Foreign Investors Stand to Benefit from China’s Crackdown on Bad Debt of Banks

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Ted Osborn, partner at PwC China, says that Beijing’s crackdown on bank’s concealing non-performing loans will result in the sale of more bad debts to foreign investors via asset management firms.

Writing for the¬†South China Morning Post¬†Osborn points out that Beijing has nearly two decades of experience in the purchase and sale of non-performing loans as part of efforts to restructure China’s bank-dominanted finance sector.

China established four state-backed asset management companies in 1999, to relieve the big four Chinese banks of NPL’s by buying up their bad debt and selling it off to investors.

The first cycle of bad debt disposal during the opening decade of the 21st century proved a resounding success, achieving the recapitalisation and listing of China’s banks as well as selling billions of dollars in bad debt to foreign investors via asset management firms.

China kicked off a second cycle of NPL disposal in 2015, in order to dispose of the mountain of bad debt accumulated by lenders in the wake of the Great Financial Crisis and Beijing’s credit-fuelled economic stimulus plan.

According to Osborn sales to investors have thus far been limited, however, because banks have become “creative in how they deal with their NPL’s, leading to fewer sales to the asset management companies than expected.”

Chinese banks are highly reluctant to reveal their NPL’s by selling them off, as China’s financial regulatory system incentivises lenders to report steady profits and low levels of bad debt.

“Banks [take] extreme measures to hide or disguise their NPL’s, through such measures as repurchase agreements and sales to related parties at par,” writes Osborn.

In Osborn’s opinion this is the chief reason behind the massive disparity in reported NPL ratios for Chinese banks – which currently stand at around 1.7% of total loans, and outside estimates such as the figure of 20% provided by Fitch, which points to total NPL’s of around 19 trillion yuan (approx. USD$3 trillion) in the banking system.

On the other side of the NPL-disposal equation are the big four asset management companies such as Huarong and Cinda, which have expanded into a broader range of operations in the nearly two decades since their establishment, encompassing brokerages, leasing companies, as well as banks of their own.

The NPL business has become a less prominent mainstay of these asset management companies, who instead use them to dodge regulatory requirements and create potential problems for the Chinese finance sector.

Osborn cites the example of Beijing’s efforts to curb lending by the big four bank to the property sector in order to cool down real estate prices.

Asset management companies capitalised upon the ensuing scarcity of credit to entice property developers to purchase NPL’s from them at par, in return for the provision of low-interest rate loans.

While the asset management companies reaped huge profits from the sale of NPL’s, developers could access cheaper loans to fuel highly lucrative property development projects.

Beijing is cracking down on the concealing of NPL’s by banks, however, with the now-defunct China Banking Regulatory Commission declaring in January that it had rooted out 60,000 individual cases of malfeasance by lenders.

Osborn expects this crackdown to come as a major boon for both asset management companies and foreign investors.

“While figures have yet to be released, I expect to see a significant pickup in the volume of portfolios being sold by banks in 2017…this trend will continue into 2018 and beyond,” writes Osborn. “The flow of NPL’s into the market should pick up considerably in the next two to three years, providing ample opportunity for new investors.”

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