The Operations of the Asset Management Companies

The first AMC, China Cinda, was charged with purchasing CCB’s bad loans and initially took in RMB 250 billion in NPLs in April 1999. The other three AMCs, China Orient, China Great Wall, and China Huarong, were established in October 1999 to manage the NPLs of BOC, ABC, and ICBC, respectively.

Each of the AMCs was granted RMB 10 billion in assets from the Ministry of Finance to run its operations and commercial banks were targeted to aid in funding. Ultimately the Ministry of Finance was to be responsible for their losses but the AMCs were monitored by the People’s Bank prior to the 2003 establishment of the CBRC. AMC operations were restricted to more recent loans. No loans extended prior to 1996 were transferable because banks were not officially held responsible for their own profits and losses until the passage of the Commercial Banking Law of 1995.

In all, the AMCs began with RMB 1.4 trillion in NPLs to work out, equiv­alent to approximately 8% of China’s GDP. They paid for these NPLs with a 2.25% ten-year bond for 83% of the total, paying cash for the remaining 17% (Garcia-Herrero, Gavila, and Santabarbara, 2006, p. 315). This arrangement had the effect of adding an interest-paying asset plus substantial cash to the SOCBs’ balance sheets at the face value of the transfer.^[115] However, the actual effectiveness of AMC operations remains somewhat unclear. In 1999, for example, the AMCs took over $US 160 billion in debt but resolved only 15% of this total. Moreover, embezzlement and accounting malpractices, both within the state enterprises and the state banks that provided them with loans, compounded the scale of the problem. The initial rate of return from AMC operations was confined to between 15% and 25% and the over­all cash recovery ratio remained around 20% into 2006 according to CBRC reports (http://www.cbrc.gov.cn). Actual rates have varied greatly across the different AMCs, with Cinda AMC consistently achieving the highest recov­ery rates (31.56% in first quarter 2006) and Great Wall AMC consistently doing much worse than the others (10.28% in first quarter 2006).^[116] Whereas Cinda was initially linked to CCB, Great Wall apparently continued to suffer from its ties to ABC, by far the weakest of the SOCBs.

Needless to say, these recovery rates imply that the AMCs have been operating with substantial losses, given that they purchased the NPLs from the SOCBs at no less than 50% of face value. This situation leaves the AMCs exposed to large accounting losses and Huarong AMC Vice President Ding Zhongchi explicitly called “on the government to provide financial help to cover the losses arising from the disposal ofNPLs” (Guerrera and McGregor, 2005, p. 19).^[117] The AMCs may well need a government bailout themselves to pay the principal on the bonds issued to the SOCBs in return for the NPLs - and there is already some doubt as to whether all the interest payments have actually been made (Garcia-Herrero, Gavila, and Santabarbara, 2006, p. 326-327). Indeed, McIver (2005, p. 15) suggests that the “AMCs represent a serious default risk to the SOCBs in their own right.”

Although the AMCs have made efforts to attract the interest of for­eign investors, sales to foreign entities have accounted for only a relatively small portion of the AMCs' overall NPL disposal. In the first NPL auc­tion open to foreign investors, Huarong AMC succeeded in selling $US 1.2 billion worth ofNPLs to a group led by Morgan Stanley. The mag­nitude of this “success” is rather qualified, however, by the fact that the actual proceeds realized from the sale were only $US 100 million, meaning that Huarong got just 8 cents on the dollar (Johnson, 2002, p. 26). Morgan Stanley did go on to establish a joint venture with Huarong to reorganize debt and to employ and train Huarong employees on how to work out loans independently. And Huarong later took the lead in aggressively compet­ing with foreign investors in NPL auctions by the other three AMCs - as well as announcing ambitious plans to transform itself into an investment bank that could extend into brokerage activities and other financial services (Guerrera and McGregor, 2005). This transformation maybe difficult unless Huarong first receives an injection of government funds to cover the large accounting losses undoubtedly sustained from its core NPL business - which would only add to the already high burden of bolstering the SOCB balance sheets.

The size of the NPLs transferred to the AMCs from the SOCBs certainly remains quite out of proportion to the funds realized as a result of their operations. Given an approximate 20% reported overall cash recovery rate, combined with the fact that only about 50% of the loans transferred had been restructured or disposed of through 2005, the true yield might more accurately be stated as 10% (Garcia-Herrero, Gavila, and Santabarbara, 2006, p. 315). Such low returns lend some support to early criticisms that the AMCs were doing little more then redistributing the NPL problem (Clifford, 2002, p. 18). Government-funded capital injections and not the AMCs operations themselves have certainly been the dominant factor in the improvement effected in SOCB balance sheets since 1998. Indeed, Ma (2006) estimates that total restructuring costs may have reached RMB 4,047 billion by the end of 2005 - after taking into account not only the losses on the NPL transfers but also SOCB equity write-downs and carving out of doubtful loans by the People’s Bank, other costs born by bank customers and foreign investors, RMB 500 billion for city commercial banks, and RMB 35 billion for the Bank of Communications in 2004.

Future costs could be significantly exacerbated by new additions to the stock of NPLs, with investment in fixed assets that approached 50% of GDP in mid-2006 raising the “risk that wasteful investment could end up bloating the bad-loan portfolios of Chinese banks” (Browne, 2006).^[118] It is, at this stage, unclear that the latest round of recapitilizations represents an end and not simply part of an ongoing process.^[119] Lardy (2005a, p. 46) actually suggests that much of the existing government-funded capital infusions to the banking system could be “washed out by the new nonperforming loans that emerge in 2005-07.” Any such developments could pose a real threat to China’s economic stability, with Bergsten et al. (2006, p. 38) concluding that:

Banks cannot continue to absorb state capital at anything like the pace of recent years if China’s fiscal position is to be sustained.