Chinese NPLs prove hard to access

A new report from PwC shows that while China has a big NPL opportunity in theory, there are major hurdles restricting foreign involvement.

Despite the stock of non-performing loans in China being estimated at over $700 billion, only five foreign investors managed to close deals in 2016, according to a PwC report.

The investors were Shoreline, which completed several portfolios, plus Lone Star Funds and Goldman Sachs, which each acquired two portfolios, while PAG and Oaktree Capital closed one portfolio each, according to the report.

“We’ve got a good relationship with an AMC. And they show us deals. But the quality of what they show us is not good. We’ve looked at 40 opportunities over the last year, and we’ve only bothered commissioning due diligence on one of those,” said a foreign NPL fund on the Chinese market.

The report explains that with NPL investments delivering over 15 percent IRR in developed markets like the US or Europe, managers require high-teens IRRs in developing countries such as China. Given that most portfolios in China only generate high single-digit or low double-digit IRRs, closing deals at a sensible price becomes the most challenging issue for foreign investors in the Chinese NPL market.

The Chinese government, the major shareholder for most of China’s listed banks, still has the liquidity to prevent banks or AMCs from becoming forced sellers of NPLs.

“Beijing posted an ‘informal request’ for our sector to acquire a certain level of NPLs from the banks last year. So we are seeing some of our competitors overpaying for NPL packages. A rival [‘big four’ AMC] paid RMB 800 million for one deal last year. Our due diligence implied a valuation of only RMB 600 million,” said the deputy general manager at one of the big four AMCs in China.

The report also mentions various measures that have been introduced by the banks to relieve pressure on NPLs. Asset-backed security (ABS) is one of the most popular channels for Chinese banks to dispose of NPLs, with 14 issuances of NPL ABS deals which generate as low as three to five percent return on the senior tranches. Also, online platforms such as Taobao, the Chinese version of eBay, have been used by the banks to sell NPLs.

Although the competitive landscape for foreign investors to enter the Chinese NPL market remains difficult, they have the advantage of being able to write large cheques whereas most domestic parties are limited to deals of around $100 million. The report suggests investors need to build up their servicing teams as the underwriting and exiting process requires extensive networking and local knowledge.