China’s banks may be selling off non-performing loans and its politicians making noises about the dangers of debt-fueled growth, but overseas debt managers hoping for greater access to a corporate debt pile estimated at nearly 145 percent of GDP should still pause for thought.
Industry veterans have been here before. A decade ago the sales were of policy-directed loans to state-owned enterprises (SOEs), dictated by government directives to clean up banks’ balance sheets ahead of them going public.
Today, the NPLs may be higher-quality loans to private sector companies and motivated by lenders wanting to operate in line with their international peers, but that doesn’t mean politics don’t play a part – particularly when the NPLs are worth 1.2 trillion yuan ($180 billion; €160 billion), according to the China Banking Regulatory Commission.
A complex web of relationships between government, the private sector, SOEs and asset management companies needs to be untangled by the intrepid investor.
That has been made even more challenging by President Xi Jinping’s anti-corruption campaign and a steady centralisation of power. While local officials may be less prone to accepting bribes, foreign companies hoping for a more level playing field describe a China marked by less government transparency and more ideologically-driven bureaucracy.
Benjamin Fanger, the co-founder of Shoreline Capital Management, a firm set up in 2004 to connect institutional capital with distressed Chinese debt, told PDI the Chinese legal system has strengthened significantly over the past 10 years as lawyers, financial professionals and judges amass more experience in dealing with debt enforcement cases. And that while Xi’s anti-corruption drive has helped ensure judges are less likely to take a bribe from a borrower than as recently as four years ago, concerns persist as to whether adequate protections exist for China’s NPLs to be an attractive opportunity.
These include legal structures to have the proper securitisation document with a payment waterfall, along with trust banks to run that waterfall and a servicing apparatus, Jamie Weinstein, global co-head of special situations at KKR, told PDI.
As the market for NPLs in China continues to evolve, there will certainly be lucrative opportunities for foreign investors, but only those with the capability to understand and capitalise on the assets those loans provide access to and confidence in their strategies for getting capital out of the country. And given the complexity of the current environment in China, a note of caution is certainly appropriate.