Evaluation in works for AMCs
By Ba Shusong and Tu Yifeng (China Business Weekly)
Updated: 2004-06-28 13:51

China established four asset management companies (AMCs) to help dispose of non-performing loans (NPL) within the Big Four State-owned Banks in 1999.

That not only concerns the future development of the AMCs, but also has a big impact on China's overall reform of the NPL disposal business.

Since 1999, the four AMCs, Huarong, Cinda, Orient and Great Wall, took over about 1.4 trillion yuan (US$169.1 billion) of NPL (calculated in book value) from the four State-owned banks, namely the Industrial and Commercial Bank of China, China Construction Bank, the Bank of China and the Agricultural Bank of China.

By the end of this year's March, the four AMCs disposed of 528.7 billion yuan (US$63.9 billion) of NPL altogether, which excluded a large sum of debt-to-equity swaps, according to statistics from the China Banking Regulatory Commission.

The cash recovered by then totalled 105.5 billion yuan (US$12.7 billion).

The total sum of bad loans disposed each year has been increasing over the past few years, and the AMCs picked up more speed since the second half of 2002.

However, as the quality of the assets possessed by each company varies, the cash recovery and the pace of disposal also differs.

Orient and Cinda, for example, are comparatively slower since they have taken over a large volume of policy-arranged loans from the Bank of China and China Construction Bank, which are harder to recover.

Moreover, the AMCs first try to dispose the assets with better quality. As time goes by, the assets that are of poorer quality become even less valuable and more difficult to deal with.

Therefore, although the total NPL amount digested each year seems to increase, the actual cash recovery rate declines.

That also creates more obstacles for the future business operation of the AMCs and adds more uncertainty to the regulatory work.

Foreign participation

Foreign investors have been actively participating in the China's efforts to dispose of bad loans.

So far, all the AMCs have sold asset packages to foreign investors, often through public bidding and auction, which would deal with tens of billions yuan of assets at one time.

A consortium led by Morgan Stanley, for example, made a first such try by purchasing a package worth 10.8 billion yuan (US$1.3 billion) from China Huarong AMC in November 2001. Goldman Sachs also won the bid for a 8.1 billion yuan (US$978.3 million) asset package from Orient in October 2002.

Huarong recently sold another 22.2 billion yuan (US$2.7 billion) package of non-performing loans to another foreign consortium. From November 2001 to January 2004, Huarong sold 36.7 billion yuan (US$4.4 billion) worth of non-performing assets to foreign institutions, which took up about 25.2 per cent of the total NPL it disposed during the period.

The deeper involvement of foreign investors in the sector also encouraged Chinese authorities to come up with an effective evaluation and liability system to check the efficiency of the participants dealing with non-performing loans.

From the deals already clinched, it is easy to see that foreign investors are generally more interested in the NPL from sectors such as power, energy, non-ferrous metal, transportation, water treatment and infrastructure.

Such projects have shown a rosy strategic outlook. With long construction cycle, big investment and stable cash flow, many can generate good returns after restructuring, which offer foreign investors a more economical and easy access to the Chinese market.

Compared to the acquisition of a domestic enterprise in normal operation, it is much less costly to purchase or buy into an indebted and troubled one.

And as for some of the strategic sectors, like power and energy, foreign investors would never find it easy to enter in normal conditions.

Meanwhile, some AMCs are creditors or equity owners in some listed companies in China. If a foreign institution can take part in relevant NPL disposal projects, it can become the creditor or equity holder of these listed firms.

Though China has introduced the qualified foreign institutional investor (QFII) scheme to open up the A share market to foreign investors, so far, only a small groups of foreign institutions can enter through such access.

The participation of foreign investors in the NPL disposal market in China is generally a positive thing and should be encouraged.

However, the trend also reveals some loopholes in China's legal system, particularly in relation to disposal of non-performing loans and relevant evaluation and liability scheme.

For one thing, solid cash flow of some good projects is the biggest attraction for foreign investors. That also gives the AMC staff more incentive to pick out the good projects and pursue short-term returns and leave the more problematic assets behind. But as discussed above, that would lay the groundwork for a future crisis.

On the other hand, so far the authorities have not found appropriate criteria to assess the efficiency of the NPL disposal efforts among foreign buyers and whether the prices of the assets sold are rational.

The fact that foreign investors often take such NPL project as a short-cut to enter some domestic industries also makes their real interest on the project itself doubtful.

Sometimes, buying bad assets from Chinese AMCs may just be a springboard into the Chinese market and the problems may remain unsolved.

Therefore, if regulators plan to develop better performance evaluation mechanisms on foreign participants and the AMCs and to designate their liabilities during the NPL-disposal process, they should pick up some appropriate indices and improve the asset evaluation method.

More participation of qualified intermediaries is needed, like international credit rating agencies, accounting firms and law firms.

The AMCs can also make innovation on the trading and pricing system and offer more diversified transaction arrangements, based on the exposure during transaction.

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