Foreign investors betting big on mortgages in China

Distressed debt fund managers including Bain Capital Credit are exploring China’s ‘secured’ lending practices.

Amid prevailing concerns about China’s growing pile of non-performing loans, foreign distressed debt investors are targeting mortgage enforcement and foreclosure in certain cities in China where managers can either try to preserve the operating value of an asset or enforce it against a mortgage.

Distressed debt investors including Oaktree Capital Management and Bain Capital Credit have increased their Chinese NPL portfolio exposure over the past 18 months.

Barnaby Lyons, a Hong Kong-based managing director and head of Asia at Bain Capital Credit, and his team have been focusing on enforcement proceedings against mortgage-backed properties because investment managers can either restructure the debt or liquidate the underlying properties.

“In many cases, the real estate itself is not necessarily a problem in China, rather, the lending practice or the debtor is,” Lyons said, adding that cashflow-based lending is not common in China as lenders require borrowers to provide collateral, typically properties.

PDI understands that Bain Capital Credit’s preferred NPL acquisition size in China ranges from $200 million to $300 million per transaction, depending on the practices of local provinces and sellers.

Still, foreign distressed debt investment managers face challenges. For instance, industry researchers have pointed out that there is no standardised practice in personal bankruptcy law in Chinese residential mortgage enforcement proceedings, according to a working paper, Mortgage Enforcement and Public Regulatory Actions in China in Selected Chinese Cities, published in July 2016 by The Lincoln Institute of Land Policy, a Massachusetts-based private think tank.

Yvonne Siew, a Singapore-based executive director, Asia Pacific and head of the capital advisory business at CBRE, told us that, as the rule of law is seen as unpredictable across cities in China, enforceability risk may in reality be higher than the level at which it has been underwritten.

For instance, her team has invested in Chinese real estate equity and debt investment opportunities, but her clients are primarily interested in top-tier cities: Beijing, Guangzhou, Shanghai, and Shenzhen.

Lyons agrees that mortgage enforcement and property liquidation do not work evenly across local jurisdictions. However, in certain provinces and cities, there is a professional judiciary measured by clear key performance indicators and the courts have become increasingly efficient in resolving NPL cases, he added.

In addition, repayments from the mortgage enforcement process do not necessarily occur offshore or cross-border, Siew added. “[This] could be challenging,” she noted.

Another challenge is rooted in financial guarantee companies which banks are relying on for loan purchase and loan servicing, the paper shows. These companies are not regulated by financial or housing agencies.

It also pointed out the complexity in land ownership structure, which creates uncertainty and increases risks for lenders.

In addition, as debt structure and land ownership are more complex in commercial property mortgages than residential mortgages, the proceedings can be more expensive than managers estimate, adding extra costs from getting pricing levels for linked vehicles to working on tax recovery, according to Siew.

It is actually very difficult for a foreign investor – on its own – to simply purchase a portfolio of distressed loans and resolve the loans through foreclosure and other creditor rights and remedies, said Joel Rothstein who is responsible for the Asia real estate practice at Greenberg Traurig, a law firm headquartered in Miami.

He added that it is challenging for non-local distressed debt investors to simply purchase a portfolio of distressed loans and resolve the loans through foreclosure and other creditor rights and remedies. “It may be necessary to acquire the assets instead from an asset management company or in a joint-venture basis with the asset management company,” Rothstein added.

In fact, in most NPL portfolio acquisition cases, foreign investment managers have joined with local partners to acquire the portfolios from asset management companies which are authorised to bid on bank NPLs.

For instance, Oaktree Capital announced in 2013 it had signed a memorandum of understanding, intending to jointly invest in distressed assets in China in partnership with China Cinda Asset Management – one of four government-backed groups mandated to buy bad debt from banks.

KKR also formed a partnership – with China Orient Asset Management, a state-run asset manager – for credit and distressed debt co-investments in China focusing on the property sector, according to a statement in 2016 from one of the affiliated units, China Orient Summit Capital.

However, an industry source who requested not to be named, told PDI that foreign participants have fewer tools at their disposal to collect the debt, compared with local participants. Some small local participants use “guerrilla tactics”, the source added.

“The most effective way [in this case] is not to sue you (borrowers) in court – they are going to take two years to take your house. Rather, they are going to scare you so that you pay back their loans,” he said.

However, Ted Osborn, a Hong Kong-based partner and leader of the restructuring and insolvency practice at PwC China said in a Bloomberg TV interview that the price level of these loans has come down due to less competition for NPL portfolio acquisitions.

The latest report, published in November 2018, shows the market has seen an uptick in sales activity since 2015. For instance, among 27 portfolios sold to foreign investors, at least 12 transactions were recorded during 2018. The report also identifies eight exemplary foreign buyers: Oaktree Capital, Lone Star, Goldman Sachs, PAG, Bain Capital Credit, CarVal, Blackstone, and LVF Capital.