PwC The Second Forum for Asian Insolvency Reform (FAIR) Bangkok, Thailand December 2002 AMCs and NPL activity in China Michael Harris

PwC Restructuring the Chinese banks: NPLs and AMCs D

PricewaterhouseCoopersBackground  Big four commercial banks – Bank of China – Agricultural Bank of China – Industrial and Commercial Bank of China – China Construction Bank  Spun-off from PBOC in 1980s  Owned by Ministry Of Finance  Policy Banks  E.g., China Development Bank  Others  Second Tier Institutions; Rural Cooperatives D

PricewaterhouseCoopers Background (cont’d)  Problems faced by “Big 4” Commercial Banks –Overstaffed –Undercapitalised –Historically, no competition to drive best practices –Lending at direction of state based on political/social considerations –“Success” measured, in part, by loan volumes

PricewaterhouseCoopers Estimated NPLs in China Standard and Poor’s US$680bn US$218bnChinese government Real number ???

PricewaterhouseCoopers The restructuring  PBOC funds AMCs in return for AMC debt Ministry of Finance AMCsBig 4 PBOC $ NPLs at face $“IOU” NPLs$ An intra-State money-go-round  AMCs pay cash for NPLs at face  AMCs to work-out the NPLs  PBOC bears the haircut  Big 4 get PBOC backed notes for NPLs at face

PricewaterhouseCoopers The AMCs Source bank Bank of China ICBC China Construction Agricultural Bank AMC China Orient Huarong Cinda Great Wall NPLs US$bn Loans categorised broadly by industry type 171.4

PricewaterhouseCoopers Functions of AMCs  Preserve assets, reduce losses  Debt/Equity Swaps  Sale of Collateral  Consultancy  Portfolio Sales  Investment Banking

PricewaterhouseCoopers Barriers to recoveries  Estimates of overall recoveries vary  Consensus is less than 20% of face  Barriers to recovery include –Inherent weaknesses in the loan portfolio, in part due to: –Age of loans transferred to AMCs »Mandated by Government –Inadequate legal framework –E.g., Bankruptcy Law provisions –Resistance to reform –Debtor expectations –Local politics –Foreign investor publicity M

PricewaterhouseCoopers AMC reported recoveries Ministry of Finance target of 30% cash recovery rate Cumulative reported cash recovery rate is 21.6% Small proportion of loans “dealt with” Early recoveries relatively high – “low hanging fruit?” Situation unlikely to improve over time Total NPLs US$171.4bn 2 Loans dealt with in 2001 US$9.4bn, of which US$3.2bn realized in cash 1.6% cash recovery to date M/T

PricewaterhouseCoopers Foreign investment solutions Changes to laws to allow foreign investment Considerable interest, but treading carefully Recoveries expected to be low, therefore investment prices are lower Common structural aspects  Ownership  Control  Servicing  Upside

PricewaterhouseCoopers Issues for foreign investor participation  Remittance  Information  Expectation gap –Pricing  Language –Everything is in Chinese ! T

PricewaterhouseCoopers Foreign investor deals “completed” so far Huarong AMC  Foreign investor roadshow – July, 2001  Deal announced – November, 2001  Final approvals received – December, 2002 China Orient  US$217m portfolio  All approvals in place  Cash changed hands  Recoveries now being remitted overseas

PricewaterhouseCoopers Foreign investor deals “completed” so far Cinda AMC –Cash changed hands –Small portfolio –Still waiting on certain approvals Great Wall AMC –Winning Bidder chosen –Documentation ongoing –Final approvals being pursued

PricewaterhouseCoopers Issues Impacting Portfolio & NPL Pricing & Resolution Historical Collection Rate (BIS Position Paper) Approval Process “Headline Targets”& Minimum Reserve Valuation guidelines & procedures Valuation of borrowing entity v. Valuation of NPL Hidden Costs Land Use Rights Registration Fees Social Welfare costs Construction completion costs

PricewaterhouseCoopers Issues Impacting Portfolio & NPL Pricing & Resolution Marketability of Debt/Equity Swap Positions Board Representation Accountability Dividend reliance Discounted Pay-off (DPO) application & liquidity considerations Competition from other sources Domestic (e.g., China Construction Bank / Morgan Stanley discussions; ICBC auction of Selected “Settled Assets” External e.g., Taiwan

PricewaterhouseCoopers Possible Future Considerations Re-assessment of bond obligations & impact To capital structure Continued adoption of Int’l guidelines For Loan Loss Reserve Analysis Limited capital chasing deals Other approaches E.g., Securitisations Clearer picture – post Party and Peoples Congresses