China to be ‘mother of all distressed opportunities’

China’s mounting credit woes will spawn a huge range of distressed and restructuring deals, argue investment specialists.

“When the credit cycle turns in China, it’s going to be the mother of all restructuring and distressed opportunities,” says Stephen Cannon, head of China at Redbridge Group, a boutique investment bank.

He argues there is evidence of the beginnings of a credit crisis in the mainland, with shadow banking being a root cause.

Speaking on a panel at the Latham and Watkins Asia Restructurings Summit in Hong Kong yesterday, Cannon cited a Credit Suisse estimate that a quarter of all credit in China originates from shadow banking.

The last non-performing loan crisis in China was at the end of 1999, when the NPL rate was estimated to be 20-30% of banks’ portfolios, notes Cannon. “Today it’s hard to find an estimate above 20% [and] an official number above 2%. That defies the law of economics.”

In the past five years, Chinese banks have added assets that surpass the total banking system in the US, he points out. “I doubt those are all good loans.”

The effects from China will be felt in Southeast Asia, which will also provide opportunities for distressed investors, says fellow panelist Suneel Kaji, partner of emerging markets hedge fund TRG Management. TRG is the recently rebranded merged entity of the Rohatyn Group and Citi Venture Capital International.

“You have a number of companies in Southeast Asia that are highly resource-based. The resource emphasis has put emphasis on China," says Kaji. As a result, a slowdown in China will directly affect the credit extended agribusiness or natural resource firms.

“While you don’t have quite the same balance-sheet shadow banking type of dynamic, you have issues of overleveraging [and] overgrowth,” says Kaji.

Panel moderator David Heller, Chicago-based partner of Latham and Watkins, notes:  “When a crisis occurs, for many financial players it's a horrible thing to waste.”

It is also one that can be accessed in China, so long as firms follow the formal and established guidelines in the mainland, says Cannon.

“In the distressed context, you’re talking about a local [mainland] business, a lot of employees at stake, and along comes a foreign distressed investor who has a solution and capital to save the company," says Cannon. “The opportunities are there.”