As appealing as the $ 1.4 trillion distressed asset pile in China is, there is little reason to believe that foreign investors will go along with substantial gains.
Prices are falling again after the blockbuster of 2017, when a wave of national institutional currency pushed the value of distressed debt to nearly 80 cents to one in 30 dollars, reflecting in part a new supply and in part, a crackdown on the shadow banking system that previously allowed unproductive loan purchases, according to Dinny McMahon of Macro Polo, an internal think tank of the Paulson Institute.
About 3,000 local investment funds, well familiar with the basic rules of China's non-performing assets, have fallen back at the moment. Returns on distressed assets declined as their quality deteriorated. The fruits at hand, such as real estate debt, which is easily recoverable, cost too much or in cities where the real estate market has begun to collapse. New bad loans are expected to hit the market as China tries to clean the house and remove overburdened borrowers.
Having been ousted until now, foreign investors are invited with open arms. Earlier this year, the State Administration of Foreign Exchange further relaxed the requirements of a one-year pilot program that facilitates cross-border transfers of Chinese NPLs to foreign investors through an exchange. In the past year, approximately 12 portfolios (including at least three loans) have been sold to companies such as Oaktree Capital Group LLC, Lone Star Funds and Goldman Sachs Group Inc., notes McMahon.
They should not be too excited. The choice will probably be minimal this time, compared to the peak of bank clean-up in the late 1990s, when China set up four asset management companies to deal with bad debts resulting from the Asian financial crisis.
In theory, the inflow of foreign institutional capital should be positive, contributing to the elimination of China's over-indebtedness while offering troubled debt specialists opportunities to leverage their expertise. However, it is becoming increasingly difficult to find good portfolios with high recovery rates, although the increase in supply and the weakening of demand are leading to easing of prices. Although underwriting in China is not a sneaky science, it requires in-depth knowledge of the market in terms of valuation, valuation and risk, said PricewaterhouseCooper in a report on China's non-performing loans.
The recovery and resolution of bad debts is usually the responsibility of debt managers, whose limited presence impedes the achievement of returns. If investors are not able to tax the collection to third parties, the legal system is the only way forward. The more difficult the process, the more expensive it is.
Investors on the troubled Chinese debt are still waiting at internal rates of return of nearly 15%, a noble target. To put this into perspective, consider the results obtained by local experts: China Cinda Asset Management Co. posted an annualized average annual return of 8.1% on some of its troubled debt assets in June of this year.
These returns do not seem convincing, given the costs and risks. Bad assets are not yet a good business in China.
To contact the author of this story: Anjani Trivedi at firstname.lastname@example.org
To contact the editor responsible for this story: Matthew Brooker at email@example.com
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Anjani Trivedi is an editorialist of Bloomberg Opinion which covers industrial companies in Asia. She previously worked for the Wall Street Journal.
© 2018 Bloomberg L.P.