China’s distressed asset funds struggle to profit from collapsing property sector

Distressed asset managers in China’s private sector are struggling to profit from the country’s slowing economy, with no bottom in sight for its collapsing property sector and lenders reluctant to write off bad loans.

Almost a dozen distressed investment funds told the Financial Times they had not increased their exposure to residential and commercial properties, usually the most popular form of collateral in Chinese debt restructurings, despite soaring defaults in the real estate sector.

“A lot of us are standing by not knowing where to spend our money,” said an executive at Qingdao Huba Asset Management Co, which specialises in trading bad loans.

China is suffering one of its worst economic slowdowns in decades after government efforts to reduce debt in the property sector, which accounts for about one-third of economic output, led to a collapse in real estate prices.

This has combined with the negative impact of the government’s strict zero-Covid policy and a regulatory blitz against high-flying technology companies to depress domestic demand. Even property companies once considered financially reliable, such as the country’s largest real estate group, Country Garden, are reporting falling profits.

Although Beijing has announced interest rate cuts and some bailout initiatives for the property sector, it has failed to arrest the meltdown: house prices fell for 11 months consecutively up to July. This has left asset managers reluctant to enter the market for fear they will not recoup investments.

“[Distressed asset management] only works when you think there is going to be mark-to-market pricing and a cyclical improvement,” said Andrew Collier, managing director of Orient Capital Partners in Hong Kong. “But if you don’t have accurate pricing and you have a structural downturn that could go on for another decade, then there is no way you can sell your assets.”

Banks are offloading existing bad debt but are mostly transferring it to large state-run asset managers, such as China Huarong Asset Management and Great Wall Asset Management. Official data show the country’s banking system disposed of Rmb1.4tn ($204bn) in non-performing loans in the first half of this year, up 18 per cent from a year before.

But rather than profiting from the disposals, many private sector distressed asset managers have been making losses. Shanghai Greencourt Investment Group, once an industry leader, reported an 86 per cent drop in profits in the first quarter of this year from a year earlier before being delisted in May. Its rival GI Technologies Group lost Rmb113mn in the first quarter of this year, following steeper losses in 2021.

The consultancy PwC said in a report this month that China’s “bad banks” — as its distressed asset management companies are known — are becoming less “active” even though they are supposed to thrive in a recession.

Local authorities want the asset management companies to bail out hundreds of unfinished residential projects left by cash-strapped developers, particularly in smaller “under-developed” cities.

But James Li, owner of a Beijing-based bad bank, said it was taking at least twice as long as normal to sell foreclosed apartments in under-developed cities, such as Zhengzhou in central Henan province where there are many unfinished projects, thanks to rising supply and lukewarm demand.

Official data show the number of foreclosed homes in Zhengzhou almost doubled in the six months to the end of March. The situation had shown little signs of easing in recent months, said local officials. Meanwhile, the city’s housing sales dropped more than a third in the first seven months of this year from a year earlier.

“I avoid economic backwaters as much as I can,” said Li. “That leaves a small number of cities still worth investing in.”

Even commercial real estate, ranging from shopping malls to office buildings, has lost its lustre as Beijing’s tech sector crackdown and zero-Covid policy have boosted vacancy rates and hit rents.

Jackie Wang, a Shenzhen-based distressed asset manager, said he had stopped looking at office buildings in the southern city. Large tech groups were scaling back following a regulatory crackdown on education and internet platforms that has wiped billions of renminbi from their market value.

“We don’t know when the worst days for technology platforms will be over,” said Wang. “That means their demand for office space, a main driver of the market, will continue to weaken.”

The problem is exacerbated by the slow pace of bad debt write-offs among Chinese lenders despite a rise in defaults. Official data show the country’s banking system added Rmb107bn new non-performing loans in the first half of this year — slightly more than the same period of 2021 but much lower than the previous six years when the economy was strong.

A government adviser said the regulator, led by the China Banking and Insurance Regulatory Commission, had relaxed bad debt ratio requirements for lenders so they could support the economy. “You won’t get punished for covering up a few billion yuan NPLs as long as you provide liquidity for cash-strapped small businesses,” said the person.

As a result, many lenders had put off writing down bad debt even though their asset quality had deteriorated rapidly along with the broader economy, said officials at two state-owned banks.

“We can’t accurately price bad loans when the market is rigged by the state,” said Li, the Beijing-based distressed asset manager.

Creditors’ avoidance of write-offs meant there were fewer bankruptcy proceedings, which distressed asset managers need to price toxic loans. Shanghai-based bad bank 01 Asset Management Co estimated that fewer than 10 per cent of distressed real estate developers had gone through bankruptcy restructuring because that would require lenders to write off their loans.

For distressed asset managers, the upshot is they would probably have to wait until the government finds the political will to launch a full bailout of the property sector, say industry operators.

“We become valuable when the government wants to solve the bad debt problem once and for all,” said the head of a distressed asset management firm in Qingdao. “[But] they [always] end up trying to delay the day of reckoning.”