BEI HU

Foreign investors may abandon China's non-performing loan (NPL) market if deal flow does not pick up substantially in the coming year, according to international accounting firm PricewaterhouseCoopers (PwC).

"We believe the biggest issue facing China's NPL sellers today is whether they can modify the current system sufficiently to entice the foreign investment community to stay in the market," PwC said in a report released yesterday.

A PwC survey of 17 international investment banks, distressed debt funds and other firms indicating an interest in Chinese NPLs suggests that foreign investors have earmarked a combined US$10 billion to US$15 billion for China's NPL market in the next three years.

Some 71 per cent of respondents see opportunities increasing as state-owned asset management companies (AMC) and mainland commercial banks put more problem loans up for sale.

A total of 94 per cent of respondents hope to remain in the market for at least five years.

"[However,] during the three-month period between survey completion and today, many of the respondents appear to have changed their tune," PwC said. "In many of our discussions with them, their optimism has turned to pessimism over the dearth of opportunities in the market."

Only US$6 billion in banking NPLs have been sold to foreign investors so far, including the US$1.8 billion in BOC Hong Kong NPLs acquired by Citigroup last year.

Should the paucity persist, foreign investors may turn instead to mature markets such as Japan and Korea, or newly emerging markets such as Germany and Eastern Europe, where the pace of NPL activity is more predictable.

"They are all commercial enterprises," said Ted Osborn, PwC's Hong Kong-based business recovery services partner. "They have all got returns to make and targets to meet."

With an estimated US$500 billion in problem bank loans, China is Asia's second-largest NPL market after Japan.

In September, US-based Lone Star, one of the bigger international buyout firms, closed its Beijing office due to the shortage of deals.

Apart from the small, unpredictable deal flow, foreign investors have also shown concerns about unclear government approval process, confusing internal approval requirements at state-owned AMCs, and the tendency of the AMCs to renegotiate terms after the initial deals have been signed.

The central government earlier this month announced a new policy to streamline approval procedures for NPL sales to foreign investors. But its impact on speeding up the deal flow remains to be seen, Mr Osborn said.

Foreign investors generally prefer large and medium-sized NPL portfolios, secured by land or real property, acquired through private deals rather than public auctions. Hotels and operating manufacturing companies are preferred over service and trading firms.

Portfolios concentrated in the affluent coastal provinces and cities such as Guangdong, Beijing, Jiangsu, Shanghai and Zhejiang are deemed most attractive.

Foreign investors demand an internal rate of return of 21 to 30 per cent from their mainland NPL investments, far more than most NPL sellers are willing to guarantee.

Despite uncertainties in the primary NPL market, Mr Osborn sees a promising secondary market emerging, as domestic investors that have bought NPL packages offload those assets falling outside their core businesses.