Asian distress

Non-performing loans can provide sophisticated investors with solid returns at a manageable level of risk. But how keen are investors to take up the challenge? Interview with Mark Lasry of Avenue Capital Group.

According to local practitioners, non-performing loans (NPLs) present one of the most intriguing investment opportunities in Asia today. A growing band of investors see this as a lower risk strategy to generate attractive returns in a region where successful control-seeking private equity investments are still difficult to pull off.


Last year, Ernst & Young reported that non-performing loan assets had hit the $2 trillion mark, as the amount of non-performing loans held by Asian financial institutions and governments had leaped by 33 per cent since 2000. The same report estimated investment capital to be approaching $100bn. Ernst & Young put the total level of NPLs at 29 per cent of the region's combined gross domestic product. The report described the non-performing loan (NPL) problem in Asia as “having the potential to shape Asia's economic landscape for years to come.”


This kind of message is music to the ears of buyers of distressed debt. These specialists aim to do business with the region’s banks and governments, which are often required by regulators to dispose of below investment grade debt, even in cases where the business of a borrower in question appears viable. Even lenders that are permitted to hold distressed assets can become sellers if they lack the resources to manage the typically complex distressed debt situations, or because they are overly pessimistic about the chances of recovery. Consequently vendors, even when driven by non-economic factors, are often willing to sell at deeply discounted levels in order to clear their decks.


At the height of the Asian economic crisis in the late 1990s, distressed debt funds were achieving realised returns of 30 to 40 per cent in a market where competition for the best deals was minimal. Although not at the same level, the prospect of good business remains. “In the current environment, it is possible to achieve returns of around 20 per cent with a fairly steady risk strategy,” says Justin Ferrier, senior vice president at ADM Capital, which manages distressed debt worth in excess of $130m.


Most active in the Asian distressed market are the international investment banks, although there are also a number of US specialist investors active in the region, such as Texan-based alternative asset manager Lone Star, which invests through its Star Asia-Pacific unit, Ripplewood Holdings, Cerberus, Avenue Capital Group, and real estate specialist Colony Capital.


Avenue Capital, the New York-based asset manager with offices in Bangkok, Jakarta, Hong Kong and Tokyo, is currently in the process of raising Avenue Asia Special Situations Fund III, which is seeking $500m from US and European institutions for investment in Asia excluding Japan. “We buy senior, secured, restructured debt at 50 cents on the dollar,” explains Marc Lasry, founder and managing partner of Avenue, the firm’s strategy. “We’re not trying to buy the bank debt and then get control of the company. We’re comfortable owning 10 to 20 per cent of the issue and having a say in the restructuring.”


Japan, which was the first market to open up to distressed buyers in the early to mid 1990s, accounts for around 80 per cent of the $20bn currently invested in distressed opportunities, although this level has been in decline since 2000 as many of the country’s NPLs have been sold. According to Ferrier, “one of the difficulties of the market in Japan stems from the higher level of saturation in the market, resulting in a disparity between vendors and buyers.” 


Taiwan, with a surfeit of banks only matched by an abundance of NPLs, is presently the biggest market in Asia, spurred on by the government’s attempts to put forward reforms to avoid a banking crisis. According to data gathered by the Asian Wall Street Journal, there is around $30bn of NPLs for sale in Taiwan’s banking sector. Last year, Taiwan’s First National Bank sold a $2.1bn portfolio of non-performing loans to a consortium comprising Lone Star, Cerberus, GE Capital and TAMCO. “Right now Taiwan is the most active market in the region,” says Brian Cheung, partner at the corporate finance and recover unit of PriceWaterhouseCoopers in Hong Kong.


Practitioners also cite Thailand, Indonesia, the Philippines and South Korea as particularly promising markets at present. According to data from Ernst & Young, non-performing loans in Indonesia and Thailand account for 34 and 40 per cent respectively of GDP.


But in terms of future potential, China is seen as an even more promising market than Taiwan. “Although quiet last year, China also presents a key opportunity going forward,” says Cheung, “especially given its entry into the World Trade Organisation and the opening up of its banking sector, which will require lending banks to reform their NPL situations.”


As this market evolves, the potential for outsize returns is likely to diminish, although this is not expected to happen any time soon. “There has been a significant increase in the number of deals in Asia over the past twelve months, and the market looks set for further growth,” says Cheung at PWC. “Our view is that there is an opportunity for the next three years,” says Lasry. “As we get more familiar with the legal structure of the Asian market, we will most likely move down the capital structure, although while you can buy senior secured debt at 25 to 50 [cent on the dollar], there’s no point in going lower.”


By Ricky Morton