China's Bad Debt Cops Get Going

A firm named Cinda launches a huge workout that may reshape China's economy

China's finance mandarins have long known what ails the country's bank system: tons of bad debt. And the mandarins have long known the solution to the problem: Hive off the bad loans from the banks and work them out one way or another, even if it means taking over the companies that cannot pay and selling off assets at cut-rate prices. But workouts hurt, and the Chinese have shied away from such a painful step.

That's why recent events at China Construction Bank are so important. CCB, one of the country's top four state-owned banks, struggles under some $30 billion in problem loans. But in late September, the bank took a big step toward financial health. On Sept. 17, China Cinda Asset Management Corp., a company charged with disposing of CCB'S bad debt, moved in on Meishan Corp., a division of Baoshan Iron & Steel. Cinda will take over $200 million of Meishan's long-term liabilities from the CCB in exchange for an equity stake in the steel company. Then, Cinda will help Meishan with a restructuring plan that aims to cut 6,000 workers and return the company to profitability.

"COMPLEX JOB." Of course, debt-for-equity swaps are pretty routine in other parts of the world. But using this technique marks a major shift in China, with potentially huge consequences. For one, it could mark the start of a serious effort by the banks to clear away an estimated $250 billion in bad debt. Just as important, if workout firms like Cinda do acquire big equity stakes in beleaguered companies--and the right to sit on company boards--they could force real restructuring. Mass layoffs, historically verboten and politically untenable in China, could be on the way.

Make no mistake: This is only a beginning to one of the biggest workouts in Chinese history. "They have a very big and very complex job to do," says Philip E. Strause, head of the Asia Pacific financial institutions practice at Deloitte & Touche Consulting Group.

Resistance from local governments and enterprises is bound to be intense, especially on the hot-button issue of layoffs. With most ailing state companies still supporting schools, housing, and health clinics, Cinda has a politically explosive task. "We definitely have to consider the social impact of what we do," says Ma Wen, deputy general manager of Cinda's asset acquisition department. "For the biggest enterprises, you can't just simply shut them down."

But at least the battle to solve the debt problem is under way. China's three other big commercial banks are forming operations just like Cinda's. And officials are now picking 500 to 600 Chinese companies to undergo the debt-for-equity restructuring process.

FOREIGNERS WELCOME. Cinda's managers--some of China's best and brightest--will be the bad-debt police. They will wade into troubled companies, restore them to viability by wiping out the debt, and turn them into real profit-making operations. Cinda's exit strategy is to sell its equity on local stock exchanges or to outside investors. Foreign investors would also be welcome in nonkey industries, such as real estate and electronics. "We would love to sell to foreign investors," says Fang Xinghai, a general manager at China Construction Bank and one of the founders of Cinda.

Along the way, CCB will transfer its bad debt to Cinda's books. And if Cinda delivers, it will be a player in major industries. Some 20% of CCB's bad debt is estimated to come from the saturated real estate and construction sectors, with other chunks from petrochemical and nonferrous metals producers. Cinda is now tackling a big petrochemical company, although Fang won't say which one. If they "restructure, get rid of some people, and rationalize their product structure, they'll have a chance to list in Hong Kong."

Cinda's managers, for the most part, are sophisticated financial engineers: Fang earned a doctorate in economics at Stanford University and spent five years at the World Bank before joining CCB and overseeing Cinda's creation. He and his co-managers provide a sharp contrast to China's secrecy-obsessed bureaucracies. Already, Cinda has solicited advice on debt-equity swaps from everyone from Goldman, Sachs & Co. to former Federal Reserve ChairMan Paul A. Volcker. "We need all the help we can get," saYs Lin Shoukang, Cinda's executive associate director for international business.

Cinda plans to open 25 regional offices in the next few months and double its staff, to more than 2,000. Its focus will be on real estate-glutted Guangdong province and other hard-hit areas, such as the island province of Hainan. To keep expenses down, Cinda is encouraging its offices to consider using real estate and even autos acquired through debt swaps. In Beijing, Cinda's headquarters sit in a complex the agency acquired in exactly this way.

Cinda is already acting aggressively. In one of its first restructurings, of China United Cement Co. in early September, the workout firm brought together three ailing cement companies. Cinda wants the new company to acquire dozens of other small plants in the highly fragmented industrial sector. At Jiangxi Guixi Fertilizer Plant, a producer of phosphate, Cinda is swapping debt for equity worth $107 million, thus reducing the company's debt-to-equity ratio from 90% to only 26%.

Sounds promising. But nothing is simple in China. For one thing, Cinda is beholden to the Finance Ministry for its existence, since the Ministry provided Cinda its initial capital of $1.2 billion. If the Finance Ministry thinks Cinda is getting too aggressive in restructuring, the pressure to slow down will certainly build.

Cinda also has too many masters. Though funded by the Finance Ministry, it is supervised by the the central bank. For any restructuring that requires a listing, Cinda must get the green light from the China Securities Regulatory Commission. Already that has led to delays due to disagreements over who would call the shots, says one knowledgeable Western investment banker.

The sheer scale of the job is also a challenge. CCB has up to 150,000 bad loans on its books. For the larger cases, Cinda intends to visit the borrowers and audit their finances. And Cinda's mandate says it must finish this initial process within just four months. "I think it will take a lot longer," admits Ma Wen. But at least it's a start. And Cinda is showing the way.

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