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Dawn of debt

For more that 15 years, both the Asia Development Bank and the International Finance Corporation have been the champions of development financing in Asia. In the last two months, these two steadfast supporters of the Asian private equity industry have broadened their focus and assumed the role of anchor investors in two debt funds, according to the Asian Private Equity Review.

Government restructuring organs laid the groundwork for what has become an active market for the region’s distressed debt

For more than 15 years, both the Asian Development Bank (‘ADB’) and International Finance Corp. (‘IFC’) have been the champions of development financing in Asia. In April and May, these two steadfast supporters of the Asian private equity industry broadened their focus and assumed the role of anchor investors in two debt funds. The $500m Yangtze Special Situations Fund (‘Yangtze Fund’) and the $500m Avenue Asia Special Situations Fund III, LP (‘Avenue Asia’) were launched within weeks of each other. In both funds the IFC is the cornerstone investor while the ADB is only participating in the Yangtze Fund. The former focuses on debt situations in Greater China, the latter in East Asia. Both bear the common characteristics of acquiring non-performing loans (NPLs) and bad debts. Each respective fund will be managed by professionals with proven track records in debt assets management.

Following the announcements from ADB and IFC, Merrill Lynch, the world’s largest securities house, revealed its plan to commit as much as 70 per cent of a ¥100bn ($897m) corporate recovery fund with Japan’s UFJ Holdings. At the same time, Bloomberg reported that the Dallas-based debt specialist Lone Star is planning to raise a $5bn fund that will largely target Asian assets. With multilateral organisations now joining Wall Street’s investment banking houses as well as global debt investors in a show of faith for debt funds, it is a firm statement that Asia’s bad debt situations must be addressed in order for it to move forward.

Debt/Restructuring Organs
In the aftermath of the 1997-1998 Asian Financial Crisis, Indonesia, Thailand and South Korea, the countries most deeply affected by the economic turmoil, established agencies to help mop up the bad debts: Indonesia set up the Indonesia Bankruptcy Restructuring Agency (‘IBRA’); Thailand established the Thai Asset Management Co. and South Korea launched the Korea Asset Management Corp.(‘KAMCO’). While the IBRA has been phased out, KAMCO’s effective disposal and management of its country’s bad assets has been key to South Korea’s recovery. These government-designated restructuring organs were the forerunners of Japan’s Industrial Revitalisation Corp. and asset management companies that are being established in both China and Taiwan.

US-based debt restructuring specialists were the first to seize on opportunities in Asia. Cerberus Capital Management (‘Cerberus’) was a pioneer in establishing a corporate recovery fund for Thailand. In March 2001, the $150m Cerberus Thai Corporate Recovery Fund began to seek opportunites in Thailand.

By 2001, the impressive restructuring results of South Korea motivated Japan to charge forward with both local and foreign institutions in supporting the establishment of debt funds. Based on various sources, no less than 35 such investment vehicles have been set up since 2001 with a combined pool of over ¥7tn ($66.7bn). The Development Bank of Japan was the first government organ in the country to assume a pivotal role in providing a platform for such funds. It has taken significant positions in the management firms of the country’s two largest recovery funds - the ¥4.5tn fund sponsored by Mizuho Financial Group, and the ¥1tn fund sponsored by the Daiwa Securities SMBC Co Ltd.

Last year, Thailand ramped up its restructuring efforts when it established a Baht100bn ($2.4bn) corporate rescue fund that is mandated to invest in sectors that face heavy debts, while setting an annual two per cent return target.

The debt fund concept is catching on. Most recently, Japan Asia Investment Corp has indicated that it intends to launch a debt fund.

A New Breed
It did not take long before the names of global debt specialists such as Cerberus, Colony Capital, Deutsche Bank, GE Capital, Goldman Sachs, Lehman Brothers, Lone Star, and WL Ross appeared on the Asian debt market scene, with Avenue Capital Group, the manager of Avenue Asia, being the latest. On the map of East Asia, they have all firmly established footholds with offices in key countries. Their geographical coverage has also expanded from northeast Asia to Taiwan with China as the next potential destination.

In Japan and South Korea, the global debt specialists have largely focussed on assets relating to banks, hotels or leisure resorts, real estate and insurance. In Taiwan, where the market opened in 2001 following the establishment of the Taiwan Asset Management Company, debt specialists have largely concentrated on acquiring problem loans from local banks. When Taiwan’s first public auction of problem loans took place in March 2002, First Commercial Bank was the seller. The public bidding of bad loans attracted eight interested parties that included GE Capital, Lehman Brothers, Lone Star, Morgan Stanley as well as Cerberus. Cerberus came out on top with a US$17 million bid for the bank’s NT$13.2bn ($394m) in non-performing loans, while the others were only prepared to pay ten per cent to 15 per cent.

