China braces for soured loans with bad-debt manager

Amid all China's efforts to contain the economic damage of the coronavirus outbreak, a crucial development slipped by almost unnoticed — the creation of the first national bad-debt manager in 20 years.

Galaxy Asset Management Co. won approval in mid-March to convert into a financial asset management firm, gaining a much-coveted license to buy bad loans directly from banks nationwide, and the ability to borrow at relatively low rates.

The economic dislocation from COVID-19 threatens to add 5.6 trillion yuan ($790 billion) of bad debt — more than double the amount Chinese banks already sit on — according to S&P Global.

"It's long been a consensus that China's capacity to dispose of distressed assets is insufficient, and the creation of the new company is certainly a positive signal," Richard Zhu, a Beijing-based partner for financial services at PricewaterhouseCoopers, said in an interview.

Galaxy Asset is the first stated-owned bad-debt manager set up since the creation of the so-called big four in 1999 to help clean up a mountain of soured loans at the nation's biggest banks.And the capacity of those four firms to digest non-performing loans is still small compared to the pile of bad debts. The two listed AMCs — China Cinda Asset Management Co. and China Huarong Asset Management Co. — bought a combined 149 billion yuan of distressed assets last year, according to their annual reports.

Unlike existing AMCs that mostly deal in non-performing bank loans, Galaxy Asset will focus more on distressed assets from capital markets, which are likely to see faster growth as volatility mounts.

For instance, onshore bond defaults since 2016 have exceeded 340 billion yuan, according to data compiled by Bloomberg, while risky assets at trust companies, a key link in the shadow banking system, surged 160% last year to 577 billion yuan.

It also has experience in the sector, having originally been set up in 2005 to handle the distressed assets of a bankrupt securities company. Its state-owned parent also controls one of the nation's biggest brokerages in China Galaxy Securities Co.

"Although the big four AMCs have developed a full range of financial licenses, the capital markets still aren't their area of competitive advantage," said Muse Zheng, vice general manager at SDIC Suiyong Asset Management Co., which specializes in distressed assets. "Opportunities abound in areas where capital-market expertise is needed."

The market turmoil could see a resurgence in problematic loans to controlling shareholders of listed companies backed by pledged stock. The issue, which strained finances at brokerages during a market downturn in late 2018, is showing signs of a comeback.

While regulatory steps, including curbs on shareholders dumping shares, has helped ease pressure on the market, PwC's Mr. Zhu said, creating a specialized distressed-asset manager like Galaxy Asset to explore more market-based, long-term solutions is "not a bad idea."