Closer Look: How Best to Manage the Rise of Bad Loans

08.12.2013 16:44

Closer Look: How Best to Manage the Rise of Bad Loans

Creating a market-driven method for dealing with certain debts will mean building the necessary infrastructure and letting investors judge risk

By staff reporter Li Tao

The top three regions where banks’ bad loans increased the fastest in the first half of the year are all in the Yangtze River Delta. This is primarily because of the economic slowdown and excess output capacity in the steel trading, solar energy and shipbuilding industries. To a certain extent, it is good that the risks have been exposed because it implies that we did not choose to continue covering them up by exacerbating oversupply and taking on new debts to repay old ones. The three regions, Shanghai and the provinces of Jiangsu and Zhejiang, are among the most market-oriented areas in the country. Their disposal of non-performing loans should thus be handled in a more market-driven manner.In doing so, they will pave the way for the banking industry nationwide to resolve the hidden risk posed by loans to real estate companies and local government financing platforms.

There has been some exploration of disposing of bad loans in a market-oriented way. As early as 1999, against the background of the Asian Financial Crisis, the government set up four asset-management companies (AMCs) to take over some of the bad loans from the Big Four state-owned banks.

At first, it was strictly administrative order: toxic assets were transferred at face value from the banks to the AMCs. Then market forces came into play, and another batch of non-performing assets was sold through auctions at a 50 percent discount to the AMCs.

Later, the Bank of China and China Construction Bank sold 149.8 and 128.9 billion yuan, respectively, worth of loans categorized as possible losses to the AMCs. The transactions were conducted in a market-driven way.

Non-performing loan disposal methods include the following: liquidation, selling collateral, write-offs, rollovers, converting debt to equity holdings, selling the debt, securitization, payment in goods, debt restructuring and packaging.

Take debt restructuring for example. Suppose a company cannot pay back the 15 million yuan it owes a bank. An AMC can take over the loan from the bank at a discount, say 12 million yuan, and then extend the repayment deadline.

In the case of liquidation, the company goes bankrupt, and the AMC, as a creditor, lays claim to its assets. These are liquidated to raise money for debt repayment.

The AMC can also choose to convert its creditor’s rights into equity shares in the borrowing company or sell its holdings of non-performing assets to other institutions.

There are a number of ways to dispose of non-performing assets in a market-driven manner. All of them, however, have a long way to go before reaching maturity. The reason boils down to a lack of internal incentive mechanism and a favorable external environment.

From the perspective of banks, adjusting the classification of loans and releasing bad debt requires senior executives to adapt their management styles to changing circumstances. Without major staff changes, branch banks will not have the incentive to identify and tackle bad loans, if the headquarters do not encourage them.

Based on the experience of developed markets, the disposal of non-performing loans requires a comprehensive system that includes a primary market, a secondary market, first-tier wholesale dealers, second-tier distributors and numerous investors.

China does not have a mature primary or a secondary market for the wholesale and trading of non-performing assets. Apart from the big four AMCs, there are few participants in the primary market. The arrangement has many disadvantages.

By contrast, the interbank market is relatively developed. The efficiency of bad loan disposal can be improved if it is carried out in the interbank market. The doubt here is whether this can diversify risk, given the dominance of banking institutions in the interbank market.

To improve the transparency of the interbank bond market, the central bank is combing through every stage of transactions in the market and rewriting rules for some of them.

With better market infrastructure, in the future, the underlying assets of asset-securitization plans can be extended from low-liquidity assets to non-performing loans. As long as the information about the products is clear and readily available, investors should be allowed to judge risk by themselves.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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