Finance

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

So Wilbur Ross, the billionaire investor who made a fortune from distressed debt, is considering buying bad loans in China. Bad idea. While he's profited before from going where few dare tread, this time he may want to think again.

The challenges begin with how to value the securities derived from China's nonperforming loans. Recovery data are scant and not necessarily reliable, so it's hard to figure out whether buying $200 million worth of loans will yield a return of $10 million or $250 million.

The best clue potential investors can hope to find is in the balance sheets of China's publicly traded asset-management companies, such as Cinda and Huarong. Unfortunately, their annual reports don't break down details on bad-loan collections, unlike Western peers.

One way to get a sense of how much companies make from collecting soured loans is to look at cash flow from operations. The business can be lucrative, no doubt. Norfolk, Virginia-based PRA Group, for one, has shown positive operating cash flow every year since it was listed. Huarong, meanwhile, reported negative operating cash flow of 44.9 billion yuan ($6.8 billion) at the end of 2015, the second consecutive year of red ink. Cinda isn't doing much better.

Hard to Collect
Cinda has had negative cash flow from operations in three of the past six years
Source: Bloomberg; company filings

Moreover, every year these companies write off a large chunk of the debt they acquire. Cinda buys restructured assets for roughly 50 cents on the dollar, according to its reports. Even that deep discount doesn't prevent impairments. Last year, Cinda made 18.9 billion yuan from its 248.1 billion yuan in distressed assets and wrote down 1.6 billion yuan, almost a dollar of loans for every $10 it recovered.

Your Loss, Ross
Cinda wrote off almost a dollar for every $10 it collected managing distressed debt last year
Source: Company filings

In developed markets, the ultimate refuge for investors in asset-backed securities is that they can always take possession of the underlying assets. That's small comfort in China. Even if Ross or another buyer managed to get a hold of the loan rights -- a daunting task in the Chinese judicial system -- they'd be hard-pressed to collect. 

Hong Kong distressed debt lawyers often say their main cash cow is private equity companies trying to collect on delinquent loans in China. Most cases don't make headlines, but cement producer Shanshui offers a glimpse of the scale of the task.

After a successful hostile takeover, Shanshui competitor China Tianrui was unable for several months to remove the former owners from the company's offices in Shandong, the site of its most important operations. By the time they took control, the official seals had vanished, making it difficult for the company to officially pay its debt (in China, nothing is official without the chops). 

Lawyers say that without support from a well connected state-owned company, collecting dues in China is near-impossible for foreigners. Buying soured loans may look like a great potential investment, in a U.S.-style legal environment. That's not China.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Christopher Langner in Singapore at clangner@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net