China debt sales inflated
Inaccurate accounting sees the amount of money to be recovered from bad loans overstated by billions of yuan
The amount of money likely to be recovered by the mainland's asset management companies has been overstated by billions of yuan through the use of inaccurate accounting.
Statements by the heads of asset managers suggest up to 22 per cent of the outstanding money will be recovered. But most bankers, using a different measure, say the returns could be 15 per cent or less.
Given that the asset managers have been given a mandate to sell US$180 billion in bad loans from the four state banks, the difference could be $15 billion to $20 billion.
Analysts said a different rule was likely to have been used as a way to convince officials - primarily from the State Council - that the bailout would not end up being a fire sale of bank assets for foreign investors.
'This will allow them to feel comfortable they are not losing out to foreigners. If they say they are getting 20 per cent, then they can do this; if it's 10 per cent, they will get criticism for doing the deal cheap,' said Wei Yen, a bank analyst at Moody's Investor Service.
The issue also illustrates what officials will do to get consensus among officials. For example, the US$45 billion injection into China Construction Bank and the Bank of China was described by officials as a loan.
But it is widely viewed among analysts as a handout from the government that will not be paid back - an important distinction in accounting and policy terms.
In the case of the asset managers, the overstatement occurred because they are treating the expected pay-off from the sale of bad loans in today's money.
The technical reasons concern a term called discounted cash flow: what someone is willing to pay today in exchange for cash sometime in the future. It is based on the idea that a yuan earned today is worth more than a yuan earned five years from now because money today can be invested and earn a return.
In addition, inflation - although less of an issue in China in recent years - could erode the value of future payments.
In the case of the asset managers, they have not discounted the cash that is expected to be earned from the sale of the assets in the future.
The impact could be substantial, but it depends on what assumptions are used. The two most important are how long it will take for the loans to be sold, and what could be earned on the money in the meantime, the discount rate.
In the first big transaction in 2002, Huarong Asset Management said it would earn US$277 million on a face value of $1.3 billion in bonds, for a return of 21 per cent.
At the time, the safest alternative investment was a 10-year corporate bond, yielding about 4 per cent. If that US$277 million figure is discounted by 4 per cent a year until 2009, when the asset managers are supposed to be phased out, the return in discounted terms falls to $206 million, or 16 per cent.
If the sale of the loans continues for two more years until 2011, the return drops to US$150 million, or just 12 per cent.
That is not to say the deals are not profitable for the asset managers and the foreign banks buying them. But the accounting suggests politics has played an important role in how they have been described.
'We knew that it was important they reflect as high a number as possible,' said one foreign executive involved in asset management loans.
'Whatever internal mechanisms are required for approval, my client gets what they want out of the deal and the government gets what they want.'
