KKR forms China distressed investment partnership

There are no targets in terms of capital commitments because the platform will operate on a deal-by-deal basis, with each party free to opt in or out. COS Capital - a joint venture in which China Orient Asset Management has an 80% stake, with management holding the rest - will be responsible for day-to-day management of investments. KKR will play a supporting role.

Real estate accounts for 16% of total lending in China - or $3.1 trillion in outstanding debt - predominantly in the form of commercial bank loans, trust schemes and wealth management plans, according to the People's Bank of China. Among commercial banks alone, non-performing loans (NPLs) amount to more than $180 billion and the majority of collateral underpinning these loans is real estate.

"The new joint venture offers an opportunity to build a scaled platform to provide flexible capital solutions, particularly in the real estate sector which is facing increased macro and funding challenges," said Edward Han, managing director and head of special situations at COS Capital, in a statement.

Henry McVey, KKR's head of global macro and asset allocation - and whose views are therefore not an indicator of investment strategy - identified debt-driven restructurings as one of his five key investment opportunities for 2016. China figures heavily in this thinking, with the economic slowdown expected to deliver openings for distress and special situations investors, although the country's major trading partners are likely to feel knock-effects as well.

China Orient Asset Management was set up in 1999 as one of four asset management companies (AMCs) tasked with resolving NPLs. These groups initially raised capital from bond issuance and the central bank and used it to acquire distressed assets from the major state-owned banks. They then started buying and selling assets on a commercial basis and began to diversify into areas such as asset management and investment.

Two AMCs - Cinda and Huarong - received capital from private market investors and have since gone public in Hong Kong. Oaktree Capital Management was one of the cornerstone investors in Cinda's IPO and also entered into a joint venture with the company to invest in distressed assets in China.

Speaking to AVCJ in 2014, Howard Marks, Oaktree's chairman, said he was optimistic about the distressed debt opportunity in China with the Cinda tie-up offering "a seat at the table." However, he cautioned that it remained to be seen how the market develops in China. It is unclear how many investments the joint venture has made - as of last November it was said to be zero. Oaktree's first China NPL investment came in 2015 through a joint deal with Shoreline Capital Management.

The average NPL ratio of China's commercial banks rose to 1.59% at the end of September, up from 1.5% in June and 1.25% at the end of 2014. Many of the loans that have turned sour were issued seven years ago when the government facilitated a credit boom in the wake of the global financial crisis.

Investors say the volume of NPLs is so large that AMCs will not be able to resolve them in house, which suggests more will be sold on to third parties. They attest to significant foreign interest, although in many cases this has yet to turn into substantive action.

However, with the exception of Shoreline, several special situations players active in Asia are more focused on restructuring companies that are at the brink rather than resolving debts against groups that have already slid into default. It is easier for these investors to get the returns they require by turning companies around and participating in the equity upside.

COS Capital was established in 2014 by China Orient Asset Management and China Summit Capital. It focuses on real estate investment and asset management, with an emphasis on onshore mezzanine financing and cross-border investment.

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• Topics
• Credit/Special Situations
• Greater China
• Restructuring
• Restructuring
• Real estate
• China
• Distress
• Real estate
• KKR
• Special Situations