Which Chinese NPL deals have you been involved in?
Chao: We first worked on the Huarong deal, which was the first and largest auction deal in which Morgan Stanley's consortium took the lion's share of NPLs. We closed that deal earlier this year. Then last week Morgan Stanley also signed the China Construction Bank deal, which we helped them with. It is also a landmark as it the first definitively signed NPL agreement between a foreign investor and a Chinese bank.
Has this been approved by the State Council yet?
No. This is just the signing. It still has to go through the approval process.
Will the process be as drawn out as it was for the Huarong deal?
I doubt it. I think the approvals in this area ought to be getting easier and easier over time as they become more routine and common. People in the government will be more comfortable with how they are structured and hence will approve them more easily.
But will the asset management companies (AMCs) be happy with this? It looks like they are now being by-passed by the international investors and that there has been a shift in policy in dealing with the NPL problem.
When the NPLs were transferred to the AMCs in 1999, only a minority of them were transferred; a large portion were not transferred. In fact more bad loans were kept in the banks than were transferred. So the banks still have a large amount of NPLs on their own balance sheets and they need to resolve them.
A normal way for the banks to resolve NPLs is to sell them. Unless there is going to be another large-scale transfer of NPLs to the AMCs from the banks - and I have not heard that this is going to happen - then the banks need to sell their own NPLs. The AMCs are still in business and have a lot of NPLs to dispose of. But the banks have more than the AMCs and need to undertake their own sales.
But does that not make a mockery of the AMC situation, having both sales processes working in tandem with each other?
The AMCs have their assignment to dispose of close to $200 billion of NPLs. And they are still working on it. They were never promised to get any more from the banks. They still have a lot of work to do.
So why are the banks making it more difficult for them by embarking on their own NPL disposal programmes, in competition with their AMC subsidiaries?
I would not put it that way. I think it is completely to be expected that the banks would want to further resolve the NPLs on their balance sheet. It would no make sense for the banks to sit on their NPLs and not sell them, just because the AMCs still have NPLs.
Is it fair to call the overall NPL disposal programme a disguised form of privatization of state owned assets?
Not really. Normally, privatizations see the transfer of equity ownership of a state owned company to private hands. That is not happening here. Selling NPLs is the transfer of debt, not equity. And most of the debt that is sold will not be converted into equity.
How will it be resolved then?
I think most of the debt will be resolved through compromise, foreclosure, enforcement and settlement. People are going to pay cash. They won't pay 100 cents on the dollar, but the vast majority will be resolved through cash settlement.
What sort of rates of recovery are you expecting?
The answer to that will only be known in the future. The investors have only just bought the assets; they haven't resolved them yet.
Politically it must be quite difficult for the investors. It does not look very good to be buying NPLs for cents on the dollar, foreclosing on a load of state owned assets and then walking away with a 100% profit margin. In China there are huge sensitivities to the selling of national assets anyway and so this must be very difficult from a PR point of view.
That issue is helped by the fact that the foreigners are paying cash up front to the sellers so the sellers are getting a guaranteed amount. The investors are taking the risk of getting less than what they paid. Who knows what they will eventually get? Also the Chinese sellers are becoming joint venture partners with the foreign investors and so they are getting a cut of the upside. It is not all going to the foreigners.
What will the future sales look like?
The big four AMCs and banks will all continue trying to sell to foreigners as well as to domestic investors, as well as resolving them on their own. They have many alternatives available to them. All of these things are on going at the same time and every AMC and bank will have slightly different strategies for which approach they want to emphasise.
What do you as a law firm bring to the table with these deals?
We have done more NPL deals than any international law firm in China. We have seen how the process works and we know what the pitfalls are. There are a lot of special rules and issues that exist, with which we are quite familiar. We also know the international practices and we represent international investors who have a need for local advice and international standard documentation, structures and methodology.
Why do you think the primary sale process has been so far dominated by investment banks rather than dedicated NPL buyout funds?
Partly it's because they are the biggest gorillas on the block. They have the resources to break the path in this market. Others are waiting for this market to be made before they join in.
Is it also a situation, which is often found in China, that connections are as important as cash or technology when it comes to doing deals and that these banks have the connections to help resolve these NPLs?
In any major transaction in China, relationships with government are important. It is not the only issue but it is important and helps the bigger players such as Goldman Sachs or Morgan Stanley.
