| Jiang Jianqing | ||||||
There have been a few rumblings coming from the Chinese mainland and its banks as they attempt to tick off the tasks on their things-to-do list. On the positive side, Bank of China has been awarding valuable mandates to privatize its Hong Kong operation.
Goldman Sachs and UBS Warburg seem satisfied with life, but still haven’t officially raised the banners and popped the champagne in public to celebrate landing such an important prize. November however is being touted as a very good month for launching such an IPO.
On the less than positive side, the issue of non-performing loans still casts a shadow over the whole restructuring process. “What we have learned in the last few months is that the hole is a lot bigger than we first feared,” says Nicholas Lardy, a senior fellow at Brookings Institution, a Washington-based think tank. Another banker based in New York, who sounds perversely upbeat, adds: “It will be worse than people or the Chinese government believed.
Much worse.”
In 1999, the Chinese authorities set up asset management companies (AMCs) to help dispose of the banking sectors non-performing loans (NPLs). With the help of Rmb10 billion (US$1.2 billion) from the ministry of finance, an Rmb800 billion bond issue, and another Rmb500 billion from the People’s Bank of China, the AMCs set about vacuuming up the distressed debt in an attempt to clean up the big four state-owned banks’ balance sheets. Two years and Rmb1.4 trillion later they still have some way to go.
Bank of China, which is becoming a more transparent and commercially-viable bank in an attempt to woo future investors, has published its annual report and disclosed figures that should have western investment bankers and the Chinese regime slightly nervous. After substantial cleaning there is still a big pile of bad assets amounting to 28% of all loans on the books. This figure was apparently reached using international accounting standards. The size is startling. “The figure was well above what many thought, and we are surprised,” says one analyst, who, like so many, did not want to be named for fear of upsetting any sensitive cheque-waving Chinese bankers which might be considering awarding his firm a mandate.
It’s little comfort that most analysts agree that Bank of China is one of the better banks in China and the best of the four state-owned banks. They also agree that Bank of China has had the advantage of dealing with shorter-term financing, trade finance and foreign exchange that meant NPLs were kept substantially lower than at other banks. The question then arises, if Bank of China’s NPLs are still so high, what is the position of the other banks?
Industrial Commercial Bank of China has 30,000 branches scattered liberally around China providing employment to about 500,000 people. It’s a big bank. But not only does it have a large presence, it has large problems. During the dark days of policy lending – we are told these are now behind us – ICBC was lumped with the responsibility of lending to state-owned enterprises in the industrial sectors. Unfortunately, these were not sectors famed for their profitability. As a result, its NPLs are at levels that very few seem willing to guess. “Because of the level of transparency it is very difficult to quantify the level of these assets,” says one banker based in Hong Kong.
ICBC however does at least claim to know the level. According to the bank’s numbers, which have been reached using China’s own accounting standards, they stand at 25.1%, with total loans outstanding at Rmb2.4 trillion. This figure contradicts those outside analysts who are willing to pick a number. Most estimate the figure is more likely to be in the region of 40% to 50%. One analyst however came out with a much higher number. He points out that the difference between Bank of China’s new NPL statistics, which were worked out in accordance with international methods, and the previous levels according to Chinese accounting, suggests a multiple of 2.6 times. Following this argument, ICBC’s NPLs would stand at a rather impressive 65%. It’s not a popular argument.
The big clean up goes on
In the run up to China’s eagerly anticipated entry into the WTO, and with the banking sector expected to be opened up to foreign competition in about five years, the Chinese realise that it is imperative that the NPL problem be sorted out. “The fact is that in five years these banks will want to be listed,” says HSBC’s Anna Borzi, analyst, financial services for Hong Kong and mainland China, “and all of these problems have to be taken from the balance sheet.”
“They are very serious about sorting out their problems,” says Shawn Xu, head of research for CICC in Beijing. Pressure is also coming from above. The People’s Bank of China has set targets for the banks to reduce their NPLs by 2-3% of total loans per year.
Whether working at that rate will allow the banks to clean their portfolios up to international standards remains to be seen.
In an attempt to show commitment to sorting out the problem Jiang Jianqing, ICBC’s chairman, is quoted in a recent interview as saying that ICBC will need at least Rmb100 billion to provide for the bank’s NPLs over the next five years. One analyst comments however that to reduce the levels to international standards in such a short time frame may be expecting too much. “Theoretically it is possible. In practice I think it is being a little bit ambitious,” he says.
A foreign banker based in Beijing also believes that the slate will take longer to wipe clean and questions the entire basis on which Chinese banks have added small incremental provisions for clearly bad loans. “How can they do it if the ministry of finance gives a mandatory maximum provisioning rate of 1% per year? A western bank provides as much as it has to. And if someone doesn’t pay, this will mean that it will eventually provide 100%. The Chinese banks do not have this choice. Even if it has been classified as an NPL for five years, a bad loan will only have 5% provisioning.” In their favour he points out: “But this is not the choice of the banks.” He believes that the banks themselves are finding the process frustrating. “They would like to be able to take a bigger hit. They may show a loss for a year or so but at least they can get rid of the problem. But that won’t happen. The ministry of finance is facing a catastrophically negative tax bill, and the banks’ profits provide much needed tax revenue.”
