China’s silent auctions

The measures were instrumental in easing the impact of a temporary rout of China's export sector and reviving consumer sentiment. Wise heads, however, questioned the implications of so large a liquidity injection. In an economy that restricts capital outflows, what would become of the surplus funds? Asset price inflation, most visible in rapidly rising property valuations, offered one answer, but others took longer to present themselves and to this day remain unclear.

In an environment of easy credit, loans were undoubtedly extended to companies that didn't deserve them and local governments hell-bent on rolling out infrastructure projects they couldn't really afford. Distressed asset investors sat up in anticipation of a new wave of non-performing loans (NPLs) on the books of China's banks.

Chinese institutions habitually push a problem to one side rather than tackle it head on. Banks shifted assets from their books to those of trust companies, until ordered to stop the practice. Local governments used standalone investment vehicles to raise funds -again helped by trust companies - once they had exhausted bank and bond channels. Beijing ended the days of plenty by imposing tighter monetary policy and restricting bank lending. But how will it resolve those debts already outstanding?

Since the last quarter of 2011, there has been increased talk among infrastructure and distressed investors about assets quietly coming onto the market.

Andrew Yee, Singapore-based global head of infrastructure with Standard Chartered Bank, told AVCJ late last year that discussions are taking place among entities holding a significant number of projects, some of which aren't generating sufficient returns to even pay the interest on the various bonds and bank loans. They face the prospect of having to sell assets to pay down debt. He said that foreign investors are seeing more and better quality assets than they ever did during the boom period.

Last week, Ben Fanger, co-founder of distressed asset specialist Shoreline Capital, noted that the four asset management corporations (AMCs) set up to handle NPLs from China's major state banks had ended their self-imposed moratorium on sales. AMC branch managers have been ringing Shoreline's office asking about deals, which suggests they want to clear some of the backlog in anticipation of new assets arriving.

These remarks amount to the door opening a tiny crack. The reality of these situations in China is that companies and their state-linked sponsors look for ways to raise funds without handing out equity stakes, while foreign investors targeting the NPL market must usually wait in line behind local players.

One issue upon which Yee and Fanger are united, despite representing very different risk-return models, is that money will be made away from the limelight. A successful infrastructure deal is most likely to come in a second- or third-tier city, where the competition is less intense, the ticket sizes are smaller and the chances of obtaining a better strategic position are higher. As for NPLs, if Shoreline sees another foreign party at an auction, it tends to head for the exit. More favorable valuations come to those who dig through obscure portfolios for previously unidentified collateral.

It remains to be seen if the fallout from China's credit boom delivers a swath of investment opportunities or amounts to little more than another state-driven whitewash. Those best positioned to capitalize will be determined, well connected and largely below the radar.

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• Topics
• Credit/Special Situations
• Restructuring
• Infrastructure
• Infrastructure
• Greater China
• Shoreline Capital Management
• Standard Chartered Private Equity
• Infrastructure
• Distress
• China