Resolving dilemmas: Restructuring paths of non-performing real estate projects

The main regulatory indicators on the banking industry for the second quarter of 2018, which the China Banking and Insurance Regulatory Commission released on 13 August, show that the total non-performing loan balance of commercial banks as of the end of the second quarter stood at RMB1.96 trillion, increasing by RMB182.9 billion from the end of the previous quarter. The NPL ratio of commercial banks rose 0.12 percentage points from the end of the previous quarter to 1.86%. Generally, there was an uptrend in NPLs.

Real estate accounts for a large proportion of collateral securing NPLs. Therefore, the capacity for disposal and revitalization of real estate projects largely affect the disposal effect of non-performing assets. At the same time, the Chinese real estate market has entered the era of co-existence between new project constructions and stock assets renewals. Restructuring and revitalization of stock real estate assets have become necessary to resolve the dilemma of non-performing real estate projects, as well as the purpose of integration of social resources.

With the introduction of a series of stringent regulatory policies, such as the Capital Management Measures for Financial Asset Management Companies (Trial Proposal) implemented on 1 January 2018, and the deepening of supply-side structural reforms, asset management companies are increasingly inclined to “return to the original mission” and “focus on the main business”, while restructuring of non-performing real estate projects is one of the focuses of their main businesses.

Non-performing causes. According to our many years of experience in the field of restructuring of non-performing real estate projects, the reasons on the macro level they get bogged down mainly include: (1) macro-control policies of the government; (2) changes of relevant departments and planning adjustments of the government; (3) significant changes in the overall economic environment; (4) the staged and regional relation between supply and demand of the related market.

The main reasons at the micro level are: (1) insufficient professional competence and inaccurate market positioning of the developers; (2) excessive financial leverage, heavy debts and capital chain breaks of the developers; (3) illegal construction and failure to complete approval procedures; (4) stoppage of project development due to disputes among project partners; (5) termination of project development due to criminal charges against the developers.

Key issues on project disposals. Non-performing real estate projects often involve the following issues from a legal perspective. Firstly, the approval procedures of the projects are absent or flawed by law, causing uncertainties to the success of the remaining construction, acceptance and sale of concerned projects.

Secondly, debt burdens on some projects may get tangled. Creditors may involve those with priority rights, such as creditors in scenarios of defaults of project payments, state-owned creditors or those with investments from state-owned enterprises, foreign-invested creditors or those with foreign capital invetments, or creditors in private lending, etc. If projects are bogged down, their cashable property is limited in value. The diverse creditors have differentiated or even conflicted interests, leading to difficulties in unified settlements and implementations. In particular, the assets of the same project may involve multiple rounds of seizures and mortgages. It is difficult to clear its seizure, mortgage, pre-sale and other issues due to long-term pendency, adjustment of governing authorities, technical upgrades and other circumstances.

At the commercial level, problematic projects require heavy new investments to solve existing debt problems and to complete outstanding construction work on the projects. In general, the original developers completely lose their credibility, after being incapable of initiating their own restructuring amid a lack of credit basis. Revitalization and restructuring require introduction of external credit and capital, as well as involvement of professional teams on project development and operation.

To respond to the problems, the “multi-dimensional mode” emerges.

MULTI-DIMENSIONAL MODE

Traditional methods of disposals of non-performing assets primarily focus on the clearing and recovering of such assets through judicial proceedings. However, problems arise from the recovery method solely reliant on judicial enforcement procedures, such as long periods of disposal and lack of variety in the methods. On the other hand, it is impossible to realize the liquidity and maximize the value of the underlying assets of concerned debt. At present, AMCs and some professional investment institutions are strengthening the classification management of acquired assets and optimizing the acquisition and restructuring business with the adoption of a market-based disposal mode, resulting in the upgrading and reconstructing of the troubled real-estate projects and turning non-performing assets into good assets, by virtue of personalized and customized restructuring methods and relying on the integration of professional resources.

The first step is to analyze the causes of the problems that such projects incur and find out if there is any unsolvable obstacles in the project reorganization. The second step is to clarify the stakeholders involved in the projects and find out if the related value after reorganization can cover reasonable interest demands of all stakeholders. Meanwhile, it is also necessary to sort out the encumbrances on the indebted enterprises and their key assets, the nature of the creditors per se and the nature of the creditor’s rights, the settlement order of the debts, the legal relationship of the underlying debts, and their authenticity and legality.

Non-industrial investors also need to introduce professional companies and operation teams in real estate development to reposition, design, build, introduce investments and operate the projects to achieve risk controls and maximization of the project value. Based on the above works, targeted selection should be made of specific technical means for restructuring and revitalization of the projects, including conditional reorganization, phased and step-by-step implementation of credit-enhancement measures, benefit sharing and valuation adjustment mechanism in accordance with different demands of specific transactions, based on a reasonable expectation of the cycle of restructuring and how co-operative all parties are with each other.

With the increasing activity of the block-trading market in the real estate sector and the accelerated wide acceptance of exit methods, such as asset securitization, the multi-dimensional mode will play an increasingly important role in solving problems concerning real estate-collateralized non-performing financial asset projects.

Zhao Jiajia is a partner and Qu Xin is an associate at Merits & Tree Law Offices