Ever since the coronavirus outbreak began eating away at his business, Zhu Bo has been making plans about how to keep his small financial information and social media company afloat.
He stopped paying rent for the office space his firm occupies in one in one of Shanghai's oldest commercial districts about two months ago, and, as losses began piling up, he halted projects for the foreseeable future and asked staff to take a month's unpaid leave.
Now, with news that prominent customers plan to halve their advertising spending this year, he is considering laying off some employees and is anxiously waiting to hear if his landlord will let him delay payments for April.
"Even though my lifestyle seems to be returning to normal, I'm still very cautious," Zhu said. "There is such big uncertainty for the future of the economy and how that would affect my advertising income."
While the business outlook may be bleak for Zhu, his situation represents a big opportunity for so-called "special situation" investors in the arcane world of global distressed debt markets.
China's distressed debt market, which covers businesses that have teetered over into default or bankruptcy and are sold to investors at a discount, is dominated by non-performing loans (NPLs) from the real estate sector, which is expected to grow significantly this year.
While business in China is beginning to return to normal after months of lockdowns and restrictions to contain the coronavirus, the economy is expected to shrink in the first quarter for the first time since 1976.
If gross domestic product (GDP) growth drops to 4.8 per cent this year from 6.1 per cent in 2019, sour debts could result in bad debt formation of about 3.45 trillion yuan (US$486 billion), according to May Yan, head of China global markets at investment bank UBS. If GDP growth fell to 3.2 per cent, then NPL formation the tally could be as much as 5 trillion yuan (US$704.4 billion), Yan said.
WeWork, which provides shared work spaces for start-ups and entrepreneurs, had vacancy rates of 36 per cent in Shanghai, 65 per cent in Shenzhen and 79 per cent in central China's Xian, the Financial Times reported in October, reflecting just some of China's speculative property development vulnerable to a collapse in asset prices.
"If tenants delay their office rent, then the question becomes whether the property company has enough cash flow to make their interest payments on bank loans," said Chen Lau, a partner at global consultancy PwC.
"And if the payments are still not being made, banks can classify these loans as non performing, in which case banks will have the incentive to offload to asset management companies."
Brock Silvers, managing director of Adamas Asset Management, said that the growth in China's NPLs began even before the coronavirus outbreak, as economic growth slowed to its lowest pace in nearly three decades.
While most this year's debt is likely to have been rolled over, Silvers said, the coronavirus may mean a significant portion of that turns into NPLs.
"China is over-indebted and faces massive debt obligations coming due this year," he said. "China desperately needs the capital. Reforms are already in the works."
PwC estimated last week that China's banks and asset management companies (AMCs) currently hold about US$1.5 trillion of NPLs and other distressed assets, up from US$1.4 trillion in 2018.
Financial regulators appear to be accelerating efforts to tackle the bad debt by opening the market up to foreign participants in a bid to attract capital, tightening oversight of the sector, and establishing another national level AMC to join China's big four.
China is over-indebted and faces massive debt obligations coming due this year,Brock Silvers
The phase one trade deal signed between the United States and China in January allowed American financial services companies to apply for domestic AMC licenses, a potential game changer for major international players like Bain, Blackstone and Oaktree.
Since 1999, state-owned banks have been selling their bad loans primarily to China's big four national AMCs, China Cinda Asset Management, China Huarong Asset Management, China Orient Asset Management and China Great Wall Asset Management.
However, these four companies do not have unlimited capital to buy NPLs because of restrictions on their own leverage levels, PwC said.
To help dispose of distressed assets, 53 city and provincial level AMCs came online between 2015 and 2017.
Earlier this month a fifth national AMC, China Galaxy Investment Management, was established. The first new domestic entrant in more than 20 years.
Under the new rules agreed to as part of the phase one deal, foreign asset managers will be able to negotiate directly with local banks, brokers, insurers, rural co-operatives, or financial leasing companies to acquire NPLs, bypassing domestic competitors.
"(China is) potentially giving a more level playing field (to foreign investors) for determining the price (of NPL purchases)," said Ronald Thompson, managing director of Alvarez & Marsal Asia. "But it's a less tested market from a foreign capital base point of view, which requires higher returns."
Thomson said that smaller foreign investors may be lukewarm toward the new policy because by establishing a domestic AMC designed to make direct NPL purchases, it would mean keeping the capital in China due to the country's capital controls.
However, with the impacts of the coronavirus expected to keep reverberating through China's economy for some time to come, Thompson expects plenty of interest from new players in the field.
"My understanding is some of those global buyers are pretty optimistic and see huge opportunities," he said. "They are growing teams to buy portfolios for workouts."
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