Banks setting up distressed asset management arms

A booth of Agricultural Bank of China Ltd at a finance expo in Shenzhen, South China's Guangdong province, Nov 7, 2015. [Photo/VCG]

China's five largest State-owned commercial banks are planning to set up their own asset management subsidiaries to carry out debt-to-equity swap programs, said people with knowledge of the matter.

Agricultural Bank of China Ltd announced on Tuesday its board of directors approved the proposal to establish a wholly owned subsidiary, ABC Asset Management Co, in Beijing with a total capital contribution of 10 billion yuan ($1.45 billion).

ABC Asset will specialize in the debt-to-equity swap business, including acquisition of debt assets, converting debt into equity, holding, managing and disposing of equity in debt-to-equity swap enterprises and other financial business, according to the announcement.

The investment, which will be funded by ABC's own capital, "meets the bank's needs to adapt to changes in the internal and external economic and financial environment".

"It will enable the bank to enhance its competitiveness and gradually transform its business model from over-reliance on the deposit and loan business and to carry out integrated operations," the bank said.

Zhang Minghe, who leads the debt-to-equity swap business of China Construction Bank Corp, said CCB is seeking to set up its own investment management company and will actively apply for regulatory approval.

"As far as we know, all five of the large State-owned commercial banks are thinking alike. Each is considering establishing a subsidiary with a registered capital of 10 billion yuan. The final result will depend on the resolution of the board of directors," he said.

"We commercial banks regard this as an opportunity to transform our business," he added.

After the subsidiaries are established, they will raise funds for debt-to-equity swaps from qualified institutional and individual investors.

The sources of money will include insurance funds, pension funds and industrial investment funds that can make long-term investments.

"By setting up a subsidiary, we'll have a professional team specializing in debt-to-equity swaps. Moreover, it will be easier for the subsidiary, as a legal entity, to isolate risks from the bank," Zhang said.

According to the State Council's guidelines, banks are only allowed to transfer debts to implementing agencies, including financial asset management companies, insurance asset managers, and newly established bank subsidiaries. The implementing agencies will then turn the debts into the equity of target companies.

Compared with choosing a third-party implementing agency, banks will have advantages by setting up their own subsidiaries with the investment function, said Lou Wenlong, vice-president of Agricultural Bank of China, in an article published in 21st Century Business Herald last month.

"First, banks have a better understanding of target companies than third-party implementing agencies, it will be more efficient and smooth to go through the procedures of commercial negotiations, due diligence and valuation for debt-to-equity swaps."

"Second, the sources of funds will be more diverse and secure because banks can make full use of their own capital or raise funds from asset management products and bond issuance."

"Finally, banks will benefit from potential earnings of target companies after their businesses take a turn for the better, which will offset possible financial losses caused by transfers of debts to third-party implementing agencies at huge discounts," he said.