Lardy picks up on Jiang’s figure. He says: “Rmb100 billion is unrealistically low. The AMCs have already taken Rmb1.4 trillion, and Rmb400 billion was from ICBC. According to the Chinese central bank’s own numbers, NPLs at year end 2000 were 25%, down from 35% in 1999. On top of this the banks are continuing to generate new NPLs at an alarming rate. Unless there are commercial credit standards introduced very quickly and their tax burden is eased, they will never make it.”
UBS Warburg’s head of banking research for Hong Kong and China, Tracy Yu, doesn’t totally agree. She says that the NPLs that appeared between 1998 and 2000 were the result of certain state owned enterprises’ restructurings. “But,” she says, “when you look at more recent statistics 40% of new loans were mortgages where asset quality is much better. The banks are shifting their lending focus from corporates to personal lending. And since China now has a very robust A-share and B-share market, corporates can raise financing quite easily, where as before they relied on bank loans.”
Chinese banks are becoming more aggressive in their attempts to recover bad loans, which would add credence to Jiang’s figure. It’s essential that they do so, because it will affect attempts to raise necessary future capital. One analyst points out: “Bank of China’s NPLs stand at 2.2 times its equity. Now if the recovery rate is below 40% the bank has negative net worth. Would you like to buy a bond from this bank? And what rate of interest would you require before considering holding them?”
Banks may be tempted to go the route of China Construction Bank. CCB has decided to take China Everbright to court in an attempt to recover some money. “China Everbright acquired China Investment Bank in 1998, which was a policy-lending bank,” explains one banker. “And it owes China Construction Bank. It really isn’t Everbright’s fault, but it can be seen as a blatant attempt by China Construction Bank to put pressure on the ministry of finance to get them to give them some of their money back.” CCB’s legal action will be the first of many.
Once the NPLs have been taken off the banks’ balance sheets and placed into the AMCs, what next? The popular cliché used by most bankers is that all that is happening is the problem is being taken out of the left pocket and placed in the right pocket. The AMCs are now struggling to shift this mountain of distressed debt themselves.
Although a lot of theories have been aired about what the AMCs could do with these distressed assets, what has actually happened is virtually nothing. They have managed to sell only the very best of the bad, still leaving a further 95% to dispose of. New buyers have not come forth. “In practical terms the AMCs are exactly the right way to go, but they still have to sell the debt on,” says Borzi.
The discount shop
The AMCs, such as Hua-Rong Asset Management, which is responsible for ICBC’s loans, have no power when deciding to sell the debt. The loans were taken off the banks at par, even though it was known they were worth far less than this, and auctioning them off will mean acknowledging large losses. They will have to be sold at big discounts, some say as much as 90%. The buck stops with the government, but it’s not going to like what it sees or hears.
“The AMCs may have agreed to auction this debt at, for example, 30 cents on the dollar, but they still have to wait for the ministry of finance to agree, since it is the ministry of finance that is writing things off. And if investors only offer nominal prices, the government won’t accept them and it will be back to the drawing board. My feeling is that they don’t understand what they will get for these assets. But when they do, they will be very frightened,” reckons a Beijing banker.
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Yu explains that there are some fundamental differences between China’s AMCs and others set up around the region, such as in Korea. The first difference is that the assets were transferred at face value.
Second, out of the Rmb1.4 trillion debts transferred, about Rmb400 billion were debt-for-equity swaps. “The AMCs will actively manage the corporates or have a leverage to turn them around. After the corporates increase the money flow they will get the money back. But the recovery rate is only 32%, which is quite low compared to international standards,” she says. Korea’s AMC, KAMCO, achieved a recovery rate of 49%. “But,” adds Yu, “you need to take into account that a lot of the lending did not require collateral, which also explains why the recovery rate is lower.”
If the recovery rate is so low, how can the AMCs afford to service the Rmb800 billion bond that they issued to the banks? Hua-Rong Asset Management alone issued a 10-year Rmb313 billion bond to ICBC with an interest rate of 2.25%, but as yet has only managed to bundle up and sell Rmb300 million of the distressed assets.
Lardy doesn’t believe they can service the bonds. “The cash proceeds from the liquidations that they have done is not enough to cover that. Perhaps the banks are accruing the interest.” In other words, more bad assets.
Yu adds to this: “When the bond matures they will need to have recovered a sufficient amount. But at the end of the day, it’s the ministry of finance that might pick up the loss.”
The government may be moving its problems from pocket to pocket, but the question that remains unanswered is just how deep those pockets are.
