HONG KONG, 18 February 2019. Pengyuan International has assigned a first-time global-scale long-term issuer credit rating (LTICR) of ‘BB’ to GoHo Financial Asset Management Co Ltd (GoHo) with a Stable Outlook.
The rating reflects GoHo’s duopoly status in Auhui Province’s local distressed asset management industry, strong startup capital, and improving earnings profile. The rating also considers the central government’s supportive policy stance towards distressed asset management companies (AMCs), which we expect will continue to fuel the sector’s growth. In addition, we view China Orient Asset Management Co Ltd (China Orient AMC; Not Rated)’s minority shareholding in the company favorably, to the extent that it enables a certain degree of knowledge transfer and operational support.
These strengths are partially offset by GoHo’s relatively short track record, modest operating scale, and limited access to financing as compared to more-established non-bank financial institutions (NBFIs). Furthermore, as the company is still in a nascent stage of development, we believe there is room for improvement in the risk oversight functions, particularly with regards to the management of counterparty credit and funding risks.
KEY RATING FACTORS
Duopoly status. Founded in 2014, GoHo was among the first five companies to be granted a local AMC license in China and was the only privately-owned entity in that group. In 2018, a second local AMC was licensed in Anhui, creating a duopolistic competitive structure in the province. As we envisage that the number of local AMC licenses in Anhui will be capped at two in the foreseeable future, barriers to entry will likely remain extremely high. While GoHo does compete with the Big Four national AMCs in the primary distressed asset market, its focus is mainly on small-to-medium sized transactions that require extensive local knowledge, relationships and execution capabilities.
Strong startup capital. In our view, GoHo’s paid-in capital – which was further replenished in 2016 and 2017 – is at a prudent level relative to its risk exposures in 2019 and 2020. Over this period, we expect the company to maintain a capital adequacy ratio of above 20%. We believe this capital buffer is critical as the firm ramps up its balance sheet from a low base and, in the process, may potentially face heightened volatilities in credit experience, collateral valuations, recovery timing, as well as short-term funding costs.
Improving earnings profile. We believe that, over the cycle, GoHo has a portfolio of businesses that are capable of generating a return on equity (ROE) of 10-15% and a return on assets (ROA) of 2.5-3.0%, levels that we consider to be adequate relative to the risks undertaken. Our expectation is for the firm’s ROE and ROA to trend up towards the higher ends of those ranges in 2019 and 2020, as it continues to build up its transaction pipelines. Key drivers that underpin our earnings forecasts for this period include average annual growth in interest-earning assets in excess of 20% and a marginal uptick in net interest spread of around 10 basis points a year.
Supportive policy stance. We believe local AMCs play a pivotal role in the resolution of non-performing loans by creating a market for distressed debt assets and the underlying collaterals. While the Big Four AMCs will likely remain dominant on a national basis, local AMCs primarily specialize in the small-to-medium segment, which has become a priority for policymakers. Potential policy benefits to GoHo may include project referrals from local governments and government-related entities, more relaxed business scope restrictions, and more diverse funding channels.
China Orient AMC’s shareholding. China Orient AMC is one of GoHo’s founding shareholders and currently owns 13.95% of the firm indirectly through its wholly-owned subsidiary Shanghai Dongxing Investment Holding Co Ltd. We view China Orient AMC’s involvement positively, especially in GoHo’s early stage of development when knowledge transfer and technical assistance are of particular value. However, we do not regard China Orient AMC’s stake to be sufficiently strategic to warrant any uplift to GoHo’s standalone credit profile.
Relatively short track record. With a short track record since 2014, GoHo’s ability to price, manage and dispose of distressed assets is relatively unproven compared to that of the Big Four AMCs. These challenges are exacerbated by the fact that distressed asset management is fundamentally a long-tailed business, with typical exit periods of 1-3 years. We take some comfort from the fact that senior management comprise industry veterans with extensive commercial banking and financial backgrounds, but we believe it may take another few years before the company acquires an adequate level of institutional knowledge to allow it to compete effectively in the long run.
Modest operating scale. GoHo’s revenues and asset base are relatively modest compared to more-established NBFIs globally. The company’s operating scale may be a constraining factor in terms of participating in larger distressed asset acquisitions, gaining access to bank financing and capital markets, and boosting human resources. Despite our expectation for a continued sharp increase in business volumes in 2019 and 2020, the relative lack of diversification compared to larger AMCs may also subject the company to increased credit and asset recovery risks.
Limited access to financing. Although we believe GoHo is well-capitalized, the remainder of its funding needs for distressed asset acquisitions is largely fulfilled by bank loans. As of end-2017, ~70% of these loans were short-term in nature. As GoHo builds on its relationships with its banking partners, we expect the company to bring the proportion of its short-term bank loans down to 50% over time. The company has continued to actively pursue financing opportunities in the onshore and offshore bond markets and we believe it may be able to achieve a funding mix of ~65% bank loans / ~25% bonds / ~10% repurchase agreements over time. In the interim, the lack of access to the interbank and equity markets will remain a credit weakness.
Room for improvement in risk management. In our opinion, GoHo’s risk management functions have room for improvement compared to more-established NBFIs. In particular, we believe the company could strengthen its counterparty risk and asset-liability management. As an example, we believe taking more prudent provisions against potential future losses would create an additional buffer against fluctuations in its credit and recovery experience. We would also view positively independent board representation as the company steps up its efforts to strengthen its corporate governance.
The Stable Outlook reflects our view that, despite a potentially more challenging pricing and asset disposal environment, GoHo’s profitability, capitalization and liquidity are likely to remain commensurate with our expectations for the current rating category in the next 12 months.
We would consider a downgrade if GoHo’s capital adequacy ratio, as defined as its economic capital / tangible assets, falls below 20% on a sustained basis; if asset impairments lead to a significant deterioration in its earnings outlook; or if its financing conditions suggest possible liquidity stress in the near term.
We would consider an upgrade if, in addition to exceeding our expectations on profitability and capital adequacy, the company can consistently demonstrate more robust internal policies and procedures. Among other things, this may include more forward-looking asset risk classification and loss provisioning practices.
Stanley Tsai, CFA
+852 3615 8340
+852 3615 8319
Tony Tang, CFA
+852 3615 8278
Date of Relevant Rating Committee: 11 January 2019
Additional information is available on www.pyrating.com
General Principles of Credit Ratings (21 Nov 2018)
Global NBFI Rating Criteria (15 Jun 2018)
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