Despite much criticism of China’s tardiness in clearing up its enormous $307 billion non-performing loan problem, a recent report by global accounting and consulting firm Ernst and Young suggest that the situation is not as dire as often reported.
According to the ‘Global Nonperforming Loan report 2004’ Ernst and Young consultants indicate that China has seen a gross disposal of $200 billion since the establishment of four asset management companies in 1999. Of that 200 billion, 107 billion are still with the AMCs, meaning that a net $93 billion has been resolved through ‘restructuring, reclassification, repayment, or write-offs.’
The last figure is the more significant one, since merely holding the loans at the AMCs does not generate any economic benefit, other than removing the bad assets from the banks’ balance sheets.
Using the same calculation, only Japan beats China, with a net reduction of $488 billion through restructuring, reclassification, repayment and write-offs. $112 billion is still held in AMCs, making a total of $600 billion in gross reduction.
China’s figure for resolving loans through restructuring etc, exceeds that of Korea ($80 billion), Thailand ($90 billion) and Indonesia ($32 billion). These latter countries, whose banking systems were hit by the Asian Financial Crisis, set up AMCs much earlier than China. Taiwan, with a serious NPL problem of its own, has only just set up an AMC, and gross NPL disposal amounts to $50 billion.
Irritatingly for US vulture investors, they have so far only been able to buy up around 5% of outstanding non-performing loans. Such deals can be enormously lucrative, with Goldman Sachs making a return of almost 1000% over two years on the first major NPL acquisition from Huarong AMC in 2001. The distressed debt market is already highly developed in the US, and the opportunities for buying debt at rock bottom levels from nervous, ignorant investors, or from investors who are unwilling to wait for a resolution, have grown much scarcer in recent years.
Disposal of NPLs in China has been predominantly a domestic affair, without the enormous deals to foreigners witnessed in Korea and Thailand. According to one AMC manager, although the AMCs have held on to roughly 75% of the debt they have bought from the banks at face value, around 15-20% has been sold in equal parts to the investment branches of state-owned enterprises, and the private sector. The latter development is important since it provides some cheap and lucrative growth opportunities to a sector which faces many obstacles. Private companies are especially active in the most difficult part of the market – the restructuring or breaking up of small to medium SOEs. The upper limit of their investment scale is usually around Rmb 50 million, estimates the manager.
The AMCs tend to put two classes of debt up for auction to third parties, the very worst and the best. The best can naturally be sold quickly at a good price, while the worst are attractive to some investors because the discount is so large. The AMCs generally try to recover the debt themselves, but selling off debt to third parties can be more efficient since impaired assets go down sharply in value over time.
China does not have a fully developed Western-style bankruptcy law. That’s not an oversight: It’s because the government is reluctant to recognize the rights of creditors over the rights of employees. In the US, when a company files for bankruptcy, wage claim come below senior creditor claims. In China, the wages of the staff are the most senior claim. As a result, restructuring can be complicated and usually only moves forward with the approval of local government and the enterprise. Only around 5% of companies have been driven into bankruptcy and their assets liquidated. But around 15% of the companies with whom Huarong has conducted debt for equity swaps, says one manager, have successfully restructured and have paid off their debt.
In some ways therefore, the Chinese system can be seen as very similar to Chapter 11 of the US bankruptcy code, which plays an important role in giving companies a respite from their creditors. Given the unprecedented changes these companies have been exposed to, there is a strong argument for giving them an opportunity to regroup, argue Chinese officials.
Just like in the US, there has been a great deal of debate in China about the value that US vulture investors can bring to the Chinese NPLs problem. US bankers would argue that they can help rapidly clean up the banks’ balance sheet and recycle assets – although that has already been accomplished by the handover to the Chinese AMCs, say Chinese officials, and the relatively steady pace of loan resolution by domestic investors.
Western Experts say that the auction and securitization formats pioneered by the Resolution Trust Corporation in the US in the wake of the ‘Savings & Loans’ collapse in the 1980s and early 1990s should be duplicated in China for reasons of transparency and efficiency.
In some ways, they are right. The RTC is generally acknowledged to have done a good job in taking over, and selling off or liquidating, insolvent thrifts.
But there are also differences. China’s AMCs have never come close to taking over the country’s big four banks and breaking them up, for example.
And despite the criticism concerning the slow pace of the setting up of the Chinese AMC, the US’ RTC was itself actually set up rather late after the first problems in the S&L appeared. Indeed, the S&L industry benefited from the relaxation of key capital requirement rules after solvency problems first started appearing. With a powerful lobby in Congress doing their best to help the thrifts appear solvent, it took ten years before the RTC was finally set up.
In addition, the RTC was accused of selling off asset too cheaply through its use of outside contractors; and of inflating its cost base through the excessive use of Wall Street bankers and consultants.
Similar claims have been leveled against Chinese AMCs, with especial criticism leveled at those deals which are negotiated secretly between local officials and investors.
But despite the obvious advantages of a rigorous and transparent court-led process, even in the US a large proportion of debt renegotiation is done out of court. US restructuring and bankruptcy expert Stuart C Gilson (see book review below) points out that only the biggest restructuring cases go to court because of the costs and complexities involved.
Ultimately, it's surely ironic that vulture investors who thrive on secrecy, mis-pricing and inefficiency in the US should express such concern when it's duplicated in China. Clearly, the most likely reason for such concerns is because they are not, so far, an important part of it.
