Non Performing Loan Transactions and Land Use Rights in China

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Non Performing Loan Transactions and Land Use
Rights in China

• Presented by
• Robert J. Allan
• USA China Law Group
• US-China Business Law Conference at UCLA
• Los Angeles, Ca - October 24, 2008

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• Current Economic and Legal Climate for
  Investments in China

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Foreign Investment in China Overview

• Top destination for foreign direct investment
  (FDI) for sixteen years
• US 52.39 B in FDI to China in the first half of
  2008 a 45.6 increase over the same period in
  2007
• Foreign invested enterprises (FIEs) play a
  major role in Chinas economy 58 of imports
  and exports
• Top foreign investors HK first US sixth
• Top FDI destination eastern region 81.9
• Hot sectors manufacturing (57.7) and real
  estate (11.9)
• Sources The US- China Business Council
• Asia Monitor, September 2008

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Issues to Watch

• Economic protectionism
• Push for indigenous innovation
• New rules on foreign investment
• Enterprise Income Tax Law
• Labor Contract Law
• Antimonopoly Law
• Catalogue Guiding Foreign Investment in Industry
• Revised regulations on the management of foreign
  exchange

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What Chinese Government Wants

• Encouraged Sectors
• Non-performing Loans
• Services
• Emerging and high-technology
• Energy and the environment
• Healthcare

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What Chinese Government Doesnt Want

• Restricted or Banned Sectors
• Real estate
• Media and publishing
• Manufacturing solely for export
• Manufacturing requiring a high usage of resources
  or energy

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• An Overview of
• Non Performing Loans in China

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Background of Chinas Non Performing Loan (NPL)
Market

• High ratio of NPLs
• Source of NPLs Politically based lending
  practices of State Owned Enterprises (SOE)
• Disposition of NPLs remains a top priority of the
  PRC
• Reform of the banking system
• WTO accession
• Privatization of SOEs
• New banking policies to address the economys
  growth
• Creation of the Asset Management Corporation
  (AMC)
• Facilitate acquisition of NPLs from State Owned
  Banks
• Facilitate acquisition of NPLs from commercial
  banks

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Opportunities and Emerging Trends

• Big Market
• Current transactions in the market
• Upcoming transactions
• Big Players
• Big Deals
• Reasons sales will increase in 2008-2009
• Impact of global recession-depression

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Why NPL in China?

• Easiest and most effective way to acquire
  interests in land use rights and businesses in
  China
• Significant discounts
• High intrinsic values
• Simplified acquisition and approval processes
• Foreign exchange benefits
• RMB undervalued by 30-40
• Source Asia Monitor, September 2008

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Challenges Facing Foreign NPL Investors in China

• Local knowledge essential to successful
  transactions
• Motivation and political agenda of the sellers
• Limited time span to undertake due diligence
• Numerous political and regulatory hurdles
• Complicated governmental approval processes
• Limited exit strategies
• No leverage

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• Investment Strategy
• and Process

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Key Investment Criteria

• Well developed primary cities
• Significant unambiguous collateral and assets
• Clear understanding of investment target
• Ability to resolve critical issues
• -Legal
• -Regulatory
• -Financial
• -Operational
• Comfortable buffer on pricing and vigorous risk
  management mechanisms

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Key Investment Criteria

• Extensive and comprehensive pre-tender due
  diligence
• Realization or enhancement of the intrinsic
  values of the assets
• Target annual IRR of 25
• Liquidity within 2 years

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Investment StrategyPrioritization of NPL
Portfolio Assets
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Investment Process

• Deal sourcing and screening
• Due diligence
• Analysis
• Pricing and deal structure
• Recovery process
• Post-acquisition value creation

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Recovery Process
Solution Implementation
Creating Preliminary Recovery Solutions
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Exit Strategy
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NPL Investment and Acquisition of Land Use Rights
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Factors Affecting Direct Investment in Chinese
Real Property Market

• Chinese concept of land ownership
• Land use rights
• New restrictions concerning foreign investment in
  real estate market
• New Property Law
• Opinions Concerning Regulating the Access to and
  Administration of Foreign Investment in Real
  Estate Markets
• Notice Concerning Regulating the Purchase of
  Residential Property by Foreign Institutions and
  Foreign Individuals
• Circular 30 Circular of General Affairs
  Department of SAFE on the Distribution of the
  List of the First Group of Foreign Invested Real
  Estate Projects which has Filed with the Ministry
  of Commerce

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Acquiring Land Use Rights Through NPLs

• Collateral for loans primarily consist of land
  use rights
• These creditors rights can be sold to the
  ultimate end user
• Most efficient and effective approach to pair
  ultimate end user with local developer

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Case Study
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Case Study

• Introduction
• Sold by AMC, originally acquired from Chinese
  commercial bank in 2007 through a public sealed
  bid offering
• 33 borrowers a majority of which are located in
  Beijing
• OPB RMB 1,098 million total legal claim RMB
  1,410 million as of 30 September 2007

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Case Study

• Due Diligence February 2008
• A desktop financial and legal review of 25
  borrowers
• represents 76 of the total accounts in number
• represents 97 of the total OPB
• Done by big four accounting firm and Alpha
  Leader Law Firm
• Scope of due diligence
• Loan information and current status of borrower
• Current status of collateral
• Litigation legal flaws
• Risk risk management
• Recovery strategy and implementation
• Recovery ability analysis
• Valuation methods
• Estimated recovery amount
• Estimated recovery time
• -Possible disposal methods
• -Recovery resources

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Case Study

• Post-acquisition Value Creation
• Examination of creditors rights and asset
  investigation
• Recovery projection, recovery analysis, cost
  estimation, independent agents opinions
• Creating preliminary recovery solutions
• Feasibility analyses and legal opinions
• Solution implementation
• Estimated total recovery amount
• -RMB 633,536,244.13

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Case Study Acquisition Time Line
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Case Study
Figures in Thousands

Original Principal Balance (OPB) ?1,097,570
Bid Price Accepted ?439,994
OPB 40
Expected Cash Recovery ?633,536
OPB 58

Capital Structure of Investment  
Equity (100) ?439,994
Debt n/a
Total Capital ?439,994
   
Income Statement
Gross Profit (Recovery minus Purchase Price) ?193,542
Margin 44
Legal Fees for Document Inspection (2) ?250
Collateral Appraisal Fees ?150
Travel Expenses ?50
Total Pre-Purchase Expenses ?450


Interest Payments n/a
Basic Service Fee ?4,840
Office rental ?0
Loan Monitoring Expenses ?0
Total Expenses during Resolution ?4,840


Total Fees and Expenses ?5,290

Profits Net of Fees and Expenses ?188,252

Distribution of 12 Incentive Fees to (Asset Manager) ?22,590

Profits After Fees and Expenses ?165,662

Taxes (_at_ 33) ?54,668

Net Profits After Tax ?110,994

Implied Return (Cash on Cash) 25.23

Portfolio's Estimated Annual Cash Flow Portfolio's Estimated Annual Cash Flow Portfolio's Estimated Annual Cash Flow
2008 2009 2010
Capital Investment (?439,994)
Transaction Exp. Taxes (?450) (?2,420) (?79,679)
Cash Recovery ?339,300 ?188,300 ?105,936
Cash Flow (?101,144) ?185,880 ?26,257
Note
1. Transaction signed in Mar. 2008 took 4 months to gain approvals to close. The loans may have been resolved in 2 years.
2. Legal fees for inspection of documents were fixed at ?10,000 per account. Investor inspected 25 accounts out of 33 in the portfolio purchased from COAMC.
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• Thank You!