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  1. 1. Session 5: The Use of Special Purpose Vehicles Yang Kaiseng World Bank conference on Corporate Restructuring: International Best Practices March 22-24, 2004 Washington, DC For more information, see:
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  3. 3. Good morning, Ladies and Gentlemen, First, I would like to thank the World Bank for inviting me to speak at this important conference. As the only representative from China, I’m proud to update all of you about China’s financial reforms and more specifically, to share with you the asset resolution strategies that China Huarong Asset Management Company has successfully employed in resolving its non-performing loans over the last three years. China is in the process of developing a more efficient banking and financial system to prepare Chinese banks to compete with international banks when full WTO integration is accomplished in 2007. China’s bank reform measures include active reduction of non-performing loans, cleaning up balance sheets, strengthening credit underwriting and moving towards international accounting standards. Additionally, China’s banks are installing new Internal Rating Based (IRB) credit analyses and lending policies that are more aligned with international Practices which include stricter lending guidelines and stronger corporate governance. Although the full implementation of these will take time and fine-tuning, China’s success has been measurable. At the end of 2003, the four State Owned Commercial Banks (SOCBs) reduced their NPL ratios from 26.1% in 2002 to 20.4% in 2003. Clearly, the banks are ‘on-target’ to achieve the Central Bank’s and CBRC’s mandate on NPLs reduction. Many of you are aware, at the end of 2003, China announced that it would inject US$45 billion of its foreign exchange reserves into two of China’s four largest banks. The government’s goal under this pilot program is to convert both the Bank of China and China Construction Bank into joint-stock banks. Each received a US$22.5 billion capital injection to prepare for initial public offerings scheduled in the following 2 years. This is just one of the many methods China is using to accelerate financial reforms, reduce NPL ratios and prepare for Initial Public Offerings to bolster capital ratios so as to better compete with foreign banks. In April 2003, the State Council created the China Banking and Regulatory Commission (CBRC) in order to separate the regulation of banks and routine management reviews from the Central Bank. This governing body is already making positive changes. In December 2003, it announced that single foreign banks may have up to a 20% strategic interest in a Chinese bank. It announced that in 2004 all
  4. 4. commercial banks in China are required to use a new five-category loan classification system which is based on a stricter, internationally accepted standards. These examples are just a few of the most recent initiatives taken by the Chinese government to accelerate and strengthen financial system reform. The Asset Management Companies (AMCs) In 1999, the four largest Chinese banks transferred US$170 billion in non-performing assets to four Asset Management Companies or AMCs. Since that time, these four AMCs have been very successful in resolving China’s non-performing loans. At the end of 2003, the AMCs had resolved 41.39% of their NPLs by recovering on-average 19.52% cash of book value. This graph shows the annual amount of NPLs at the four AMCs. As you will see in later slides, Huarong is among the top performing AMCs. Huarong is the largest of the four AMCs and I would like to spend my remaining time discussing the various approaches that we have developed to collect and resolve NPLs in China. But first, I would like to provide you with some background about Huarong so you can better understand our Company, its business plan and our accomplishments to- date: Established in late 1999, Huarong acquired over US$50 billion of non- performing loans from the Industrial and Commercial Bank of China. Our daily tasks are closely tied to the purchase, management, and disposal of our non-performing assets. Our primary goal is to maximize the recovery. In order to quickly implement their business plans, the Ministry of Finance injected each AMC with paid-in capital totaling US$1.2 billion. The head office of Huarong is in Beijing and we have 30 branch offices throughout China as shown by this slide. Asset resolution and collections are the core business drivers of an asset management company. Huarong’s special legal status and broad business scope has enabled us to use various resolution strategies and collection techniques. The different resolution strategies we utilize through our day-to-day operations include: • Revised repayment plans with borrowers,
