Exploring China Huarong’s diminishing pursuit of NPL business

It has emerged that China’s largest distressed asset management company was paying significantly less for newly added distressed debt assets in 2018 than it had been the previous year.

Data compiled by Moody’s show that Huarong Asset Management Company, the country’s largest state-backed asset management firm, recorded acquisition costs of 199.4 billion yuan ($28.8 billion; €25.7 billion) for these assets for 2018. This represented a sharp drop on the 408 billion yuan recorded in 2017.

The decrease suggests one of two developments: that the company has cut back on its core business of acquiring banks’ distressed asset portfolios; or that the primary sellers of NPL portfolios have significantly reduced their prices.

Industry sources have said the pricing levels of Chinese bank NPL portfolios have been high in recent years. Gregory Ritchie, a co-founder and managing principal at LVF Capital, told Private Debt Investor: “It [the high pricing level] is primarily because of the AMCs’ low cost of capital compared to private capital and [because of] some aggressive buyers both onshore and offshore.” Ritchie believes the lower acquisition costs are the result of distressed asset management companies pulling back on their core business activity.

It is understood that Orient Longxin Capital, the manager co-founded by LVF Capital, purchased at least one China bank NPL portfolio from Huarong AMC. The portfolio was originated in Hunan province in southern China.

According to company disclosures, LVF Capital in 2017 launched a $500 million closed-end China distressed debt fund, Orient Longxin Fund I. Its strategy includes investments in distressed real estate assets.

Other industry participants believe the fall in the amount of NPLs acquired by Huarong is related to the impact of ongoing investigations. Reuters reported in January that Chinese prosecutors had ordered the arrests of four former senior executives at the company’s subsidiaries. Huarong did not respond to our requests for comment on the report.

Sean Hung, a Hong Kong-based vice-president and senior analyst at Moody’s, told PDI: “In 2018, the acquisition cost of newly added distressed debt assets by Huarong AMC substantially declined. It could indicate that the company’s activities in the distressed debt management market or acquiring the bank NPLs was affected by the investigations into its senior management and restructuring.”

Another industry source who preferred not to be named said buyers’ sentiment had changed over the past year: “Some onshore NPL investors are turning more cautious.” The source added that their team had also looked at a few potential purchases but decided not to proceed with them.

Among private debt managers in China, Bain Capital Credit has purchased NPL portfolios from Huarong AMC that were originated in the central province of Hubei, as reported by PDI. A Hong Kong-based spokeswoman for Bain Capital Credit declined to comment on the investigations or their implications for other AMCs’ decisions.

Going local

The Moody’s data also suggested that provincial banks have been rapidly emerging into the country’s NPL market over the past year. The rating agency said in the report, published on 11 June, that there were more than 50 provincial-level licensed distressed AMCs, most of which had been created over the previous three years.

It added that the China Banking and Insurance Regulatory Commission would further encourage smaller rural and city commercial banks to recognise and dispose of their problem loans after the country’s National Audit Office highlighted a surge in bad debt at small banks in April.

The rise in the recognised volume of NPLs is in part the result of a regulatory requirement, introduced in February 2018, whereby loans that are overdue by more than 90 days have to be downgraded to the status of ‘non-performing’. Research by EY into publicly listed state-owned banks showed that some had disclosed higher loan loss provisions in their annual reports as a result.

In fact, official data showed that the amount of NPLs held by China’s commercial banks had surpassed 2.16 trillion Chinese yuan at the end of March – the highest level since 2003.

Given the sheer size of the NPL market in China, some Chinese distressed debt investors have been relying on their partnerships and relationships with domestic loan-servicing companies that have strong relationships with provincial AMCs.

Offering his view on specific provincial jurisdictions and performance indicators for NPL buyers, Ritchie said there are legal risks associated with servicing loans originated at a local level within China. “As a fund, we act as a master servicer, and we do need a local team for local loans,” he added.

Another investor in Chinese NPLs added that it was important to have strong working relationships with loan servicers in specific provinces and align economic interests with compliance requirements.