Established locally at the height of the Asian financial crisis in 2000, Deutsche Bank's strategic investment group celebrates its 10th anniversary this month. Stephen Le, head of the group and a veteran in Asia Pacific's distressed product market, spoke to FinanceAsia on the development of Asia's distressed market and where the opportunities lie.
What do you see as the key developments in Asia's distressed asset market during the past decade?
Our business was initially established locally in 2000 to seek out opportunities arising from the Asian financial crisis, with most of our activities linked to the trading of distressed loans from local banks desperate to recapitalise. Since then, we have seen the region's distressed market grow significantly in terms of product breadth and the variety of situations we encounter.
Along with the relatively straightforward trading of distressed bonds and loans, we have seen: the acquisition of equity stakes to drive management and debt restructurings in distressed companies; the acquisition of partially completed real estate projects; bridge financing; and some sizeable non-performing loan portfolio auctions.
The growth of the private financing and pre-IPO markets prior to the [recent] credit crisis also created a number of opportunities as investors sought to exit illiquid credit positions and funding for companies that were dependent on strong rates of economic growth dried up in the wake of the credit crisis.
Overall, we expect the diversity of distressed opportunities in Asia to continue to grow in spite of the region's highly liquid banking sector and a strong recovery in asset prices over the past year.
It seems the recent financial crisis did not create the flood of distressed opportunities many investors expected from Asia. Why is this?
I think it's fair to say the recent financial crisis was a developed market crisis -- a leverage crisis, if you will. With Asia's banks well-capitalised and plugged into increasingly large pools of onshore liquidity, the region's corporate sector has been able to access a reliable and deep source of credit, particularly in those countries where economic stimulus was largest.
This was of course a very different experience for companies in developed markets, which struggled to access credit from a strained banking system. It goes some way to explaining why we have not seen a large supply of distressed assets emerging from Asia over the past couple of years, with the exception of the leveraged buyout (LBO) market in Australia.
That said, the region is extremely diverse and there are a number of factors that can cause credit to become constrained. Such opportunities may be balance sheet-, regulatory- or market-related; the key is knowing where these opportunities are and how to access them.
How do you see the role of your business in relation to traditional lenders?
I suppose we are the people that step in when others aren't interested, providing liquidity when it isn't there and taking the time to work with the relevant parties to recover value from financing arrangements that are either close to, or in, default.
There are many aspects to the business: trading of more liquid securities such as loans and bonds; working with distressed borrowers to restructure their credit obligations; helping holders of illiquid and underperforming loans to exit their positions etcetera.
Some of the situations we get involved in require a lot of analysis and onshore expertise, particularly when navigating the region's fragmented legal systems. Having a local banking network really helps with this -- being able to call on colleagues at Deutsche's local branches is a huge advantage when it comes to sourcing and evaluating opportunities, as well as getting involved in the practical side of restructuring borrowers' debt.
Having this capability also allows us to get involved in a much broader range of deals, rather than being limited to the opportunities available in the region's main centres. For example, this may involve stepping in to resuscitate pre-IPO deals in China, taking stakes in incomplete real estate projects in India, or working out problem loans in Indonesia. Each scenario requires a significant amount of expertise and in-depth understanding of relevant legal processes involved.
Where has the greatest amount of activity been in recent months?
The Australian LBO market was particularly busy before the crisis and has subsequently provided a number of opportunities for distressed traders in the region. While Australian banks remained fairly immune to the crisis in terms of capital adequacy and enjoyed the support of a government-guaranteed debt issuance programme, the sheer volume of LBOs written prior to the crisis saw many banks seeking to sell heavily discounted or problem loans. This has been a particularly busy market for all originators of distressed assets and one where we have seen the greatest levels of trading activity in the region.
We have also started to see banks looking to offload what we would call 'out of favour' loans; loans that aren't quite distressed, but which are nonetheless at a discount to face value and tying up capital that could be more efficiently redistributed elsewhere.
Given the global economic recovery and the rebound in demand for credit, banks are taking a view to reallocating these funds to new loans, providing an attractive source of opportunities for providers of liquidity such as ourselves.
Auctions of non-performing loan portfolios also continue to attract a fair amount of activity, particularly now that markets have recovered and banks have the opportunity to re-deploy capital into new loans.
As asset prices improve, how do you see the market in Asia developing?
Supply will obviously be affected as asset prices recover, however opportunities with out-of-favour loans are growing quite strongly, particularly in Australia. These transactions are largely done on a bi-lateral basis, involving loans linked to illiquid assets such as real estate, and provide a means for banks to free up capital for distribution elsewhere.
As such, assets that are trading at smaller discounts to traditionally distressed assets, such as those trading at $0.70 to $0.90 rather than $0.20 to $0.40 on the dollar, will likely make up a larger slice of distressed activity this year.
It is however important to consider that even during the credit rally of 2005-2007, activity in the distressed space continued to grow as there are many factors that can contribute to instances of default, particularly in such a fast-growing region as Asia. The key is really being able to source opportunities and having the capability to work out situations in local markets around the region.
The real estate sectors in China and India will continue to produce opportunities, particularly with some of the larger scale projects that were underway prior to the onset of the credit crisis.
Regardless, as with any distressed transaction the key elements for a successful conclusion will remain the same: knowing the borrower; staying as close to the assets or collateral as possible; and finding the most efficient way of getting consent from all parties involved.
Stephen Le will be a speaker at our second annual Global Recovery Investing Summit: Maximising Opportunities in Distressed and Troubled Assets on May 4-5 at the Renaissance Harbour View Hotel in Hong Kong. For more information see: www.financeasia.com/distressed
