The Second Forum for Asian The Second Forum for Asian Insolvency Reform (FAIR)Insolvency Reform (FAIR)

Bangkok, Thailand Bangkok, Thailand

16-17 December 200216-17 December 2002

AMCs and NPL AMCs and NPL activity in Chinaactivity in China

Michael HarrisMichael Harris

Restructuring the Chinese Restructuring the Chinese banks: NPLs and AMCsbanks: NPLs and AMCs

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BackgroundBackground

Big four commercial banks

–Bank of China

–Agricultural Bank of China

–Industrial and Commercial Bank of China

–China Construction BankSpun-off from PBOC in 1980sOwned by Ministry Of Finance

Policy BanksE.g., China Development Bank

OthersSecond Tier Institutions; Rural Cooperatives

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Background (cont’d)Background (cont’d)

Problems faced by “Big 4” Commercial Banks

– Overstaffed

– Undercapitalised

– Historically, no competition to drive best practices

– Lending at direction of state based on political/social considerations

– “Success” measured, in part, by loan volumes

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Estimated NPLs in ChinaEstimated NPLs in China

Standard and Poor’s US$680bn

US$218bnChinese government

Real number ???

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The restructuringThe restructuring

PBOC funds AMCs in return for AMC debt

Ministry of Finance

AMCsBig 4

PBOC

$

NPLs at face

$ “IOU”

NPLs$

An intra-State money-go-round

AMCs pay cash for NPLs at face

AMCs to work-out the NPLs

PBOC bears the haircut

Big 4 get PBOC backed notes for NPLs at face

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The AMCsThe AMCs

Source bank

Bank of China

ICBC

China Construction

Agricultural Bank

AMC

China Orient

Huarong

Cinda

Great Wall

NPLsUS$bn

32.8

50.1

45.9

42.6

Loans categorised broadly by industry type 171.4

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Functions of AMCs

Preserve assets, reduce losses

Debt/Equity Swaps

Sale of Collateral

Consultancy

Portfolio Sales

Investment Banking

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Barriers to recoveriesBarriers to recoveries

Estimates of overall recoveries vary Consensus is less than 20% of face Barriers to recovery include

– Inherent weaknesses in the loan portfolio, in part due to:

– Age of loans transferred to AMCs» Mandated by Government

– Inadequate legal framework– E.g., Bankruptcy Law provisions

– Resistance to reform– Debtor expectations– Local politics– Foreign investor publicity

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AMC reported recoveriesAMC reported recoveries

• Ministry of Finance target of 30% cash recovery rate

• Cumulative reported cash recovery rate is 21.6%

• Small proportion of loans “dealt with”

• Early recoveries relatively high – “low hanging fruit?”

• Situation unlikely to improve over time

Total NPLs US$171.4bn

2Loans dealt with in 2001 US$9.4bn, of which US$3.2bn realized in cash1.6% cash recovery to date

M/T

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Foreign investment solutions

Changes to laws to allow foreign investment

Considerable interest, but treading carefully

Recoveries expected to be low, therefore investment prices are lowerCommon structural aspects Ownership Control Servicing Upside

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Issues for foreign investor Issues for foreign investor participationparticipation

Remittance

Information

Expectation gap

– Pricing

Language

– Everything is in Chinese !

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Foreign investor deals “completed” so far

Huarong AMC Foreign investor roadshow – July, 2001 Deal announced – November, 2001 Final approvals received – December, 2002

China Orient US$217m portfolio All approvals in place Cash changed hands Recoveries now being remitted overseas

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Foreign investor deals “completed” so far

• Cinda AMC–Cash changed hands–Small portfolio–Still waiting on certain approvals

• Great Wall AMC–Winning Bidder chosen–Documentation ongoing–Final approvals being pursued

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Issues Impacting Portfolio & NPL Pricing & Resolution

• Historical Collection Rate• (BIS Position Paper)

• Approval Process• “Headline Targets”& Minimum Reserve• Valuation guidelines & procedures

•Valuation of borrowing entity v. •Valuation of NPL

•Hidden Costs•Land Use Rights•Registration Fees•Social Welfare costs•Construction completion costs

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Issues Impacting Portfolio & NPL Pricing & Resolution

•Marketability of Debt/Equity Swap Positions•Board Representation•Accountability•Dividend reliance

•Discounted Pay-off (DPO) application & liquidity considerations

•Competition from other sources•Domestic (e.g., China Construction Bank /

Morgan Stanley discussions; ICBC auction of Selected “Settled Assets”

•External•e.g., Taiwan

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Possible Future Considerations

•Re-assessment of bond obligations & impactTo capital structure

•Continued adoption of Int’l guidelinesFor Loan Loss Reserve Analysis

• Limited capital chasing deals•Other approaches

E.g., Securitisations

Clearer picture – post Party and PeoplesCongresses