The highly fragmented market for distressed debt in China has enjoyed a steady flow of deals in recent years, and pricing is set to improve for debt buyers due to the impact of the coronavirus crisis, according to one of the few foreign operators working successfully in this space.
Estimates of China’s legacy non-performing loans range from US$1.5 trillion to more than US$3 trillion dollars, says Benjamin Fanger, managing partner and founder of ShoreVest Partners, a private investment firm specialising in Chinese distressed debt and special situations such as bridging debt.
Before COVID-19, there was already a significant flow of non-performing loans (NPLs) due to a strong government focus on cleaning up the banking system by recognising and selling NPLs, Fanger told the Investment Magazine Fiduciary Investors Symposium.
Speaking with Alex Proimos, Investment Magazine’s head of institutional content, Fanger said China’s experience with Covid-19 has yet to cause a spike in the availability of NPLs as the Chinese government has asked banks to implement forbearance with loan defaults like many other countries around the world. But pricing for investors is improving.
“One difference [since the onset of COVID-19] is you have a lot fewer potential buyers in China with liquidity to be able to buy these non-performing loans so that’s likely to cause some downward pressure on the pricing that the sellers can get for the loans they’re trying to sell.”
Post-forbearance, more loans will be recognised and prepared for sale, and sent to the four big asset management companies (AMCs)–known colloquially as ‘bad banks’–which are essentially clearing houses where they are put to market, Fanger said.
These won’t likely start coming through until the end of this year or even later, but when they do, pricing and deal flow for debt buyers will likely improve, Fanger said.
Fanger’s team has been operating China for over 15 years, investing in over 15,000 Chinese NPLs. ShoreVest adopts a strategy of buying debt backed with assets, typically senior secured loans backed by buildings.
While real estate sales volumes have fallen this year, prices haven’t yet, Fanger said, and even if they do, they would have to fall a long way to impact ShoreVest’s investments.
“Fortunately for investors like us we don’t price to anything close to the value of the underlying collateral, so we are buying NPLs at about a third of the underlying collateral’s value and even the special situations we do are usually less than 50 per cent loan-to-value.”
The Chinese legal system has improved significantly in the 15-plus years ShoreVest has been operating, taking one or two years for a “plain vanilla case” enforcing credit, compared to four or five years when ShoreVest first started, Fanger said.
But one area where foreign investors do run into trouble is situations that might cause social unrest, and these need to be spotted and avoided as part of due diligence.
“If the building we want to auction employs thousands of people and there’s no potential buyer that can continue to employ those people, so essentially you have to lay off hundreds or a thousand people, the government, especially the local government, is going to be very concerned about protests,” Fanger said.