Non Performing Loan Non Performing Loan Transactions and Land Use Transactions and Land Use

Rights in ChinaRights in China

Presented by:Presented by:

Robert J. Allan Robert J. Allan USA China Law Group USA China Law Group

US-China Business Law Conference at UCLAUS-China Business Law Conference at UCLA Los Angeles, Ca - October 24, 2008Los Angeles, Ca - October 24, 2008

Current Economic and Legal Current Economic and Legal Climate for Investments in Climate for Investments in

ChinaChina

Foreign Investment in China Foreign Investment in China OverviewOverview

Top destination for foreign direct investment Top destination for foreign direct investment (“FDI”) for sixteen years *(“FDI”) for sixteen years *

US $52.39 B in FDI to China in the first half US $52.39 B in FDI to China in the first half of 2008 – a 45.6% increase over the same of 2008 – a 45.6% increase over the same period in 2007 **period in 2007 **

Foreign invested enterprises (“FIEs”) play a Foreign invested enterprises (“FIEs”) play a major role in China’s economy – 58% of major role in China’s economy – 58% of imports and exports *imports and exports *

Top foreign investors: HK first; US sixth *Top foreign investors: HK first; US sixth * Top FDI destination: eastern region – 81.9% *Top FDI destination: eastern region – 81.9% * Hot sectors: manufacturing (57.7%) and real Hot sectors: manufacturing (57.7%) and real

estate (11.9%) *estate (11.9%) *

Sources: * The US- China Business Council Sources: * The US- China Business Council ** Asia Monitor, September 2008** Asia Monitor, September 2008

Issues to WatchIssues to Watch

Economic protectionism Economic protectionism Push for “indigenous innovation”Push for “indigenous innovation”

New rules on foreign investment New rules on foreign investment Enterprise Income Tax LawEnterprise Income Tax Law Labor Contract Law Labor Contract Law Antimonopoly Law Antimonopoly Law Catalogue Guiding Foreign Investment in Catalogue Guiding Foreign Investment in

Industry Industry Revised regulations on the management of Revised regulations on the management of

foreign exchange foreign exchange

What Chinese Government What Chinese Government WantsWants

Encouraged SectorsEncouraged Sectors:: Non-performing Loans Non-performing Loans ServicesServices Emerging and high-technologyEmerging and high-technology Energy and the environment Energy and the environment HealthcareHealthcare

What Chinese Government Doesn’t What Chinese Government Doesn’t

WantWant

Restricted or Banned Sectors:Restricted or Banned Sectors: Real estateReal estate Media and publishing Media and publishing Manufacturing solely for export Manufacturing solely for export Manufacturing requiring a high Manufacturing requiring a high

usage of resources or energyusage of resources or energy

An Overview of An Overview of

Non Performing Loans in Non Performing Loans in ChinaChina

Background of China’s Non Background of China’s Non

Performing Loan (“NPL”) MarketPerforming Loan (“NPL”) Market High ratio of NPLsHigh ratio of NPLs Source of NPLs – Politically based lending Source of NPLs – Politically based lending

practices of State Owned Enterprises (“SOE”)practices of State Owned Enterprises (“SOE”) Disposition of NPLs remains a top priority of the Disposition of NPLs remains a top priority of the

PRCPRC Reform of the banking systemReform of the banking system WTO accessionWTO accession Privatization of SOEsPrivatization of SOEs New banking policies to address the economy’s New banking policies to address the economy’s

growthgrowth Creation of the Asset Management Corporation Creation of the Asset Management Corporation

(“AMC”)(“AMC”) Facilitate acquisition of NPLs from State Facilitate acquisition of NPLs from State

Owned BanksOwned Banks Facilitate acquisition of NPLs from commercial Facilitate acquisition of NPLs from commercial

banksbanks

Opportunities and Emerging Opportunities and Emerging TrendsTrends

Big Market Big Market Current transactions in the marketCurrent transactions in the market Upcoming transactionsUpcoming transactions

Big PlayersBig Players Big DealsBig Deals Reasons sales will increase in 2008-Reasons sales will increase in 2008-

2009 2009 Impact of global recession-depressionImpact of global recession-depression

Why NPL in China?Why NPL in China?

