Securitisation could provide soft landing for non-performing loans

The non-performing loan (NPL) ratio among China’s commercial banks hit 1.67 per cent at the end of 2015, marking the 17th consecutive quarterly increase, according to data from the China Banking Regulatory Commission (CBRC). That pushes the total quantity of failed loans to US$196 billion (RMB1.27 trillion).

A joint report by global investment bank Houlihan Lokey and M&A intelligence provider Mergermarket highlighted that as economic growth decelerates, pushing more onshore corporates – private and state-run – closer to bankruptcy or to defaulting on loans and bonds, the official level of NPLs is likely to rise further and faster, with deterioration in asset quality set to accelerate.

“For China, the journey of deleveraging is a painful but inevitable one. Securitisation offers a potentially viable way for banks to improve their asset quality in an efficient and cost-effective way, but there are policy, regulatory and legal hoops to jump through,” the report said.

“The Chinese distressed debt market also faces challenges when it comes to valuation, pricing, competition and investment demand in a finite universe of buyers for distressed credit,” it said.

“Partnerships between foreign investors and domestic asset management companies (AMCs) could help chart the way forward.”

Houlihan Lokey, in conjunction with Mergermarket, took a close look at corporate distress and loan securitisation trends in an exclusive thought leadership newsletter, Non-performing loans securitisation in China.

The report highlighted that China’s securitisation market is now the largest in Asia, outpacing both Japan and South Korea.

“The details of specific funding and loan sale/purchase arrangements between selling banks, AMCs and other financial institutions involved in the process are not well understood by foreign investors due to the opaque nature of these transactions. Therefore, any foreign buyer will likely demand that the vehicle is bankruptcy remote,” Houlihan Lokey’s Global Head of Portfolio Valuations Cindy Ma said.

The global investment bank’s director for financial advisory services, Gunes Kulaligil, said there is certainly no shortage of NPLs in China, though many investors would rate the ease of doing business as low and describe the legal system as opaque and favouring locals.

“Given the immense size of the opportunity and the plethora of complexities, it would make sense to scale into the trade; and perhaps soft enter through a partnership or a co-investment scheme with local buyers,” Mr Kulaligil said.

In a prognosis of the year ahead, Houlihan Lokey vice-president for Asia-Pacific financial advisory services Ethan Ma expects large global distressed funds to start testing the waters, potentially through partnerships or co-investments with on the ground entities at a small scale.

“Once the investment thesis is tested and proven to be a viable strategy, we would then expect rather large investments by a small number of investors or even dedicated funds,” he said.

[Related: AMP to buy stake in China pension fund]