Global private equity firm KKR has teamed up with state-owned enterprise China Orient Asset Management to tap into the growing number of distressed real estate opportunities in China.
Bankruptcy filings are rising as the world’s second-largest economy slows and Beijing has become more relaxed about allowing companies to fail as it seeks to reform its financial markets.
However, investors have struggled to navigate China’s unpredictable court system, hampered by the lack of transparent resolution processes as bankruptcy law evolves and by interference from local government officials concerned about protecting jobs.
Critical to successful investing in distressed companies in China is securing the right position in the company’s capital structure. Most foreigners invest via offshore bonds, rendering their rights to onshore collateral tenuous.
Onshore lenders are often first in line when dividing up a company’s assets after a default. In the case of Kaisa, the Chinese property developer owes around $2.5 billion to offshore creditors out of almost $11 billion worth of debt, and offshore bond holders are struggling to get a settlement.
KKR is seeking to invest alongside a local partner that is already plugged into the flow of deals and who knows their way around the legal system.
China Orient is one of four licensed wholesalers of non-performing loans in China, known widely as bad banks.
The joint venture also includes local investment manager China Orient Summit Capital, which is itself a JV between Orient AM and a group of investment professionals.
Rich pickings
China’s real estate market has $3.1 trillion of outstanding debt, making up about 16% of the total lending market in China, mostly in the form of commercial bank loans, trust schemes and wealth management plans, according to the People’s Bank of China.
Amongst the commercial banks in China, PBoC statistics show that total non-performing loans amount to over $180 billion. According to KPMG, the majority of the collateral underpinning these non-performing loans is real estate.
Growing understanding
The courts do exercise wide discretion in resolving bankruptcies but one distressed debt professional said that over the last couple of years he had witnessed a growing understanding and sophistication among China’s judges in disputes, especially along the eastern seaboard.
He said some discussion among lawyers about setting up specialist bankruptcy courts was particularly encouraging.
However, even investing directly onshore with a partner has not always worked out.
Oaktree Capital Management said in November that its joint venture with another of China’s banks, China Cinda Asset Management, had yet to make an investment almost two years after agreeing the partnership and earmarking $1 billion for distressed debt purchases.
KKR also said the joint venture partners would be exploring “strategic initiatives for broader collaboration.”
China Orient is preparing to go public by selling a stake to the National Social Security Fund by March. That will pave the way for it to sell a 15% to 20% stake to domestic and foreign investors ahead of an initial public offering by the end of 2017.
Oaktree made a pre-IPO investment in China Cinda Asset Management in 2013.