Easiest and most effective way to Easiest and most effective way to acquire interests in land use rights acquire interests in land use rights and businesses in Chinaand businesses in China

Significant discountsSignificant discounts High intrinsic valuesHigh intrinsic values Simplified acquisition and approval Simplified acquisition and approval

processesprocesses Foreign exchange benefitsForeign exchange benefits RMB undervalued by 30-40% *RMB undervalued by 30-40% *

Source: * Asia Monitor, September 2008

Challenges Facing Foreign NPL Investors Challenges Facing Foreign NPL Investors

in Chinain China

Local knowledge essential to successful Local knowledge essential to successful transactionstransactions

Motivation and political agenda of the Motivation and political agenda of the sellerssellers

Limited time span to undertake due Limited time span to undertake due diligencediligence

Numerous political and regulatory hurdlesNumerous political and regulatory hurdles Complicated governmental approval Complicated governmental approval

processesprocesses Limited exit strategiesLimited exit strategies No leverageNo leverage

Investment Strategy Investment Strategy

and Processand Process

Key Investment CriteriaKey Investment Criteria

Well developed primary citiesWell developed primary cities Significant unambiguous collateral and Significant unambiguous collateral and

assetsassets Clear understanding of investment targetClear understanding of investment target Ability to resolve critical issues:Ability to resolve critical issues:

-Legal-Legal-Regulatory-Regulatory-Financial-Financial-Operational-Operational

Comfortable buffer on pricing and Comfortable buffer on pricing and vigorous risk management mechanismsvigorous risk management mechanisms

Key Investment CriteriaKey Investment Criteria

Extensive and comprehensive pre-Extensive and comprehensive pre-tender due diligencetender due diligence

Realization or enhancement of the Realization or enhancement of the intrinsic values of the assetsintrinsic values of the assets

Target annual IRR of 25%Target annual IRR of 25% Liquidity within 2 yearsLiquidity within 2 years

Collection Medium

• Analysis

• Litigious or non-litigious

• Assignment of staffing for collection

Selection of most efficient collection medium

Asset ranking

• Rank debt accounts for collection

• Collection on high value accounts

• Assignment of staffing for collection

Prompt action on high value accounts

Asset categorization

• Categorize accounts

• Assign specialist according to the categorization

Specialization to ensure collection

Difficulty assessment

• Assessment

• Allocation of specialist

Ensure collection even adverse cases

Investment StrategyInvestment StrategyPrioritization of NPL Portfolio AssetsPrioritization of NPL Portfolio Assets

Investment ProcessInvestment Process

Deal sourcing and screeningDeal sourcing and screening Due diligenceDue diligence AnalysisAnalysis Pricing and deal structurePricing and deal structure Recovery processRecovery process Post-acquisition value creationPost-acquisition value creation

Recovery ProcessRecovery Process

Creating

Preliminary

Recovery

Solutions

Solution

Implementation

Exit StrategyExit Strategy

NPL Investment and Acquisition NPL Investment and Acquisition of Land Use Rightsof Land Use Rights

Factors Affecting Direct Factors Affecting Direct Investment in Chinese Real Investment in Chinese Real

Property MarketProperty Market Chinese concept of “land ownership”Chinese concept of “land ownership”

Land use rightsLand use rights

New restrictions concerning foreign New restrictions concerning foreign investment in real estate market investment in real estate market

New Property Law New Property Law Opinions Concerning Regulating the Access to and Opinions Concerning Regulating the Access to and

Administration of Foreign Investment in Real Estate Administration of Foreign Investment in Real Estate MarketsMarkets

Notice Concerning Regulating the Purchase of Residential Notice Concerning Regulating the Purchase of Residential Property by Foreign Institutions and Foreign Individuals Property by Foreign Institutions and Foreign Individuals

