Chinese distressed debt

Buyers' market for Chinese NPLs created by tighter credit

Stricter credit requirements, the Sino-US trade war and defaults are creating a bonanza of Chinese non-performing loans for foreign investors.
China's bad loans are expected to rise this year.
China's bad loans are expected to rise this year.

Tighter credit requirements, defaults and the Sino-US trade war are boosting the supply of nonperforming loans (NPLs) in China, which is attracting foreign investment.

“Every default, we get happy. Our business in Chinese NPLs is growing rapidly,” said Ronald Thompson, Asia managing director of international turnaround and investigation firm Alvarez & Marsal. 

At a press conference in Hong Kong on Wednesday, Thompson said that over the past year or so, his team has grown rapidly.

Year-to-date, 68 corporate bonds totalling Rmb46 billion ($6.7 billion) have defaulted in China, more than any previous year except 2018, according to Chinese financial data provider Wind. The brisk rate of corporate bond default this year puts it on course possibly to surpass last year, when a record 125 corporate bonds totaling Rmb121 billion defaulted.

Foreign investment in Chinese NPLs is forecast to rise this year. PwC predicts that $1.5 billion of foreign capital will be invested, the same amount as in the 18-months from mid-2017 to the end of last year.

“Last year, people thought it was a seller’s market because prices [of NPLs] were higher. People expect that to change with tighter regulations,” said Thompson.

This year has become a buyer’s market. Auction prices for Chinese NPLs have hit lows unseen in nearly a decade. Prices dropped to nearly 31 cents on the dollar in the third quarter of 2018 from a record high of 48 cents to the dollar in the first quarter of 2017, according to a January report from UBS.

NPL prices are expected to fall further due to greater supply. For the first quarter of the year, the amount of NPLs in Chinese commercial banks grew by Rmb95.7 billion to Rmb2.17 trillion, the highest level since 2003, according to the China Banking and Insurance Regulatory Commission (CBIRC)

In response to stricter requirements, Chinese banks will be selling more NPLs to foreign investors. Regulators do not want a high level of risky assets in banks, so banks will sell NPLs to investors, Thompson explained. If a bank’s NPL ratio gets too high, it may bring down the bank, which can have a knock-on effect on other financial institutions.

At the end of last year, several Chinese banks had NPL ratios above 40%. This poses serious credit risk, according to a recent National Audit Office report.  

Chinese state media reports that the CBIRC is encouraging banks to classify loans overdue by 60 days or more as NPLs, although this is not a formal regulatory requirement. Currently, the CBIRC requires banks to include loans overdue by 90 days or more among NPLs. This measure is expected to increase the banks’ NPL ratios significantly.

Other causes for rising NPLs include shadow banking and the ongoing Sino-US trade war. US tariffs on over $200 billion of Chinese products will prove challenging for weaker Chinese manufacturing and trading companies with low profit margins. As a result, NPLs companies are likely to rise.

Manufacturing accounts for the biggest share of NPLs at 36% in China, followed by retail and wholesale at 31%, according to Wind.

Foreign investors are estimated to have invested over $2 billion in China’s NPL market since 2015. From 2015 to 2018, foreign investors acquired 27 NPL portfolios in the country. Oaktree, Goldman Sachs and Lone Star Funds are the most active foreign buyers of NPLs in China, each of which has closed five deals since 2015.

Foreign investors prefer NPLs in the more developed Chinese provinces like Jiangsu, Zhejiang and Guangdong, due to their more established judicial systems, explained Thompson.

A structured agreement is indispensable for foreign investors in China, otherwise they may not be able to get their money, said Jiffriy Chandra, managing partner of Hong Kong asset manager TransAsia Private Capital, at the Fixed Income Leaders Summit in Hong Kong at the end of May. “In China, it’s an absolute must to perfect the documentation, so you can take control of assets,” he added.

Another draw for foreign investors in China’s NPL market is its sheer size. While the CBIRC has put the official amount of NPLs at around $400 billion, China-based distressed debt investor Shorevest Partners estimates that NPLs could be as much as $3.1 trillion.


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