|
China NPLs: Trends and Future Issues
SUMMARY
OF CONTENTS
programme
overview
The Chinese government estimated that the
non-performing loan (NPL) ratio for major commercial banks in China, including
the four wholly state-owned commercial banks (Bank of China, China Construction
Bank, Industrial and Commercial Bank of China and Agricultural Bank of China),
amounted to RMB 1.7 trillion (US$240.7 billion) or 13.2% at the end of September
2004, down 4.6% over the year. Bank of China separately reported an NPL ratio of
4.55% as of October 2004, down from 5.16% at the end of September 2004 and 16.3%
at the beginning of the year. China Construction Bank reported an NPL ratio of
3.74% at the end of September 2004, the lowest among the big-four state banks.
However, private estimates are much higher. The
difference in the NPL estimates could be due to different methods of calculation
or subjectivity of the evaluators, and the official figures have in any event
been flattered both by significant one-off transfers from the banks of bad loans
and an increase in overall lending.
But the origin of this dauntingly high level of
NPLs is certain. It is a result of over 40 years of extensive policy lending
under a centrally planned economy, and the banks still remain subject to
government control and direction.
Unfortunately, the big-four do not have decades
to resolve this historic NPL problem. By 2007, China will complete its full
integration into the WTO. At that time, the country's banking market will open
to foreign competitors and the big-four will be subject to full market
competition. It is therefore essential to restructure the big-four and clear up
their balance sheets in order to ensure their continued solvency and their
future listings on overseas stock markets.
Back to Top
AMCs
In response, the Ministry of Finance [herein
MOF] set up four asset management companies [herein AMCs] in 1999, one
for each wholly state-owned commercial bank. Thus, Cinda (for China Construction
Bank), Huarong (for Industrial and Commercial Bank of China), China Orient (for
Bank of China) and Great Wall (for Agricultural Bank of China) came into being.
The main purpose of these AMCs was to acquire the banks' NPLs at book value -
hence separate the bad bank (AMCs with the NPLs) from the good bank (the
big-four with ongoing operations and performing loans).
In 1999, the State Council ruled that the AMCs
would acquire RMB 1.39 trillion of NPLs from the banks at book value without
discount. The purchase was made in part by cash (lent to the AMCs by the
People's Bank of China [herein PBOC], China's central bank) and in part
by bonds issued by the AMCs to the banks. The partial use of debt to pay for the
loans meant that the banks were still exposed to AMC credit risks (equivalent to
the original NPL exposure). To address this, the PBOC was required to guarantee
the AMC bonds; thereby the credit risk was passed to the PBOC. Since the MOF
owns the AMCs, the banks and the PBOC, there was no net cost incurred to the
State in providing such backing. The arrangement effectively passed the credit
risk of the NPLs from the banks to the PBOC, via the AMCs. The end result is, of
course, a dramatic strengthening of the balance sheets of the banks.
Back to Top
DEVELOPMENT OF
AMCs
Over time, the role of the AMCs has developed, so
they are now not rigidly tied to one particular bank and recently, for example,
have been competing between themselves (but not with third parties) to purchase
NPLs from China Construction Bank and Bank of China in preparation for the
banks' proposed listing. In June 2004, Cinda beat the other three AMCs to
purchase a combined RMB 280 billion (US$34 billion) of distressed assets from
China Construction Bank and Bank of China. In December 2004, China Orient agreed
to purchase RMB 130 billion (US$15.6 billion) of the China Construction Bank
portion of the portfolio from Cinda. ICBC is inviting the AMCs to bid on loans
with a face amount of approximately US$54.4 billion equivalent, although this
time the loans may be divided into separate pools unlike with the China
Construction Bank/Bank of China sale where there was a single asset pool.
The original life of the AMCs was to be 10 years,
but this is now being extended along with changes to function on more of a
commercial basis. In this regard, the AMCs are additionally becoming involved in
taking over failing securities brokerages and Huarong has even received the
certificate of ISO9001:2000 from the British Standards Institution. It is
possible the AMCs will evolve into financial holding companies, involved in
asset management as well as corporate and investment banking. It is also
possible the stronger AMCs may merge with the weaker ones.
