SHANGHAI — The specter of non-performing loans is once more looming over China.
The quantity of troubled debt, which has been rising as a result of economic downturn since this past year, is very likely to rise further with monetary authorities asking banks to actively lend cash to companies hit by the publication coronavirus outbreak. And overseas distressed debt investors, frequently referred to as vulture funds, see chance. The government tolerates foreign currency because it supports the market, putting China on the international front for investing in poor loans.
The 19-narrative Shuibo Hotel stands at the middle of Kunshan, a town in Jiangsu Province, a few 70 kilometers west of Shanghai. The marble-floored lobby appears lavish, but a closer look shows cracks and stains. Lighting is kept to a minimum even in the day. The 300-seat restaurant has been shut.
A booking site proves an overnight stay in the hotel prices between 300 yuan and 400 yuan ($43-$58). It is more costly than business resorts nearby, which cost approximately 200 yuan per night. “We had not been compensated. However, the resort became a quarantine centre for COVID-19 sufferers in February and March with monetary assistance of 2.8 million yuan in the local authorities. It gave us a fresh lease on life,” said a worker in a cafe at the resort, the only company open.
The resort is among those properties placed on sale by China Great Wall Asset Management, a government-backed bad loan disposal firm. Having purchased the resort in the Industrial and Commercial Bank of China for 70 million yuan many decades before, the management company is searching for an investor to purchase the home for 120 million yuan. “The price is only for show. An institutional investor arrived to observe the resort lately,” boasted an origin near the provider. Local governments apparently request the resort be kept open for the sake of employment. Presentation to possible investors may be the following motive.
The Shuibo Hotel is only 1 example of this non-performing loans in Chinese financial institutions. The outstanding volume of these debt held by commercial banks stood at 2.6 trillion yuan at the end of March. Loans classified as “in danger” equates to 4.1 trillion yuan. Analysts agree that lots of the at-risk loans in China have actually become desperate. The combined quantity of non-performing and at-risk loans surpasses 100 trillion yen ($950 billion). PricewaterhouseCoopers estimates the quantity of widely defined NPLs held by banks and disposal businesses reached $1.5 trillion in 2019.
As a point of contrast, Japanese financial institutions held non-performing loans worth a joint 52 trillion yen ($492 billion) in their summit in 2002. Even if the gap from the financial dimension of Japan and China is accepted into consideration, excessive debts and poor loans are the Achilles’ heel of the Chinese market.
Another government-backed Entry firm, China Orient Asset Management, states average market costs of desperate debts were approximately 30% of the publication value at 2019, down about 10% from the year before. The falling prices have drawn the attention of foreign investors.
Oaktree Capital ManagementBain Capital, Lone Star Funds and Goldman Sachs purchased Chinese non-performing loans totaling $1.1 billion last year, according to PwC. Assuming that their market value is one-third of their book value, the loans are worth 350 billion yen. Separately, these investors reportedly spent at least $2.5 billion on refinancing bonds with higher credit risks and mortgage-backed securities.
Thus, it can be said that the second act of foreign investment in Chinese bad loans has begun. The first took place in the early 2000s when bad loans accounted for between 20% and 40% of outstanding loans held by state-run banks. The government set up disposal companies, and transferred 1.4 trillion yuan of distressed debt to them. Goldman Sachs is one of the foreign entities that took charge of the final stage of disposal.
But vulture funds left China after the 2008 global financial crisis. So why are they coming back now? “Falling prices of NPLs have led to an internal rate of return of around 15%, which foreign funds want to achieve,” says Li Jiaqi, an executive at China Ping An Trust, a Ping An Insurance subsidiary providing intermediary services for distressed debt transactions.
The investment environment has turned favorable for them, as the U.S.-China “Phase One” trade agreement signed in January allows American investment funds to purchase NPLs directly in Chinese banks, on condition that they obtain a license from Chinese authorities. The first fund to do so was Oaktree in February. As the economic slowdown is causing the volume of non-performing loans to grow, authorities have changed tack to utilize international money. As a result, U.S. companies are getting more investment opportunities in China.
Foreign investors, however, don’t have a magic wand turns Chinese bad loans into money, says Li. “Actually they are less capable than domestic disposal companies, partly because of human resource shortages. What they are doing is mostly selling collateralized property,” Li says.
One company symbolizes the difficulty of collecting debts. Jiangsu Sanyuan Stainless Steel Products is located in a village in the city of Taizhou in Jiangsu. It was supposed to have been liquidated in the spring of 2017, but factory operations are continuing at one third of capacity. The Bank of China, which had extended a loan of 12 million yuan, exercised its right and tried to sell the property to recover the debt, but it hasn’t succeeded.
The office next to the factory was cluttered with toys, while children of managers and employees ran around. From seemingly out of nowhere, company representative Gu Yuming suddenly appeared. “This is a farming village,” Gu said. “Some of the land is collectively owned, which means a sales contract cannot be signed without approval from the village committee.”
The committee chair, Gu’s relative, has allegedly promised not to approve the sale as long as the company maintains employment. A Bank of China document shows that the lender has lowered the appraisal value of its loan to the company to virtually zero.
That foreign investors are taking on the hard task of debt collection suggests that it brings in worthy returns. One source says Bain and Oaktree have succeeded in raising new funds. But the pandemic prevents investors from coming to inspect propertieswhich could possibly lead to a year-on-year decline in investment volume in 2020. While bank supervision authorities forecast a surge in non-performing loans, many think that vulture funds will be in full operation mode from next year.
Interestingly, the U.S.-China confrontation has had little impact on fund activities. There’s only one reason that pragmatic China allows international investors to operate: it needs money for poor loan disposal. A PricewaterhouseCoopers report discloses that a authorities-affiliated disposal company wanted to sell debts even if doing this generates a secondary loss. A critical point really is approaching.