Finding a local partner a possible way in to China’s potentially lucrative bad-debt securitisation market, report says

Western companies looking for distressed debt opportunities amid a rise in non-performing loans in China may find the going tough due to legal, regulatory and other hurdles, and would be advised to try partnerships with local entities in China, according to experts from investment bank Houlihan Lokey.

According to the latest figures released by Standard & Poor’s, Chinese banks’ non-performing loan ratio is estimated to almost double to 3.1 per cent by the end of this year compared with 2015. The ratio among Chinese lenders was 1.67 per cent at the end of 2015, according to China Banking Regulatory Commission. But many market analysts believe the true rate could be as high as 20 per cent.

The government has been looking at a number of ways to deal with the problem, with securitisation one of the options. The four asset management companies, China Huarong Asset Management, China Cinda Asset Management, China Orient Asset Management and China Great Wall Asset Management, set up in 1999 to process bad loans from the country’s big four state lenders, have all sought, at one point or another, to sell tranches of NPLs to investors, but with mixed success.

In a newsletter published jointly with Mergermarket, analysts from Houlihan said they did not expect quick progress in the resolution of the bad-loan problem. They said that the process could take a decade or more, especially as China’s economy slows. Given that the majority of the NPLs owned by the four asset managers are commercial and industrial, economic deceleration would be bad news for any plans to securitise such loans, they said.

On top of this, they added, the road for foreign investors to get involved in the NPL securitisation market is a difficult one.

“The details of specific funding and loan sale/purchase arrangements between selling banks, AMCs and other financial institutions involved in the process are not well understood by foreign investors due to the opaque nature of these transactions,” said Houlihan Lokey’s global head of portfolio valuations, Cindy Ma.

Foreign investors would also face political pressures on the asset managers to keep the problem within China and not be seen selling the debt to overseas buyers, while there are also challenges of valuation, pricing, competition and investment demand in a finite universe of buyers for securitised products, the analysts wrote.

However, the report suggested that the way in for foreign investors is not shut, noting that in 2013, Oaktree Capital Group entered into a joint venture with Cinda, while in January 2016, KKR joined hands with Orient.

“What we do expect in 2016 … is for large global distressed funds to start testing the waters, potentially through partnerships or co-investments with on the ground entities at a small scale. Once the investment thesis is tested and proven to be a viable strategy, we would then expect rather large investments by a small number of investors or even dedicated funds,” the analysts wrote.

This article replaces an earlier version which contained instances of information incorrectly attributed to Houlihan Lokey and quotes wrongly attributed to analysts. The investment bank did not warn of any rise in bad loans and did not make any predictions on the outlook for bad loans or any forecasts of how much they may be. It also adds a missing reference to the report being jointly produced by Mergermarket.