As bad debts clog Vietnamese banks, investors wait

HANOI - The soured loans clogging up Vietnam's banks and the rows of abandoned houses gathering mold in the Hanoi rain are signs of a sick economy. But to foreign investors they represent an opportunity for sparkling returns — if only the Communist government makes them welcome.

Neil Hagan, an American debt recovery specialist who wants to start a company servicing bad loans in Vietnam on behalf of foreign buyers, says he gets weekly calls from hedge funds based in Singapore and Hong Kong asking whether now is the time to scoop up some of the debt.

So far at least, he advises them to stay put.

"They see the kill, but they just can't get in," said Hagan, who serviced debt for Lehman Brother's and others in Asia after the financial crisis in 1998. Foreign investors bought billions in bad debt and distressed assets following the meltdown.

Hagan predicted that by the end of year a couple of smallish deals or "teaser cases" might be possible. He named private equity giants like Lone Star and Fortress as possible buyers. Other economists and investments bankers were less confident, noting the government would have to make significant changes in the law for this to happen smoothly.

Vietnam's banks lent out billions of dollars in the late 2000s as the government sought to stimulate the economy in the face of a global economic slowdown. Much of the money was lent with little oversight to state-owned companies, many of whom invested in the property market.

Now, with property prices slumping and the economy posting its slowest growth for more than 10 years, companies and individuals who took out the loans are unable to pay them back. These so-called non-performing loans are threatening to bankrupt many of the smaller banks and crimping lending at others, further squeezing the economy.

Selling bundles of soured loans to international investors is one way take them off the books of the banks. Typically, investors will buy tranches of loans along with their assets at significantly below face value. They hope to male make money by flipping the assets or spending money sprucing them to sell later or squeeze revenue from them. They employ loan servicing companies to carry that out.

But for this to work the government has to force banks to sell off its bad debt. Doing that in Vietnam will require well-connected bank chairmen and shareholders to accept losses, as well as the government to speed up state-owned enterprise reforms. Foreclosing on thousands of houses and small enterprises is politically difficult for a government which denies its citizens basic political rights but whose credibility rests in delivering rising living standards for them.

"Whichever way they turn, there is no easy solution" said Gareth Leader, Asia specialist at London-based Capital Economics. "But until you get the banks lending again, the economy is not going to fire."

Many observers say the government appears to be hoping that a global economic recovery will result in a rebound in asset prices in Vietnam. In the meantime, the banks can fudge the amount of bad loans on their books, a so-called "pretend and extend" strategy.

In May, Vietnam announced the formation of an asset management company to buy bad loans from banks, but there are widespread doubts over whether it will be effective. It has funds of $23 million. The banks have reported their NPL ratio to be 4.9 percent, but Fitch Ratings recently estimated it could be between three and four times that. The company might consider partnering with foreign investment institutions to make up the shortfall, analysts said.

"One American hedge fund could match the spending of the entire Vietnam Asset Management Corp," said John Sheehan, a NPL expert with Capital Services Group who recently visited Vietnam to meet with bankers. "If you put the infrastructure in place there are quite a lot of foreign investors willing to come in. The sooner they do this, the sooner the place will get moving again."

There are a host of roadblocks for NPL investors: Many of the worst debtors are state-owned companies, so recovering debts from them is seen as especially hard if not impossible. The heads of the companies could face criminal charges if they sell off assets cheaply because that would be "causing losses to the state." Foreigners are not allowed to own property or mortgages.

David Harrison, a lawyer with Mayer Brown based in Vietnam, said it appeared likely that government would change the law to allow foreigners to buy property assets linked to the loans, perhaps in partnership with the asset management company.

"I wouldn't sell Vietnam short in devising a formula that works on this, or some other unique structure," he said.

Investors will also be looking at the quality of the assets used as collateral against the loans. Lending during the credit boom was poorly regulated, leading to fraud and corruption within banks. Properties need maintaining and assets such as factories, machinery and ships quickly lose their value if left idle.

Hagan said one set of five related loans he was examining for a potential client had the same stock of steel as the collateral in each case.

"I don't know if they physically moved the steel each time but they used the same inventory," he said. "The branch manager must have been an idiot. Five guys in a row who pledged a bunch of steel that probably doesn't exist."