Friday, May 27, 2005

WSJ : China's Game of Musical Chairs

By TED OSBORN [Mr. Osborn is a partner at PricewaterhouseCoopers Hong Kong/China specializing in NPLs.]

May 27, 2005

Today's non-performing loan market in China sometimes looks like a merry-go-round. With much fanfare, a state-owned company recently held an auction that ended up with the NPLs being sold to a sister company.

It was first of two auctions by Cinda AMC, one of China's four asset management companies charged with disposing of the country's $300 billion plus of non-performing loans, to sell off two batches of prime NPLs it acquired from Bank of China in 2004. Cinda stated that it was appointing foreign financial and legal advisers to oversee the sale of a $845 million pool of NPLs in Qingdao, followed by a second auction involving a $615 million pool of NPLs in Tianjin, both of which would target the international investment community. Starved for deal flow, international investors readily ponied up the stiff $40,000 registration fee for the Qingdao auction.

But then it emerged that Great Wall AMC, a sister AMC to Cinda had registered as a bidder. That provoked an immediate outcry from the international investment community, who argued that AMCs are supposed to be disposing of NPLs, rather than acquiring them on the open market. When Cinda did not back down, several experienced foreign investors including Morgan Stanley decided to skip the auction altogether. Why spend all that time and money on due diligence when a state owned AMC was bidding -- an entity with no real investment return targets who could therefore bid whatever they liked? And finally came the outcome they most feared: on May 10 Great Wall was quietly announced as the auction's main winner.

From Cinda's perspective the auction was a success. After all, they reportedly bought the loans in question for 31 cents and then successfully sold them for 42 cents -- a tidy profit of $93 million they can crow about to their supervisory body. As long as Great Wall manages to collect more than they paid -- and doesn't resell the NPLs to another AMC -- then Cinda's profit will be real and the loans will have been dealt with.

But the foreign investment community views the Cinda Qingdao NPL auction as nothing more than musical chairs involving loans. Instead of selling to a genuine third party investor who would not only cough up real cash for the loans but also actually do something about resolving them, Cinda instead chose to pass the loans from the government's left hand to its right, accomplishing nothing in the process. The problem with this, they say, is that by selling to Great Wall the buck hasn't stopped as it would have if they had been sold to genuine third party investors. And if such sales continue it is not clear it ever will.

The real shame is that by allowing Great Wall the opportunity to bid in the first place Cinda has shot itself in the foot with the very investors it was hoping to cultivate for future auctions, including its Tianjin auction scheduled for June 15, which is now off to a rocky start after both Great Wall and China Orient AMC have been reported to have registered as bidders. With foreign investors now complaining to Beijing and threatening to stay out of the game until the playing field gets level, Cinda is reportedly rethinking its approach for future auctions.

But can Cinda really be faulted for allowing the AMCs as bidders? As the AMCs have it in their mandates that they can acquire NPLs on the open market, what is the problem with their selling to other AMCs? As long as they pay up -- and take the NPLs off the merry-go-round -- absolutely nothing. Should Cinda really be concerned with the perceived investment targets of its bidders? Or simply getting the highest absolute price?

From a seller's perspective, in order to maximize the value from the sale of a portfolio of NPLs, they need only follow the tried and true formula: Drive-up market participation, provide bidders with quality information and a fair and transparent process, assemble portfolios of assets that appeal to the bidders and voila -- competition and high bids. Other than driving-up market participation Cinda has followed this approach and they got their high bid.
But from a broader perspective, the question is whether in the long run China's AMCs can afford to drive away international investors by selling to each other.

The merry-go-round cannot continue forever. And when it stops, will anyone be on it?


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