 2017. The underlying bank loans of potential DES transactions mainly consisted of special mention loans (SML) and normal loans. If the DES business accelerates in 2017, we expect the pace of NPL generation to decline.

    Our concerns rest on the mechanism to select proper DES clients, DES pricing, the turnaround if banks were to hold a significant equity stake in DES clients, and the exit mechanism for China banks that hold equity stakes after a DES transaction.

    What we recommend: We remain Negative on the China Banks Sector, which is currently trading at an average 2017E PBR of 0.7x. If the scale of DES spikes in 2017, banks would see less new NPLs generated and thus relatively lower credit costs, which would help restore banks’ bottom-line growth. But in practice, proper selection of debt to be swapped, pricing and the exit mechanism would be the determining factors for a successful DES transaction. BoCom (3328 HK, HKD5.54, Buy [1]) remains our top sector pick. Main upside risk: market-oriented implementation of DES to ease asset quality concerns.

    How we differ: Unlike some in the market, we do not view banking AMCs as a rerating catalyst, as the risk of distressed loans is likely to remain within the banking system.