BEIJING (Reuters) - Veteran investor Jack Rodman has had enough. After waiting 11 years for China to sell its rising pile of bad bank loans, he is quitting and going to Spain instead.
His pull-out exposes a pressing failing in China’s booming financial sector: it does not properly dispose of a growing store of bad loans from banks’ profligate lending, keeping risks pent up within the world’s second-biggest economy.
And the problem only scratches the surface of deeper troubles plaguing China’s banking industry, where heavy government intervention has produced a dysfunctional system that is at times better at destroying capital than creating it.
The frozen market for bad loans shows just that.
For years, China has shuffled bad debt that was run up by big state firms between state banks, other state companies and Beijing in labyrinthine deals that hid the cost of bad banking, and shielded un-viable state enterprises from bankruptcies.
These losses lurk in the system unaccounted for, tarring banks’ and China’s fiscal health, and frustrating those such as Rodman who say Beijing quashed the bad debt market by refusing to sell dud loans openly to protect state firms from creditors.
“I’ve gone to Europe because I recognize that China is never going to come honest and play fair with its non-performing loans,” said Rodman, who runs his own investment firm Global Distressed Solutions after working for auditor KPMG for 37 years.
“China should have a real process (when selling bad debt)where it lets accountants, regulators and rating agencies in, which they don’t do.”
The broken system may soon come home to roost. The debt debris is growing as China’s economy confronts its slowest growth in a decade. Three of its four biggest banks reported rising bad debt losses last month.
China has to clear the debt mess sooner rather than later if it wants to free up its financial markets by 2020. And it won’t be cheap or easy.
The last time Beijing cleaned up its banks and rescued them from bankruptcy, it took three broad waves starting in 1998 and ending in 2005, required huge capital injections and bad loan transfers to specially created asset management companies.
The Bank for International Settlements estimates 20-24 percent of 2004 GDP was pumped into the banking system, in one of the biggest bank rescues in history.
Such colossal government spending not only hurts state coffers, it risks fuelling inflation unless the central bank takes counter measures to soak up the extra cash.
Yet China’s problem of bad loans is not likely to go away anytime soon. Its state banks still lend on the orders of their political masters in state firms and local governments.
“The next few years will see heightened economic and financial turbulence in China with the banks at the centre of it all,” said Diana Choyleva, director at Lombard Street Research.
“On the face of it, since 1998, the Chinese authorities have reformed the banks. But fundamentally, they didn’t change anything. Banks remain puppets in the hands of the state.”
China’s banking regulator reported 1.05 trillion yuan ($167 billion) of nonperforming loans in the banking system at the end of 2011, larger than the size of New Zealand’s economy.
Despite the eye-popping sum, some analysts say it is probably understated as frenzied bank lending after the 2008/09 financial crisis, including 10.7 trillion yuan of loans to local governments, likely left a wave of sour loans in its trail.
The fastest way for China to recoup losses is to sell dud loans to investors, except that it can‘t.
Its market for bad debt, started in 1999 by Beijing when it bailed out its banks, was decimated in the mid-2000s by what investors described as extensive government interference that chased away buyers and saddled the state with steep losses.
China recovered only 21 percent of some 1.4 trillion yuan of bad loans it sold after removing them from its top four banks in 1999, an abysmal record next to the 60 percent recovery by the United States during its savings and loans crisis in the 1990s.
Investors say Beijing only has itself to blame.
It drove buyers away by setting minimum bid prices for bad loans on auction, protected state borrowers from creditors, and enforced murky regulations, typified by a court ruling against UBS in 2009 that obstructed payment collection, they said.
“They are supposed to sell (bad loans) at auction at market clearing prices. But they didn’t like prices that investors were paying because investors were realizing these things are really crappy and these borrowers are really dodgy,” said Rodman.
From a crowd of over 30 foreign investors including Goldman Sachs (GS.N) which gathered following China’s first-ever bad loan sale in October 2002, only a handful of small investment houses remain today, lamenting a market that never lived up to its potential as one of the world’s biggest.
Making matters worse, investors say the four state-owned Chinese sellers of bad debt, known locally as asset management companies (AMCs), are reluctant sellers.
“What the AMCs did was to hang on to more of the non-performing loans themselves,” said Ted Osborn, head of business recovery services for PricewaterhouseCoopers in Hong Kong.
“I think initially people were worried about working themselves out of a job. If they sold all their non-performing loans, whether to foreigners or domestically, or worked them all out themselves, then they would have nothing else to do.”
Because China fared so badly in selling its sour loans to investors, it could not repay some 1.2 trillion yuan worth of bonds it issued to buy the bad debt carved out from banks to recapitalize them, analysts said.
Pressed for a solution, China decided to roll-over all the bonds for another 10 years when they matured in 2009, sweeping bad debt losses under the carpet.
The mound of rolled-over bonds sit on the books of Chinese banks right now, leaving lenders still exposed to bad loans that should have been disposed in Beijing’s 1998-2005 clean-up.
Investors say roll-overs buy China time in dealing with its debt woes, but fail to tackle the crucial question of who ultimately pays for bad loan losses.
And analysts say roll-overs are hardly the solution China needs for its bad debt: attacking the source of sour loans by shutting down unprofitable state firms, and restraining the state from using lenders to bank roll all projects.
But these are politically difficult decisions which Beijing likes to put off for as long as possible. In a repeat of history, it ordered banks to roll-over or restructure troubled local government loans this year.
“It’s a crying shame that the country with the largest amount of NPLs, probably in the world, is paying so little attention in trying to resolve the problem,” said a distressed asset investor in Beijing who declined to be named.
($1 = 6.3041 Chinese yuan)
Reporting by Koh Gui Qing