China’s $1.5 Trillion Pile of Bad Debt Lures Foreign Funds

(Bloomberg) --

China’s massive pile of soured debt is set to get even bigger, giving foreign investors more opportunities to try to profit from the cleanup.

Nonperforming loans and stressed assets are likely to keep growing after reaching $1.5 trillion in 2019, according to a new study from PricewaterhouseCoopers.

The mountain of soured borrowings is rising as the world’s second-largest economy opens further to foreign capital. As part of a recent trade deal, China is now allowing U.S. firms to apply for licenses to buy non-performing loans directly from banks.

While the PwC report didn’t discuss the new coronavirus, other observers say the epidemic may add to credit strains. That could further increase the need for distressed debt specialists to expand operations in China. Read more about how the illness threatens a broader wave of defaults here.

“The size of the distressed market is huge,” said James Dilley, Hong Kong-based partner at PwC, in an interview. “If you’re a distressed debt fund sitting in Boston, sitting in New York, sitting in London, the market is just so big it’s difficult to justify to LPs why you’re not looking at China,” he said, referring to investors known as limited partners.

The contagion could “wreak havoc” in certain areas of the economy and there will probably be a substantial increase in distressed debt unless the central bank injects liquidity, according to Oaktree Capital Group LLC’s co-chairman. China’s beleaguered banks could take a $800 billion hit as the sickness threatens large swaths of the economy, S&P Global Ratings said.

Read about Goldman Sachs’ view that Chinese policymakers may adopt a forbearance stance

Borrowing costs for Chinese firms have increased recently due in part to the virus concerns, and that could make it more expensive for weaker companies to refinance obligations coming due soon.

China’s $1.5 Trillion Pile of Bad Debt Lures Foreign Funds

China’s actual amount of bad loans has often been a source of debate. PwC’s measure is a broader one that includes NPLs, as well as loans on bank watch lists and NPLs held by asset management firms.

Official Chinese figures show that Chinese banks had 2.2 trillion yuan ($316 billion) of nonperforming loans reported as of the end of June.

However you slice it, the nation’s growing pool of soured debt is becoming harder to ignore.

PwC estimates that international investors made $1.1 billion of investments into NPLs in 2019, and a number of high-profile investors have been “screening deals and will be looking to close their first transaction in 2020.” Most of the transactions done by foreign investors in the current cycle have been in China’s richest regions including Jiangsu, Zhejiang and Guangdong, PwC said.

Investors are targeting annualized returns of around 13% to 15%, and adding leverage to boost this, PwC said. Anecdotally, there have been concerns about returns, and this is likely due to disappointing results on a handful of deals closed by foreign investors between 2015 and 2017, according to PwC.

Some investors were “naive” when it came to the time needed to recover individual loans, which affected returns, while the reduction in domestic liquidity since mid-2018 has made it tougher for some to on-sell their loans to local investors, the consultancy firm added.

©2020 Bloomberg L.P.

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