Chinese democracy

Ernst & Young has withdrawn its recent NPL report because of concerns about the numbers, but that does not mean China's bad debt woes are gone.

Last month, accounting and consulting firm Ernst & Young released—and later withdrew—its 20th report on the global bad debt market. The report, which tracks how non-performing loans have gone from a collection of scattered, rag-tag transactions to a $1.5-trillion (€1.2 trillion) industry, was recalled after concerns arose over the value of China's distressed debt.

The E&Y report became a story in and of itself when the consulting firm withdrew the paper less than two weeks after it was released. The report “conservatively” estimated China's NPL liability at approximately $900 billion, including $358 billion held by China's four state-owned banks, prompting the Chinese government to call the report “ridiculous and barely understandable.” The official amount of non-performing loans in China is $133 million.

After E&Y withdrew the report, it released a statement noting that it had acted as an auditor for the Industrial and Commercial Bank of China in advance of its planned IPO later this year—and that the audit division's numbers support the official tally.

Discussing the report on a panel at the Harvard Club in New York City on the day it was initially released, E&Y real estate partner Mark Grinis talked about why the NPLs were of interest to private equity real estate funds.

“The goal is to buy this thing and turn it into cash,” he said. “It is the grounds of what opportunity funds are all about: bad information, lack of transparency and risk.”

Participants on the panel predicted that new investor activity would most likely focus on markets where activity is continuing, albeit at a slower pace, such as Thailand and Indonesia, and countries with an emerging NPL trade, like China, India and the Philippines. But many on the panel voiced investors' frustrations with China, where state-owned banks have been slow to liquidate their bad debt.

“My concern is [Chinese] banks looking to IPO will send a message that the non-performing loan problem is behind them,” said Jack Rodman, a Beijing-based partner for transactions and advisory services with Ernst & Young.

Still, Rodman cautioned that the NPL markets are for savvy investors with an appetite for a gamble. “This is not for the faint of heart,” he said. “We think it is highly opportunistic.”