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Prepare for a new round of Asian distressed debt – opinion

20 Sep 2012

Conditions are ripe for a new cycle of distressed debt investing thanks to the European debt crisis, tighter access to bank funding and rising non performing loan numbers.

The last cycle of distressed debt investing in Asia followed the region’s financial crisis in 1997 when funds piled into the region to pick up cheap assets. But in the wake of the fallout, Asian governments sorted out their financial systems and the region has experienced strong growth fuelled by an expansion in credit.

As a result, Asia has been fairly barren hunting ground for distressed debt practitioners in recent years. But investors are starting to allocate increased resources to distressed debt in the region. Already this year distressed debt and special situation funds have raised US$4.6 billion to invest in Asia Pacific, according to alternative assets data provider Preqin. This is more than double 2011’s and 2010’s full-year totals of US$1.4 billion and US$762 million, respectively.

A combination of factors is leading to a perfect storm for distressed debt in Asia. As is evident in China, Vietnam and elsewhere, the stimulus packages unleashed by governments in the region to maintain growth while the global financial rattled along led to a culture of easy credit and excessive lending. The policies worked and Asia rebounded to growth quickly but an increasing proportion of these loans are turning bad.

In August, the China Banking Regulatory Commission (CBRC) said NPLs fell to 0.94% at the end of June from 0.97% three months earlier but this was offset by overdue loans growing by 17%. Fitch recently reported that Indian NPLs for fiscal year 2013 would be higher than its initial forecast of 3.75% which was already a rise of 2.9% for the previous 12 months. Meanwhile, the State Bank of Vietnam put NPLs at nearly 9%, double the government’s figure but still less than highest estimates of 15%.

The pressure on asset quality is exacerbated by the eurozone debt crisis which is having a twin impact. The sluggish growth in that part of the world is hurting export-orientated economies with companies finding a shrinking market for their goods. No doubt when Asian policymakers embarked on their stimulus drive, they expected the world economy to be back on track in 2012 but instead it’s plodding along as the major markets of Europe and the US struggle to generate robust growth.

Europe’s debt problems have also forced that region’s banks to deleverage from Asia as they seek to shore up their balance sheets. And although Asian banks are stepping in, the cost of capital is increasing making it more expensive to borrow money. And that’s if companies can get hold of financing. The increasing numbers of NPLs means many banks in the region are facing pressure from regulators to tighten up their lending practices or at minimum have more focused lending policies.

Property is one area which will give rise to a lot of distressed assets. The squeeze that China’s property sector finds itself under is well known. Securing funding from a bank has long been difficult for this sector but now the China authorities are looking to shut off another source of liquidity by restricting asset management companies (AMCs) from buying property assets.

Financial assets will also prove a fertile hunting ground for distressed debt investors. As already noted, NPLs are rising in the region and one way banks can clean up their balance sheets is to sell that debt. European banks are also offloading portfolios as they scale back their footprint in the region. One of the more high profile cases took place in June when UK bank Lloyds sold its £809 million (US$1.3 billion) estate loan portfolio to Blackstone and Morgan Stanley for £388 million. In Vietnam, policymakers seem to have recognised the problem of bad debts and have announced plans to set up an AMC that will buy non performing assets from the banking sector and sell them on to investors.

Bargain hunters could also be heading to Australia as it is home to Asia’s only real leveraged buyout market. The current wrangling between Nine Entertainment and its private equity investors over how to restructure AUD3.75 billion (US$3.9 billion) of debt is one of the more high profile cases but will surely not be the last. And as the era of record high commodity prices passes, Fortescue is unlikely to be the only Australian miner struggling to service its debt.

But Asian policymakers now need to act on two fronts. Firstly they need to ensure their regulatory environment allows investors, especially those from outside the country to buy distressed assets. A KPMG survey published earlier this year showed that there are still huge obstacles in Asia with China, Indonesia and Australia voted as the most difficult jurisdictions for distressed debt investing.

Secondly, the right policies need to be in place to halt the growth in non performing assets. The deterioration is credit quality of course creates an opportunity but if there’s a sense the problem could get much worse before it gets better, special situation investors may hold back from entering the market. Worse still, governments also risk creating long-term damage to their economies.

The return to a distressed debt scenario should not necessarily be viewed as a bad thing. Distressed assets are an unavoidable part of any economic cycle but if there are buyers willing to invest this will provide a welcome injection of liquidity, help companies to overcome their indebtedness and ensure the interest is short lived.

20 Sep 2012