As at the end of March 2005, Huarong, Great Wall,
China Orient and Cinda had resolved RMB 214.44 billion, RMB 213.61 billion, RMB
106.79 billion and RMB 153.71 billion worth of NPL assets, respectively,
recovering RMB 42.57 billion (19.85%), RMB 22.24 billion (10.41%), RMB 24.37
billion (22.82%) and RMB 51.71 billion (33.64%), respectively.
Back to Top
AMC AUTHORISED
ACTIVITIES
In purchasing NPLs from a state-owned bank, the
business scope of an AMC encompasses the following:
- debt collection;
- the leasing, transfer or restructuring of
assets comprising the NPLs purchased;
- debt equity swap, and the temporary holding of
shares of corporations;
- sponsorship in the listing of, and
underwriting bonds and stocks for, companies falling within its scope of
asset management;
- bond issuance and borrowing from financial
institutions;
- providing financial and legal advice, asset
and project valuations;
- all other activities as approved by the China
Banking Regulatory Commission (CBRC) and the China Securities Regulatory
Commission (CSRC).
As noted, an AMC can swap the debt interest with
an equity interest in the corporate borrower of the NPL. Such equity interest
held by an AMC will not be subject to the requirements on the net asset amount
or the registered capital ratio of the corporate borrower. After the debt equity
swap, an AMC may, as shareholder of the corporate borrower, nominate
representatives to take part in board meetings and supervisors' meetings, and
exercise other rights of a shareholder. An AMC can also assign its equity
interests in a corporate borrower, or sell the equity interests back to the
corporate borrower.
Back to Top
AMC FOREIGN
EXCHANGE ACTIVITIES
In the purchase of NPLs, an AMC may engage in the
following activities involving foreign exchange:
- the purchase of nonperforming foreign exchange
assets disposed of by the respective state-owned commercial bank;
- the exchange, transfer or sale of foreign
exchange assets and foreign debt collection;
- the restructuring of foreign debt
obligations;
- foreign debt equity swaps and temporary
shareholding;
- and all other businesses approved by the CBRC
relating to the taking on of nonperforming foreign exchange assets.
Back to Top
RESTRUCTURING,
DEBT COLLECTION AND DISPOSAL OF ASSETS
In order to attract foreign capital in buying and
restructuring the NPL assets, the Ministry of Commerce (former MOFTEC), MOF and
PBOC jointly promulgated the "Absorption of Foreign Capital by Financial
Asset Management Companies to Participate in Asset Restructuring and Disposal
Tentative Provisions" on October 26, 2001 [herein 2001 AMC Decree].
Article 6 of the 2001 AMC Decree authorises an
AMC to absorb foreign capital under any of the following circumstances:
- the selling or transfer of equity or debt
interests in nonlisted companies after restructuring of the same by the AMC;
- the direct sale or transfer of equity and debt
interests in nonlisted companies to foreign investors;
- the sale of tangible assets by way of
transfer, tendering or auction, etc.; and
- the setting up of a foreign invested
enterprise in collaboration with a foreign investor by the injection of
equity interests and tangible assets of the original corporate borrower.
The 2001 AMC Decree also provides that asset
valuation reports should be compiled before an AMC sells or transfers
restructured assets.
In order to facilitate the AMCs to collect debts
through court proceedings, the Supreme People's Court issued a specific notice
on April 3, 2001 (which took effect on April 23, 2001) according AMC's special
legal status in the following circumstances:
- While a branch of an ordinary company does not
have locus standi to appear before courts in the PRC, a branch of an
AMC is given such standing by virtue of the Supreme Court notice.
- According to Article 80 of the PRC Contract
Law, an assignment will not take effect unless and until the creditor has
notified the debtor of the assignment. The Supreme Court notice provides
that a public announcement in a national or provincial newspaper made by an
AMC will be deemed to be proper notice to debtors of the transfer of the
loan to the AMC.
- In order to enforce a court order, a plaintiff
may apply for an interim order for preservation of property (similar to a
Mareva injunction) in accordance with the Civil Procedure Law. However, the
court usually requires the plaintiff to provide security equivalent in value
to the property sought to be frozen. The Supreme Court notice has in effect
dispensed with such a requirement when an AMC applies for such an order.
