China on the cheap

While groups like New York’s Avenue Capital are seeing distressed opportunities increasing around the world, China is currently grabbing most attention. Andy Thomson finds out why.

As someone who jokes that he attended law school because he couldn’t get into business school, Marc Lasry has been demonstrating notable business acumen since he launched New York-based global distressed debt investor Avenue Capital Group in 1995 along with co-founder Sonia Gardner. Having built a reputation as an astute purchaser of discounted debt positions, Avenue has managed to garner some $10.5 billion (€8.4 billion) in assets under management in the subsequent 11 years, while building up its employee roster to more than 200.

According to Lasry, now is a great time to be operating in the distressed arena. Well, he would say that, wouldn’t he? But, speaking at a recent conference staged by Swiss alternative asset manager Partners Group, it became clear that he had a point. In his presentation, he referred first to the US, where talk of impending economic stagflation grows louder by the day and where certain industries, such as automotive and airlines, have already imploded. In Europe, meanwhile, pressure stemming from the planned Basle II banking reforms relating to capital adequacy – and the likelihood that these rules will have to be complied with by 2008 – is thought likely to result in a bad loan bonanza.

But, for all that, Asia is the part of the world that Lasry and colleagues seem most excited about. The firm currently has around 70 staff in its Asian offices in Beijing, Bangkok, Hong Kong, Jakarta, Manila, New Delhi, and Shanghai. They are likely to be kept busy. According to sources, Avenue is shortly to close on a new Asia-focused fund that will give it somewhere in the region of an extra $1.5 billion to deploy.  

In speaking of the Asian opportunity, Lasry becomes most animated when referring to China. And there is good reason for that. According to conservative estimates, the non-performing loan (NPL) market in the country currently amounts to more than $400 billion (a recent report suggesting the real figure was closer to $1 trillion was allegedly withdrawn at the request of the Beijing authorities). In response to a question from the conference floor, Lasry admitted to viewing a large proportion of these debts as unrecoverable, but said that around a quarter of the market was potentially of interest to his firm (at least $100 billion worth of possible deals, in other words).

One question to consider is how a country that has delivered growth of around ten percent per year for the last seven years wound up with a bad loan crisis. Part of the answer is found in the pre-1999 era, when loans in China were typically made for political rather than credit reasons. Even though the Chinese government then did its best to reverse this situation, it continued to worsen for some years because, in Lasry’s words, “it was still the same guys making the loans”. Only in the last year or two have Western standards begun to be applied to credits and the NPL issue seriously tackled.

Lasry says in some cases it is possible to buy good state-owned portfolios in China for as little as 30 cents on the dollar. Even allowing for political risk and the opaque legal system in the country, he says that, given such valuations, investors are being overly rewarded for the risks they are assuming.

One reason why this might be the case is growing speculation that the brakes will soon be applied to China’s runaway economy. In fear of such an eventuality, state-owned organisations are seeking to tidy their books as much as they can before a fresh batch of bad loans begin to be racked up. And, as they go about that tidying process, investors like Lasry’s Avenue are standing by to clean up.