Industrial and Commercial Bank of China (ICBC), the largest commercial bank in the People's Republic, last week launched a securitization backed by non-performing and sub-performing loans (NPLs) with a book value of Rmb2.6 billion (US$314 million). Credit Suisse First Boston's Tokyo-based ABS team acted as sole financial adviser and structuring agent for the deal, with Citic Securities in a supporting role and China Credit Trust as the trustee.

Officials at CSFB were reluctant to give too much information while investor subscription is still being finalized. What is known is that ICBC is looking to realize around Rmb800 million from the deal. Domestic agencies China Chengxin International and Dagong will rate the issue.

"The Ningbo Branch [located in the eastern province of Zhejiang] NPL transaction is a watershed event in further developing China's securitization market and broadening the tools available to banks in China for managing their existing NPL portfolios," said Paul Calello, CSFB's chief executive officer for the Asia-Pacific region.

At the moment there is no specific securitization law in China, and achieving a true sale is difficult due to the attitude of regulators toward the establishment of special purpose vehicles. Under Chinese law, SPVs must be properly capitalized - a fundamental difference compared to other jurisdictions - and approved by a number of different regulatory bodies. And while there is undeniably a drive within the PRC to deepen the capital markets, anyone familiar with legal reform in China will know it is a laborious process at best.

The situation is further complicated by the fact that associated reforms, including bankruptcy and disclosure laws, are also something of a work in progress in China.

Consequently, ICBC will utilize the country's trust and contract laws, following the path set by Huarong Asset Management Company in a deal completed in June 2003. In order to pay interest on a Rmb31 billion bond it issued to ICBC in 1999 to fund a purchase of NPLs from the bank, Huarong packaged a portfolio of assets worth Rmb13.25 billion into a single trust, with Citic Trust and Investment as the trustee.

Under the terms of the trust, senior registered beneficial interests (the equivalent of bonds) were created for 10% of the agreed value of the pool and sold to investors. The three-year deal pays an annual coupon of 4.17%, a significant pickup on the three-year bank deposit rate of 2.52% and the 2.32% available from treasury bonds with the same maturity.

On the face of it, the structure can hardly be termed efficient given that only 10% of the value of assets was sold to investors. But the issue of NPL resolution is of such urgency in China that recouping 10% of assets - many of which were lent as far back as the early 1980s to now-defunct state enterprises - is actually recognized as something of a triumph.

By 1999, it was conservatively estimated that China's four big state-owned banks - ICBC, Agricultural Bank of China (ABOC), Bank of China (BOC) and China Construction Bank (CCB) - had amassed around US$500 billion of NPLs, 30% of all loans in the financial system, leading to the establishment of four AMCs - Cinda, Great Wall, Huarong and Orient - to try to resolve the problem.

The China Banking Regulatory Commission has estimated that around 25% of the loans have been resolved, although some analysts question that figure. What is undeniable, however, is that because China's accession to the World Trade Organization in 2001 was dependent on the country opening up the banking sector to foreign competition by 2006, it is imperative the banks slash the NPLs further in order to make themselves competitive, especially as all four banks plan future listings.

The central government injected US$45 billion into BOC and CCB last year to aid their listings, scheduled for late 2004 and early 2005, respectively. However, the government has stated that ICBC and ABOC need to show significant improvement in their NPL figures before they can expect similar backing. ICBC did reduce its NPLs by a percentage point in the first quarter of this year, but its NPL ratio is still over 20%. The bank will hope that securitization can make a significant dent in that figure.

Other institutions in China are also getting in on the act. Late last year, Cinda AMC signed a partnership agreement with Deutsche Bank for a potential deal worth US$190 million, while Morgan Stanley is currently training CCB on using securitization in the disposal of distressed assets.

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