Distressed Asset Markets in China: An Interview with Phil Groves
A major part of China’s current reform efforts involves strengthening the financial system and re-structuring and re-capitalizing, or selling, most of the companies still owned by various levels of government. Estimates of the number of remaining state-owned enterprises (SOEs) varies from 30,000 to 50,000 depending on the percent of state ownership involved. Non-performing loans (NPL) held by the commercial banks in China are estimated to be about 13% of total lending.
Center Director, Penny Prime, talked with Phil Groves, President of DAC Management, LLC., a distressed asset management company. Mr. Groves has been involved in evaluating and participating in the market for these companies and NPLs in China for the last several years.
PP: You have experience in distressed assets around the world. What changes in China motivated you to participate in this new market?
PG: The single biggest factor is, of course, the decision by China to focus great attention and resources on reforming its banking system. In 1999, four new entities were created to address the large amount of non performing loans held by the Big 4 state owned banks. The new entities, the four Asset Management Corporations (AMC’s), received nearly $200 billion in NPL’s from the state owned banks. In 2004, they received another batch of NPL’s. The AMC’s have been the primary source for Chinese NPL’s over the past four years.
A second factor has been China’s entry into the WTO at the end of 2001. As part of the negotiations, China agreed to improve its banking system and also open it up to foreign banks by 2006. This has created an impetus to address the large amounts of NPL’s and distressed assets in the banking system.
A third factor has been the conscious effort to privatize state owned entities (SOE’s) during the past few years. This has created great opportunities for investors as the amount of potential acquisitions has grown substantially over the past several years.
A fourth factor has been the steps taken by the Chinese central bank to address the economy’s growth. Credit tightening, interest rate hikes and other regulatory mandates have had a significant impact upon the distressed market in China.
PP: Could you tell us about your companies and what business you are doing in China?
PG: We have a group of companies that focus exclusively on investing in China. The main entity is DAC Management but we have a variety of entities inside and outside of China. The group was formed in 2002 to source, invest in and manage Chinese distressed assets, with a primary focus on China’s banking system and state owned enterprises. With offices in Beijing, Harbin, Hong Kong and Chicago, the DAC companies are pioneers and leaders in acquiring and managing non-performing loan portfolios (and other state owned assets and entities) from China’s four state owned Asset Management Companies (AMCs), banks and various governmental entities.
The firms employ twelve professionals in China and the United States, with broad experience in alternative investments and China’s distressed debt and asset market. Prior to creating DAC, I represented and co-invested with the first foreign investors to acquire a portfolio of China’s NPLs in 2001 and the first foreign investors to repatriate dollars from China through the successful management of a NPL portfolio in 2002.
PP: Where do you see the greatest opportunities in distressed assets and non-performing loans in the next two years?
PG: The greatest opportunities will be the privatization of the thousands of SOE’s and the NPL’s currently still held by the banks (as opposed to the AMC’s).
PP: What is the expected pace of the SOE privatization process?
PGl: China is working hard at privatizing SOE’s now. In my opinion the next 2-3 years will be the “golden age” for investors. Since no new SOE’s are being created (unlike NPL’s) they are a scarce resource.
PP: I understand that right now the banks are not allowed to sell their NPL’s. Is that correct, and if so, when do you expect this to change?
PGl: You are correct that there has never been a direct bank sale of NPL’s due to regulatory and approval issues. Many distressed investors have been waiting for the first bank NPL for some time. I expect it to happen in 2005, but the timing is uncertain.
PP: What are the greatest risks and challenges in working in this sector?
PG: The greatest challenge is establishing an on the ground team that can successfully acquire and profit from distressed assets and debt. It is a long and arduous process that requires infinite patience. The greatest risk, in my opinion, is the uncertainty of the laws that impact distressed investing in China. The laws and regulations in this area are not clear and not well established. Thus, there is uncertainty that makes long term planning difficult.
PP: Mr. Groves, thank you very much for talking with us.
Phil Groves’ contact information:
President, DAC Management, LLC
200 South Wacker Drive, 31st Floor
Chicago, IL 60606