In November 2004, changes were made to attempt to
speed up the transfer of NPLs to foreign investors. AMCs are to report proposed
sales to the Development Reform Commission within 30 days of agreement, and the
Commission is to respond within 20 working days. In December 2004, it was
announced that details of transactions must be submitted to SAFE within 15
working days of completion. Since January 2005, foreign investors have been
permitted to remit out of China funds related to NPL disposals, subject to
reporting transaction details to SAFE.
Back to Top
FOREIGN
INVESTMENT
Various attempts have been made to attract
foreign investment in these restructured assets. In November 2001, Huarong
signed a landmark agreement to sell RMB 10.8 billion worth of NPL assets to a
consortium led by Morgan Stanley, which agreed to pay Huarong in cash about 9%
of the face value of the loans. In December 2001, Huarong sold a second tranche
of RMB 1.97 billion worth of NPL assets to Goldman Sachs. Goldman Sachs
successfully structured and executed the first joint venture in China, Rongsheng
Asset Management Co., to own and operate an NPL Servicing Company to resolve the
loans. Shortly after that, the joint venture between Huarong and the Morgan
Stanley Consortium, First United Asset Management Corporation was established.
The Goldman Sachs and the Morgan Stanley transactions received government
approvals in February and March 2003, respectively.
Separately, in December 2001, China Orient
arranged the sale of a US$217 million NPL portfolio to the US-based Chenery
Associates. The transaction involved a complete sale of the portfolio from China
Orient to Chenery Associates for a consideration of US$21 million payable in
cash on completion, which is about 10% of the face value of the loans. As part
of the structure, the financial advisor to China Orient, PricewaterhouseCoopers,
was also appointed to service the NPLs portfolio, and in turn retained China
Orient to assist in the process of assets recovery. As a result, China Orient
was entitled to claim a success fee equivalent to approximately 50% of all
realisations above a certain threshold.
In 2003 and 2004, further deals came into the
market as the AMCs geared up foreign investors initiatives. China Construction
Bank moved forward with a portfolio sale of NPLs to Morgan Stanley but ran into
approval problems, not least as the deal envisaged a direct sale by the bank and
the sale of loans at below book value. China Construction Bank also undertook a
sale of "settled assets" to foreign investors, i.e., the assets
securing the loans, thereby circumventing various regulatory restrictions, with
Morgan Stanley and Deutsche Bank the successful bidders.
Another significant deal in 2003/2004 was the
auction sale of Huraong's RMB 22.5 billion worth of NPL assets. The winning
bidders included Citigroup, JP Morgan, Goldman Sachs, UBS, Morgan Stanley,
Lehman Brothers and at least one Chinese company. Of the 22 portfolios on offer,
only three were won outright with another 14 being acquired after further
negotiation. The remaining five portfolios were withdrawn as the bid prices were
too low.
Back to Top
FURTHER
DEVELOPMENTS
A number of private deals are ongoing. For
example, Citigroup has agreed to buy a portfolio with a face value of RMB 2
billion from China Great Wall Asset Management. This transaction takes the form
of an outright sale, rather than a joint venture as was usually the case with
Huarong.
Transactions also seem to be getting bigger. In
December 2004, Great Wall invited bids for assets valued at US$18.1 billion,
more than four times the total sold so far to foreign investors. Cinda is
currently planning to offer RMB 21.5 billion of NPLs to both domestic and
foreign investors, but with only two portfolios really aimed at foreign
investors.
Both Cinda and Huarong have begun to assess the
use of securitisation to dispose of their NPL portfolios. Cinda has engaged
Deutsche Bank as its advisor to issue bonds to overseas investors and Huarong
has signed a similar co-operation agreement with Korean Asset Management
Corporation.
As an alternative method of investment, Citigroup
in 2004 took a 16.4% stake in Silver Grant International Industries, a Hong
Kong-listed affiliate of Cinda charged with acquiring and managing NPLs.
Specialist, well funded and well connected
institutions such as FDC Fengde Capital are playing an increasingly important
role in the NPL market.
Back to Top
This technical briefing is an amended version of chapter 4.01[1][c][i] of "Banking Regulation in China" by Philip B. Gilligan, forming part of Gruson & Reisner's "Regulation of Foreign Banks" published by LexisNexis in the US in 2005. Whilst every effort has been made to ensure the accuracy of this publication, it is intended to provide general guidance and not definitive legal advice.
|