  5. 5. • Discounted borrower payoffs, • Debt-to-equity swaps, • Collateral sales, • Litigation, and; • Selling NPL assets to third party investors (either as single asset or portfolio sales). Over the past four years, we have resolved more than US$16.6 billion in NPLs. From this next slide you can see our average asset recovery rate is 32.24% and our cash recovery rate is approximately 21.5%. And here are total resolutions presented by resolution strategy type. As you can see, the most common Huarong resolution strategy is discounted pay-off with borrowers. The ability to forgive partial debt is a major legal advantage AMCs have over the State-Owned Commercial Banks. The law gives the AMCs special legal powers to resolve assets at less than their book value. Presently, SOCBs are prohibited from granting debt forgiveness to borrowers to prevent moral hazards. Huarong has four key principles in managing our asset resolutions: 1) Remain Fair, Open, and Transparent: These are the basic requirements of a market economy. We adhere to this principle in order to justify our efforts to explain our market-based results, and to remain an impartial debt collector. 2) Utilize Competition to Optimize Recovery: Through competition and comparison, Huarong can maximize the market pricing of its NPLs. We stimulate competition during our NPL sales by bringing more NPL Investors to the market. We are able to optimize the recovery price of these assets by comparing historical internal recovery rates with competitive bids and various Joint Venture deal structures to negotiate higher prices with investors. 3) Manage with Checks and Balances: To avoid technical and moral hazards,
  6. 6. Huarong has standardized asset resolution procedures which fit within the framework of government rules and regulations. For example, we have two separate committees for managing NPL assets. One committee is responsible for asset evaluation and pricing, while a separate committee is responsible for final approval of the asset resolution strategy. In our company, all asset resolutions must follow established approval procedures which are guided by collective decision-making and authorization as shown in this slide. 4) Find balance between high recovery and fast resolution: The four AMCs have more than US$100 billion NPLs which will be resolved. They all vary by industry type, location, operating status, and existence of pledged collateral. The true value of each asset is linked to a variety of factors such as quality, timing, market conditions, and legal issues. In Huarong’s resolution practice, we quickly assess the different factors that influence asset value. For example, for assets that are likely to depreciate in value, we will take measures to collect them as quickly as possible. But, for assets that have future market potential, we resolve them when a reasonable market value can be achieved. While the four principles guide our resolution activities, we also realize that our operational strategy is closely tied to China’s current NPL market trends and government policies. Since the loans transferred to us from ICBC were all underwritten years ago and most of the borrowers have already defaulted, a longer holding period usually results in poor asset quality and lower recoverability. In order to increase the speed of asset resolution, we embraced a strategy of bulk sale transactions beginning in 2001. Here you can see the big transactions we have had over the past three years. I’m honored to say that Huarong was the first AMC in China to sell a large NPL portfolio to foreign investors. In that transaction, we auctioned an NPL portfolio of US $ 1.5 billion to two groups of international investors: a Morgan Stanley led consortium and Goldman Sachs. More importantly, we managed to resolve the regulatory and policy issues allowing foreign investors to participate in China’s non-performing loan market. Although this transaction took place in 2001, it is still worth mentioning because it was a pioneering effort in China’s financial reform. With the momentum from this first international auction, we launched our second international auction in December 2003. We brought to market an NPL portfolio totaling US$3 billion comprised of over 1,900 borrowers in China. We structured these assets into 22 investment units based on geographic location to appeal to both international and domestic investors. 19 international and domestic investors registered to bid in this transaction. To date, we have negotiated a Memorandum of Understanding on more than half of the 22 units with several international and domestic investors. Now we are finalizing the contracts with the winning investors and our financial adviser, Ernst & Young.
  7. 7. In the first half of 2003, we piloted a “Quasi-NPL Securitization Program” for NPL portfolio with a face value of US$ 1.3 billion (OPB). Under the structure, Huarong cooperates with a trust company using an “Asset Trust” relationship. With the help of a third-party appraiser and a rating firm the assets are evaluated. Then the assets are stratified into two classes --- “preferred” and “subordinated” based on the level of expected future cash flows. Finally through the trust company the interest in the preferred class is transferred to investors. It is not a “true” securitization because China still faces numerous implementation problems including legal, accounting, and supervisory obstacles which limit bona fide securitizations, but it has been rewarding to push the securitization concept and creatively manage a transaction within the existing legal framework. Huarong continues to explore the creative aspects of resolution strategies and methodologies for the sole purpose of maximizing NPL recoveries on a time efficient basis. I am confident that Huarong will be well prepared for the influx of foreign competition in the financial sector by 2007. Huarong’s many successes have inspired confidence that China can overcome its NPL problems. Chinese banks are better positioned to face international competition through reform- minded thinking and creative strategies. Chinese banks, with the support of the CBRC, have already begun the daunting task of developing a more efficient and competitive financial system. I hope that my presentation has increased your awareness of China’s reform efforts and progress in reducing non-performing assets. I want to encourage you to seriously consider investing in China, the fastest growing economy in the world. THANK YOU!!