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China redoubles its efforts to reduce NPLs, reform banks

Efforts by China's asset management corporations to hive off more non-performing loans (NPLs) suggest the government is renewing its bid to clean up the banking system, as international pressure mounts to speed up currency reforms, analysts say.

A Beijing-based electronic exchange reportedly will soon begin selling NPLs, while Yang Kaisheng, president of Huarong Asset Management Company, China's largest manager of distressed debt, is currently in New York marketing US$2.2 billion in loans directly to foreign investors.

After decades of easy loans to loss making state-enterprises, China set up Huarong in 1999 and three other companies to take over 1.4 trillion yuan (US$170 billion) in non-performing loans from the country's big four commercial banks.

As China has pushed forward with market reforms, it has come under increasing pressure to offload this mountain of bad debt, ahead of the arrival of foreign competition to its financial sector under promises made to the WTO when it joined in late 2001.

This latest push to dispose of part of the estimated US$500 billion in total NPLs, has also been triggered by international pressure on China to speed up the loosening of its foreign exchange controls in the wake of an increasingly bitter dispute over the country's currency policy.

"The fact is that this time around there is more pressure on the yuan and on capital account liberalization which just makes reform more pressing," said HSBC economist Qu Hongbin.

"The reason China can't compromise in this key area is that it still has a shaky banking system," Qu said.

These latest moves mark the first significant attempts to dispose of such problem assets since US investment banks Morgan Stanley and Goldman Sachs bought 10.8 billion yuan and 1.97 billion yuan of NPLs respectively earlier this year.

Despite signs that the government is moving faster to liquidate NPLs, these type of debt deals are in their infancy, and the process is fraught with difficulties.

"There is value in these non-performing loans -- they're not totally invaluable, but there are all sorts of problems," said Brian Cheung, a partner with Price-waterhouseCoopers Hong Kong.

Analysts said that negotiations over the sale of non-performing loans were often troubled by inadequate or poorly organized documentation and investors faced problems in taking control of property used to guarantee loans.

Because many loans held by the asset management companies (AMCs) were made prior to 1996, when property prices were significantly lower than today, local governments have interfered to prevent them from taking possession of the now more valuable property.

Given the array of potential landmines, David Mahon, managing director of investment advisory service CMG Mahon in Beijing, questioned the approach taken by the leading investment banks.

"One must question buying a job lot of anything in China," he said.

While the investment banks are buying up loans in chunks to achieve "critical mass," he said there was little evidence they would be able to carry out due diligence to realize their value.
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