However such willingness may be attributable to

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Unformatted text preview: ingness to accept a 13.12% return and forego 40.88% to foreign investors may seem surprising at first glance (Table 10). However, such willingness may be attributable to several factors. First, the published recovery rate could be overstated. The reported asset recovery rate sometimes is an accrued number with a significant portion of total recovered amount paid in the following years or promised to be paid later. The longer the lead time is, the more uncertain the realization of these payments. The reported asset recovery is also the sum of the realty and other goods recovered and the total cash recovered. The recovered properties have to be converted to cash through auctions, mostly at deep discount. To be conservative, the cash recovery rate might be a more realistic number for comparison in this case. In 2001, Huarong's reported cash recovery rate was 32.5% before deducting workout expenses. If we apply this rate in the Liu, Mingkang, International Financial Report, 2001-2002, p. 339, 02/2002, Bank of China International Finance Research office. 36 sensitivity analysis and assume 2% workout expenses, Huarong actually would give up only 20% potential return to foreign investors (Table 10). Second, loan portfolio sales to foreign investors could speed up the disposing speed and thus avoid the evaporation of asset value. It is, in fact, a price issue between wholesale and retail. Huarong already received the up-front payment which could potentially be used to boost its overall return if invested prudently. Third, by selling the NPL portfolio, Huarong could share the risk with foreign investors and save substantial workout expenses from the deal. Finally, without giving up a lion's share of return to the foreign investors, it would be very hard to attract foreign capitals to China's much riskier NPL market as compared to other Asian countries. Chart 4: Return Distribution Between Huarong and Morgan Stanley 60.00% 50.00% 40.00% 0 Huarong AMC N Morgan Stanley .Z 30.00% 20.00% 10.00% 0.00% 10% 20% 30% 33% 40% 50% 54% 60% 70% Total Recovery Rate The 32% cash recovery rate, however, is a benchmark for Huarong's return in this deal. It may not apply to Morgan Stanley because a 20% of return could not justify the opportunity cost of Morgan Stanley's real estate investment fund given the fact that it had to bear very high risks in an uncertain market such as China. However, if Morgan Stanley were to achieve a recovery rate above 50%, its return would be three times that of Huarong. At such rate the risk is justified (Chart 4). In this case, a higher recovery rate than Huarong's average cash recovery rate of 32.5% is feasible. First, the quality in the sold loan portfolios was higher than that of Huarong's overall NPL pool. Even though it was denied by Huarong personnel, some resources still showed that about 40%- 60% of the NPL portfolios sold in this deal were collateralized. Collateralized NPLs tend to have a higher recovery rate (Chart 5). If we arbitrarily assign th...
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