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Weekly UpdatesThe issues listed above must all be resolved if China is going to realize higher prices on the sale of the NPLs to foreign investors. In addition to these issues, bidders must rely on local partners for information. The collection of reliable and detailed information is difficult, because contact with borrowers and guarantors is prohibited and public sources of information are not readily available.
The legislation that will allow the market in China to develop as rapidly as they desire is just now being passed. The State Council is working on a variety of regulations that will encourage foreign investments in China. While bankruptcy and foreclosure laws to enforce creditor rights have been established, Westerners have yet to experience whether or not local courts will enforce the laws. Critical regulations with respect to repatriation of foreign capital and setting up foreign investment enterprises to work on NPLs through joint ventures with the AMCs had just been passed at the end of 2002.
The explanation for the system's slowness to change lies in the fact that the government is both a debtor (in its capacity as the owner of SOEs) and a creditor (in its capacity as the owner of state banks). Its ambiguous financial position has created a plethora of conflicting economic incentives.
Furthermore, because of the social and political disruption that would result from "overly aggressive" restructuring and the liquidation of moribund SOEs, it is hard to get AMCs to accept significant discounts on the book values of their NPLs, although there are signs this is changing.
At the present time, there is active disagreement in the Chinese government and in the academic community over the speed and methods needed to resolve China's NPLs. Some argue that since the resolution of NPLs is associated with the stability of SOEs and employment rates, the government and its regulators should be wary of opening conduits for private sector investors, either domestic or foreign. On the other hand, this apparent failure to address China's NPLs may well result in a financial crisis that could lead even the "big four" to bankruptcy.
SUMMARY AND CONCLUSION
China is pursuing a course to resolve its NFL problem that follows closely out of the United States' experience with the Resolution Trust Corporation. They have established four AMCs, which have similar powers arid responsibilities to the RTC. The AMCs are in the midst of overcoming a number hurdles to bring in foreign investment to purchase some of the NFL portfolios. The auction by China Huarong AMC has brought these efforts to a head, since many of them must be resolved in order to close the first sale to the Morgan Stanley consortium.
Table 2 summarizes the fifteen factors discussed above that affect investors' perceptions about the Chinese NFL market.
Of the three broad areas above, the legal environment is the most developed. Laws with respect to seizing property, getting control of collateral, and realizing value for creditors through foreclosure and bankruptcy appear to be in place to support a favorable resolution of NPLs. On the surface, the system supports orderly transfer of assets and has been used by the four AMCs to resolve a number of NPLs already. The leadership at the national level has demonstrated a strong commitment politically, but there is still considerable uncertainty about reactions at the local level. In addition, the strong commitment of the new national leadership to address with the hard issues surrounding NFL resolution especially with respect to closing down factories and job losses has yet to be confirmed.
It is in the third area, execution, that investors face the greatest uncertainty. The government has been moving forward to resolve key issues with respect to repatriation of capital and tax rates for foreign buyers. Other issues depend more on what happens at the local level or on property-level negotiations such as laid-off employee liability. While these areas would benefit from strong national direction, only experience in resolving actual loans is likely to reduce investor uncertainty.
It is revealing in that more than half of the above factors are a source of considerable uncertainty for investors. If the experience of the early foreign buyers of NPLs is positive, then many of the uncertainties in Table 2 will be quickly reduced. The long list, however, helps to explain why it has taken over one year to close the first auction sale by China Huarong to the Morgan Stanley consortium. As China Huarong's president, Yang Kaisheng has emphasized, however, the situation has not been static. In fact, over the past year they have been extremely active in addressing the fundamental issues that must be resolved before significant foreign investment will occur.
The success of the RTC in the United States hinged primarily on the speed with which NFL assets were brought to market and securitized. Investors responded creatively to the opportunity, and prices, which were initially low, rose quickly, thereby reducing the losses to the government. The Chinese government has attempted to apply the lessons of the RTC by creating the AMCs to speed the loan resolution process, and by encouraging foreign investors to buy the NFL portfolios. Whether or not prices in China will rise rapidly as they did in the United States depends on whether foreign investors are able to get control of NFL assets quickly and to realize higher recovery values than they currently project from the real estate assets and other collateral of the state-owned enterprises.
Acknowledgements
We would like to acknowledge the significant participation in developing this paper by George von Liphart. Managing Director of Lehman Brothers, Tokyo, Japan in the Global Commercial Real Estate Group. Jack Rodman, Managing Director, and Chris Seyfarth, Partner, of Ernst & Young, and Dr. Yang Kaisheng, President of China Huarong Asset Management Corporation, also provided critical input and advice on many aspects of the transactions described herein.
Endnotes
(1.) It should be noted that any losses associated with the NPLs were deferred when the government issued 10-year bonds to enable the AMCs to buy the assets from the Big Four state-owned banks. The losses will be recognized only when the bonds are retired and there is insufficient capital from the NFL resolution to pay off the bonds. Presumably the difference will be made up by the government.
(2.) William Overholt, speaking at a forum on Asian Financial Restructuring (Harvard Kennedy School of Government, December 13-15, 2002), stated that among Asian countries, only China acted before the crisis hit. "The system had a strong leader who could rally the nation and get acceptance of difficult measures."
(3.) In cases where loans are not registered, then lien priorities are determined by the order in which loan documents were signed and dated.
(4.) This conversion fee is in essence the state's payment for selling the leasehold right to develop or use property to the tenant.
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Richard Peiser *
Bing Wang **
* Michael D. Spear Professor of Real Estate Development, Harvard Design School or rpeiser@gsd.harvard.edu.
** Harvard Design School
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