China’s first international auction of distressed debt was held in late May by Bank of China Hong Kong (Holdings), the Hong Kong-listed arm of Bank of China. Citigroup came in with the winning bid, and is reportedly paying between $500m and $600m for NPLs with a face value of $1.8bn. Cerberus and Lone Star did not participate in the bid, though the US banking giant faced competition for Merrill Lynch, UBS and Deutsche Bank.

Future Prospects
While the investment performance of acquiring Asian distressed assets remains largely unknown, there have been isolated instances of success, a few of which could be characterised as phenomenal. One of the best known examples is Japan’s Shinsei Bank. In late 1999, the US-based Ripplewood Holdings led a consortium of investors and acquired the 2.4 billion common shares of the then defunct Long Term Credit Bank (‘LTCB’) with ¥1bn while committing an additional ¥1.1bn to recapitalise LTCB. In February this year, Shinsei Bank was listed on the Tokyo Stock Exchange. The five-fold return made by Ripplewood and its investors in selling a portion of its holdings in Shinsei Bank has become legend in the private equity industry.

Another success story, albeit on a smaller scale, was WL Ross’ disposal of The Kansai Sawayaka Bank which the debt specialist acquired in September 2000. When the bank was acquired by Kansai Bank in May 2003, WL Ross made a 1.82-fold return and recorded an internal rate of return of 25 per cent.

The prognosis on distressed funds performance was improved last year when Eurekahedge, the research and index group of hedge funds, indicated that the best performers in the Asian hedge fund industry in 2002 were in the distressed debt funds category. Avenue Capital Group’s Avenue Asia International was among the top performers. As a benchmark indicator, the Ashmore Asian Recovery Fund has boasted an average net return of 16 per cent a year since its was founded in 1998.
On a macro level, distressed situation fund investors and governmental efforts to propel such funds have played a role in the economic recovery of both South Korea and Japan. Four years since South Korea welcomed foreign investors with open arms to help overhaul its economy, the peninsula’s gross domestic product grew 3.9 per cent, quarter on quarter, between October and December 2003. The South Korean central bank, meanwhile, announced that the economy expanded 3.1 per cent in 2003.

Even the long period of economic stagnation in Japan appears to be ending. Asia’s economic giant recently announced its eighth consecutive quarterly growth for the period ending March. In the first nine months of its current fiscal year, Japan’s gross domestic product grew by 1.4 per cent, well above the 0.9 per cent previously forecast. The data on its bankruptcy rates has dropped to a record low. Corporate bankruptcies in Japan fell nearly 17 per cent in the year that ended 31st March, the second consecutive year of decline. Of the four major Japanese banks - Mitsubishi Tokyo Financial Group, Mizuho Financial Group and Sumitomo Mitsui Financial Group - three boasted 2002 balance sheets in the black.

Observation
With various reports suggesting that Asia currently faces a staggering US$2tn in NPLs, accounting for 20 per cent of the region’s gross domestic product, the situation could potentially threaten to derail the growth path of the world’s fastest growing economic zone.

The sale of non-performing loans and having the appropriate vehicles to acquire them have become central to the long term prosperity of Asia. China holds the key to this movement. So far, China has taken pragmatic measures to address the critical issue of reducing the country’s massive debt situations. Its banking system is estimated to be carrying a colossal debt of $480bn. Last year, Beijing mobilised $45bn from its foreign reserve to bail out Bank of China and China Construction Bank as part of measures to bolster the two banks’ balance sheets. The banks will soon participate in the first transfer of bad debts to the country’s asset management companies. Bank of China is expected to transfer Rmb140bn in bad debts to China Orient Asset Management, while China Construction Bank will move Rmb56.9bn to China Cinda Asset Management. China’s commitment to institute sound financial structure to its enterprises will ultimately determine the role of debt funds in Asia and whether they will become a new dimension in private equity investing in Asia.

Asia Private Equity Review (APER) is the foremost voice on matters related to private equity/venture capital in the region. Well-recognised as being the singular source for accurate and timely news, in-depth analysis and global perspectives, APER is published by the Hong Kong-based Centre for Asia Private Equity Research. For further information please visit our website at www.asiape.com or email us at info@asiape.com