Banks strengthen IPO efforts
By Mo Fan and Zhang Zhengyan (China Business Weekly)
Updated: 2004-06-08 11:38

[The authors are contributors to China Business Weekly.]

Drooling over 2 trillion (US$241.5 billion) in non-performing loans (NPLs) offered by China's State commercial banks, global top players such as Citigroup, Goldman Sachs, JP Morgan, Deutsche Bank and Merrill Lynch are competing aggressively again in China's capital market while State lenders race to clean up their bad debts ahead of the planned public listings.

Encouraged by the unprecedented opportunities, both sides have accelerated their pace.

Earlier this year China Construction Bank (CCB), the third-largest lender in China, announced that it had launched a tender offer of about 4 billion yuan (US$483 million) worth of non-performing assets worldwide.

The move marked its significant attempt to dispose of bad assets before the bank's planned initial public offering (IPO).

It is the first time that China's State-owned commercial banks have sold non-performing assets directly to international investors. It used to be done through China's four asset management companies (AMCs), established years ago to deal with the bad loans of four State banks -- the Industrial and Commercial Bank of China (ICBC), the Bank of China (BOC), the CCB and the Agricultural Bank of China.

The auction set no bottom price. It offered great chances but with potential risks.

"Distressed debts in Asia in the past three years have been a rising tide lifting every boat,'' said Bart Broadman, JP Morgan's vice-chairman in Asia-Pacific.

The final winners are Morgan Stanley and Deutsche Bank. They paid 34.75 per cent of the face value of three packages of non-performing assets, according to CCB statement.

"This is a good chance, and international investors are eager to get it,'' said an economist at Ernst & Young, which was the deal's financial adviser.

The total book value of the bad assets on sale is 4 billion yuan (US$483 billion), 97 per cent of which are real estate, involving 150 mortgage units, including lands, hotels, factories, residential apartments, and office buildings.

Heavy NPLs are a great concern for China's banking industry, as the sector is set to open by 2007 according to China's WTO (World Trade Organization) promise. BOC and CCB have planned their overseas IPOs, which could be as early as next year.

In 1999 and 2000, China's Big Four banks transferred a total of 1.4 trillion yuan (US$169 billion) in NPLs at face value to four AMCs created to handle bad debts.

The AMCs, namely China Cinda Asset Management Co, China Orient Asset Management Co, China Harong Asset Management Co and China Great Wall Asset Management Co, shoulder the responsibility of taking over, managing and disposing of the non-performing assets (NPAs) stripped off from China's four State banks.

Insiders said that given the tight schedule for the banks to complete restructuring and meet IPO requirements, it seems unavoidable that the authorities would have to unload some of the banks NPLs and transfer them to professional institutions for faster disposal.

They said the current NPL recovery rate is not satisfactory.

Meanwhile, the cooling down of China's economic growth may hinder efforts to reduce NPLs ratios over the next six to 18 months. Standard & Poor's (S&P), a credit rating agency, forecast 7-8 per cent economic growth this year compared with last year's 9.1 per cent.

Based on the current official NPLs ratio of 17.8 per cent for the banking industry, it could take China's banking sector six to 16 years to write down their bad loans to the ratio of 2-3 per cent of total loans as in some developed banking systems, according to S&P's commentary.

CCB is trying to cut its NPL ratio to 3-5 per cent from the current claimed 8.77 per cent, to pave the way for its IPO this year.

Ernst & Young partner Jack Rodman, who described himself as the "Godfather of bad assets'' and helped open several Asian bad debt markets after moving to the region in 1998, said foreign investors had the capacity to buy US$5-6 billion worth of Chinese bad assets every year.

In order to participate in the bidding, the investment giants spend a huge amount of money for the buy-out of bad assets in China's banks.

Apart from the registration fee, there is a 10-per-cent guarantee fee to pay.

Despite being "non-performing,'' NPLs are also a kind of economic resource that can be utilized, with enormous potential value. Foreign vultures see rosy prospects in China's NPL market.

Last December, China Huarong Assets Management Co sold NPLs worth 1.78 billion yuan (US$214.9 million) to a group formed by GE Asset Management Inc and Morgan Stanley Acquisition (Asia) Inc.

"Such action is very likely. But the exact method and timing of the transfer are still to be decided,'' said Wang Haijun, director of the investment banking department at China Cinda Assets Management Co.

The advantages of foreign investors are obvious. They can take some measures which domestic bank seldom take to recover loans, including exerting pressure on the government officials, using their powerful capital advantage to engage in lawsuits, and buying financial derivatives to hedge the risks, experts said.

The foreign investors pay about 5-30 per cent of the bad loans' book value. If investors can recover 80 per cent of the principal, the net profit can reach 200 per cent.

International investors purchase the bad asset as an investment vehicle to enter the China market, indicated a report from Ernst & Young. An analyst at China Great Wall Asset Management Co said the reason why foreign investment banks buy the bad assets eagerly is that the banks can enter the officially restricted industry, as well as buying into a huge potential profits.

Citigroup in April agreed to buy 2 billion yuan (US$241.5 million) worth of NPLs from the Great Wall Asset Management Co. The 2-billion-yuan (US$241.5-million) package involves more than 600 borrowers in South China's booming Guangdong Province. They are from various industries including agriculture, real estate, machinery, trade, building materials and food processing, Citigroup said in a statement.

US Colony Capital has launched with Shanghai Industrial Holding Company a fund named Yangtze Special Situations Fund LP, which specializes in distress debts.

Through co-operation with foreign counterparts, some exotic vehicles have been introduced for NPL disposal, including securitization of bad assets packages, which is popular in developed economies.

In April, Credit Suisse First Boston (CSFB) signed an agreement with ICBC's Ningbo branch to securitize bad assets with 2.6 billion yuan (US$314 million) book value. This agreement will include credit ratings and setting a special purpose vehicle to take over the debt.

Kevin Lam, head of securitzation ING bank (Asia), said the implementation of asset securitzation would be helpful to improve the liquidity of bank loans.

"The deal with ICBC in Ningbo is a historic record, introducing a new movement in China market,'' said Paul Calello, CSFB's Asia chairman.

Through the deal, CSFB can get the cutting edge, but when the cake becomes bigger, the competition will become fierce among the international investment bankers.

Close