Circular 30 – Circular of General Affairs Department of Circular 30 – Circular of General Affairs Department of SAFE on the Distribution of the List of the First Group of SAFE on the Distribution of the List of the First Group of Foreign Invested Real Estate Projects which has Filed Foreign Invested Real Estate Projects which has Filed with the Ministry of Commercewith the Ministry of Commerce

Acquiring Land Use Rights Acquiring Land Use Rights Through NPLsThrough NPLs

Collateral for loans primarily consist Collateral for loans primarily consist of land use rightsof land use rights

These creditors rights can be sold to These creditors rights can be sold to the ultimate end userthe ultimate end user

Most efficient and effective approach Most efficient and effective approach to pair ultimate end user with local to pair ultimate end user with local developerdeveloper

Case StudyCase Study

Case StudyCase Study

Introduction Introduction • Sold by AMC, originally acquired from Sold by AMC, originally acquired from

Chinese commercial bank in 2007 Chinese commercial bank in 2007 through a public sealed bid offering through a public sealed bid offering

• 33 borrowers a majority of which are 33 borrowers a majority of which are located in Beijinglocated in Beijing

• OPB RMB 1,098 million; total legal OPB RMB 1,098 million; total legal claim RMB 1,410 million as of 30 claim RMB 1,410 million as of 30 September 2007September 2007

Due Diligence – February 2008 Due Diligence – February 2008 • A desktop financial and legal review of 25 borrowers A desktop financial and legal review of 25 borrowers

represents 76% of the total accounts in number represents 76% of the total accounts in number represents 97% of the total OPB represents 97% of the total OPB

• Done by big four accounting firm and Alpha & Leader Law Done by big four accounting firm and Alpha & Leader Law Firm Firm

• Scope of due diligence Scope of due diligence Loan information and current status of borrowerLoan information and current status of borrower Current status of collateral Current status of collateral Litigation & legal flaws Litigation & legal flaws Risk & risk management Risk & risk management Recovery strategy and implementation Recovery strategy and implementation

• Recovery ability analysis Recovery ability analysis • Valuation methods Valuation methods • Estimated recovery amount Estimated recovery amount • Estimated recovery time Estimated recovery time

-Possible disposal methods-Possible disposal methods-Recovery resources-Recovery resources

Case StudyCase Study

Post-acquisition Value Creation Post-acquisition Value Creation • Examination of creditors rights and asset Examination of creditors rights and asset

investigation investigation • Recovery projection, recovery analysis, cost Recovery projection, recovery analysis, cost

estimation, independent agent’s opinions estimation, independent agent’s opinions • Creating preliminary recovery solutions Creating preliminary recovery solutions • Feasibility analyses and legal opinions Feasibility analyses and legal opinions • Solution implementation Solution implementation

Estimated total recovery amount: Estimated total recovery amount: -RMB 633,536,244.13-RMB 633,536,244.13

Case StudyCase Study

Case Study Acquisition Time LineCase Study Acquisition Time LineProcedure

COAMC purchased the portfolio from BankDec. 2007

Mid. Jan. 2008

Time Line

Early Jan. 2008

Late Dec. 2007 COAMC issued the transaction timetable

Approach major foreign investors

Reach initial MOU among co-investors

Roll-up

Portfolio DD

Investors going through internal approval process

Go through tender process

Obtain approvals from National Development and Reform Commission

Obtain approvals from State Administration of Foreign ExchangeTransaction Closed

Mid. Jan. 2008-Late Jan. 2008

Feb. 2008

Late Feb. 2008

3rd Mar. 2008

Apr. 2008

May 2008

Case StudyCase StudyFigures 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/aTotal 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 (@ 33%) ￥ 54,668

Net Profits After Tax ￥ 110,994

Implied Return (Cash on Cash) 25.23%

Portfolio's Estimated Annual Cash Flow2008 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.

Thank You!Thank You!