Drive to sell China's bad debt abroad

Jack Rodman, a partner at Ernst & Young's Asia-Pacific unit, has spent four years pushing China to sell its US$438 billion ($617 billion) in bad bank loans to overseas investors.

His result: One US$1.3 billion sale agreed, approved and completed.

Just 6 per cent of US$71 billion in debt settled since 1999 will go to buyers such as Citigroup, Morgan Stanley and Deutsche Bank.

More than two-thirds of that is still awaiting approval by Government agencies. International banks are missing out on a potential US$40 billion in purchases that could generate as much as US$8 billion in profit.

"Foreigners are losing hope," says Rodman, who advises China's debt sellers and Beijing banks.

Buyers are not seeing the deals that helped Japan's banks clear US$600 billion of debt in seven years.

"China does not have the gumption to resolve five decades of misguided state lending," says Tim Clissold, a banking adviser in Beijing.

"This is an incredibly sensitive political issue, involving the write-off of billions of dollars in state-owned assets.

"There's no political will to streamline the process and make it more transparent to push these things through."

About three-quarters of the US$71 billion resolved so far has been settled with borrowers, mainly state-owned companies, accounting firm Ernst & Young estimates.

Since September, China's four asset managers have sold US$22 billion of bad debt to each other or to related companies.

The US$1.3 billion overseas sale took 18 months to run the gamut of approvals. The November 2001 auction, won by a Morgan Stanley-led investor group, was China's first international sale. Another US$572 million had been sold and transferred as of December.

Japanese banks also were reluctant at first to sell distressed assets, especially to outsiders, Rodman said. That changed in 2002, when Japan's banking regulator ordered lenders with the world's largest non-performing debt pile to halve bad loan ratios by March 2005.

"What China needs is for someone to take a hard line," he said. At stake for China is the ability of its four largest banks to flourish after 2007 when international banks will be able to trade anywhere under a World Trade Organisation deal.

Standard & Poor's estimates it will take US$600 billion to clear state-run banks of loans in arrears. The Beijing-based China Banking Regulatory Commission said overdue loans rose 2.2 per cent to US$205 billion in the quarter ended September 30 - on top of US$233 billion stripped from the four largest banks since 1999.

Dallas-based Lone Star Funds did not wait around. The private-equity firm shut its Beijing office in September, having failed to land a deal for two years.

"The lack of deal flow in China and substantial flow in the rest of the world meant it didn't make sense for us to keep our office," said president Jay McLennan.

Many firms, such as Morgan Stanley and Ernst & Young, have cut their workforce too.

The message may be getting through. China's National Development and Reform Commission last month set new rules that require the four asset-management companies to specify the amount of bad loans they plan to sell next year.

The new rules also enforce a 40-day approval process, which previously involved sign-offs from the central bank, several ministries and several more commissions.

China's National Audit Office is to review spending and sales by the four asset companies.

- BLOOMBERG