Ex-Lehman Trader Loads Up on Bad Chinese Debt

  • Distressed debt investors buy as NPLs climb to 11-year high
  • Oaktree meets with local managers; KKR starts joint venture

When hedge fund titans from George Soros to Kyle Bass look at China’s mountain of bad loans, they see a financial crisis waiting to happen. Denis Zhang spots an opportunity to load up on bargains.

The former Lehman Brothers Holdings Inc. trader is among a new breed of Chinese distressed debt investors making big money as banks sell their non-performing loans at fractions of face value. Zhang’s Oriental Asset Management, which purchases NPLs on behalf of clients, has doubled its profit every year since 2013. Sincetop Asset Management, another home-grown buyer of troubled credit, is generating annualized returns of more than 20 percent.

Denis Zhang

Photographer: Wei Zhao

The market has proven so lucrative that some of the world’s biggest investors are stepping in. KKR & Co. started a Chinese joint venture in January, while Oaktree Capital Group LLC has met with at least a dozen domestic managers to explore potential partnerships, according to a person familiar with the matter.

China’s supply of discounted NPLs is “overflowing,” said Zhang, who co-managed Lehman’s first European quantitative hedge fund and served as Amundi Asset Management’s chief investment officer in China before co-founding Oriental three years ago. “There are way more bad loans than we can take.”

Once the exclusive domain of state-run bad banks, China’s market for troubled debt is now opening to private money managers as NPLs surge to an 11-year high. As more investors jump in, the ruling Communist Party may find it easier to clean up lenders’ balance sheets and lay the groundwork for a more sustainable expansion in the world’s second-largest economy.

“Both banks and regulators see an imperative need for bad-loan disposal,” said Zhou Min, a Hong Kong-based analyst at Sanford C. Bernstein & Co. “This has already given private investors some opportunity to tap into the distressed asset management space, and that opportunity will continue to grow.”

For more on China’s efforts to support its economy, click here.

After years of flooding the financial system with cheap credit, Chinese banks now face a reckoning as borrowers get hammered by the weakest economic growth in a quarter century. NPLs jumped by more than 40 percent in the 12 months ended March to 1.4 trillion yuan ($210 billion), according to official figures, which many analysts say probably understate the true total.

When lenders seek to shed their most troubled debt, the first port of call is typically one of China’s bad banks, which were founded by the government in the 1990s. China Orient Asset Management, the bad bank that teamed up with KKR this year, spent almost 70 billion yuan on distressed debt in 2014, followed by another 50 billion yuan last year. China Orient will quicken NPL buying in some regions this year, though the firm declined to disclose an overall purchase target in an e-mail to Bloomberg News.


Even with the backing of China’s government, state asset managers don’t have enough capital to absorb every bad loan on offer. So they’re increasingly passing on NPLs from banks to private buyers, charging a broker fee of between 2 percent and 3 percent. The loans purchased by Zhang and his counterparts are usually tied to individuals or small businesses, which the bad banks find too costly to pursue.

Zhang’s firm is managing debt with a face value of 10 billion yuan. The loans were purchased for about 4 billion yuan, and have an estimated collateral value of 14 billion yuan, giving investors a sizable “safety cushion,” Zhang said. To extract returns from the NPLs, his firm sues debtors, takes control of their collateral, and auctions it for cash. The process typically takes two to three years, and Oriental charges clients an annual fee between 1 percent and 2 percent of assets under management.

Seeing rising demand from wealthy Chinese seeking higher returns amid falling interest rates, Zhang’s company sold almost 30 million yuan of NPL assets to individuals through Shanghai Suntime Fund Distribution Co. in October, handing them an 8.5 percent annualized return. The fund distributor’s wealthy clients have warmed up to distressed assets after some initial skepticism, and the companies are now planning their fourteenth such product, according to Anise He, Shanghai Suntime’s head of product research.

Soros Warning

At Sincetop Asset Management, Chairman Zhang Naxin tries to beef up returns by revamping the distressed assets he acquires via NPLs. For example, Sincetop might work with construction firms to develop a parcel of seized land before auctioning it off. The company’s bad loans under management have increased by more than 50 percent a year since 2013 to about 20 billion yuan.

Of course, not all NPLs prove profitable for investors. Oriental’s Zhang says he factors in a 5 percent to 10 percent failure rate when buying bad debt, a figure that could climb if the economy deteriorates further.

That’s exactly what some prominent bears expect to happen. Soros, a billionaire investor, said in January that a hard landing in China is “practically unavoidable,” while Bass, the founder of Hayman Capital Management, predicts losses in the banking system will dwarf those suffered by U.S. lenders during the subprime mortgage crisis. Kynikos Associates LP’s Jim Chanos and Passport Capital’s John Burbank are also among hedge fund managers who have warned of China’s surge in bad loans.

Expansion Plans

One concern for Chinese authorities is that there still aren’t enough qualified buyers to soak up the debt banks need to unload. In one sign of tepid demand last month, the inaugural deals in a 50 billion yuan program to package banks’ NPLs into securities were mostly sold to other lenders, according to people familiar with the matter.

That may change as more international money managers enter the market. In 2014, regulators made it easier for the likes of KKR and Oaktree, the world’s biggest distressed debt investor, to participate by scrapping the need for pre-approvals on bad loan purchases and the conversion of proceeds into foreign currencies. Oaktree declined to comment.

Local players are still in expansion mode. Oriental’s Zhang, who expects his firm’s profit to reach 90 million yuan this year and 150 million yuan in 2017, has plans to list the company on China’s over-the-counter exchange for startups. Sincetop has expanded from its base in the eastern port city of Qingdao to more than eight locations across Shandong province, while the firm opened an office in Zhejiang last year.

“Before 2013, banks barely had any bad-asset packages to sell and were not keen even when we approached them,” Sincetop’s Zhang said by phone. “Now, many of them are coming to us, offering various ways of cooperation.”

— With assistance by Dingmin Zhang

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