Foreign investors cautious on China's bad debt market second time around

Buying up chunks of state-owned assets is sticky business on the mainland. Foreign banks found that out a decade ago when several tried to invest in a 1.4 trillion yuan wave of bad debt that was shifted from its four biggest banks onto the balance sheets of newly created, state-controlled asset management companies.

The vast majority of the spoiled loans back then were streaming straight from state firms and the marketplace for restructuring and disposals was led firmly by a central government hand.

A new wave of deteriorating loans is swelling in the wake of the mainland's 4 trillion yuan (HK$5 trillion) stimulus package launched in late 2008. As mainland banks report increasingly higher non-performing loans (NPLs) towards the end of the year, foreign investors are questioning whether a new bankruptcy law and a higher quality of assets this time around will make the mainland bad debt market more palpable - and digestible.

"The first time, there were a lot of legacy policy loans and foreign investors were very cautious," said Howard Lam, a Hong Kong-based partner at Latham and Watkins, who participated in the debt auctions 10 years ago.

Policy loans are government-directed lending, usually to state companies. In the mainland's case, such loans are used to prop up employment and economic growth often without consideration for whether the firms can ever service the debt.

The fear at the time was that foreign investors would not be allowed to restructure or liquidate assets so closely tied to the mainland's social stability.

Progress has been made on the legal front, especially with the passage of a bankruptcy law in 2007. However, the effectiveness of the new law, the cornerstone of the restructuring process, is far from reaching international standards.