While economists and many foreign investors fret about China’s spiralling debt and rising defaults, a small niche of alternative asset managers is braving the China credit space, attracted by high yields from borrowers shut out from other sources of finance.
Global banks have pulled back on cross-border lending to China, but some alternative asset managers are moving in to plug gaps in a domestic financial system still dominated by state-owned banks.
Crayhill Capital Management, a New York-based alternative asset manager, recently announced a $300m investment in a trade financing platform operated by Stenn International, a UK-based trade financing provider. Stenn purchases trade receivables from suppliers in China and Southeast Asia who export consumer goods such as apparel, toys and electronics to big western retailers. The focus is on small- and medium-sized enterprises.
“International banks are largely out of the business of trade finance for SMEs in China and local Chinese banks have not stepped up so this financing is filling that gap,” said Carlos Mendez, managing partner at Crayhill.
Higher capital charges under Basel III have sapped global banks’ appetite for trade credit, especially to SMEs. Anti-money laundering and “know your customer” rules have also contributed to the pullback.
Mr Mendez believes Chinese trade receivables combine the best of two worlds. SME suppliers pay Chinese-style interest rates — sometimes in the double digits — to receive cash immediately for receivables with a typical maturity of about 120 days. But Stenn has no exposure to Chinese credit or currency risk, since the trade invoices it buys are denominated in US dollars and carry credit exposure to western retailers and distributors.
Other foreign investors in China debt do take on credit risk from Chinese borrowers but these fund managers say they can protect themselves by avoiding borrowers from struggling “old economy” sectors such as manufacturing, focusing on emerging consumer and service sectors.
Hong Kong-based Adamas Asset Management lends to Chinese SMEs who cannot get loans from Chinese banks or capital markets.
“The economy is going to be driven by companies in these emerging sectors, but lenders have been slow to lend to start-ups and the new economy because they don’t have much collateral, and their cash flow is hard to ascertain,” said Barry Lau, managing partner at Adamas.
Adamas’ portfolio includes a convertible bond from Global Pharm Holdings, a Shenzhen-based producer of traditional Chinese medicine. It has also invested in a hot-springs resort project in south-east China’s Fujian province. The investment is technically an equity stake, but it includes a put option that allows Adamas to sell its stake at a guaranteed 25 per cent premium to the original investment, giving the deal a debt-like character.
“The opportunity is huge, but people don’t want to do it because it’s complicated and has to be closely managed. A lot of foreign investors just don’t trust the Chinese courts to protect them. We do.” Mr Lau declined to reveal the size of Adamas’ investments in Chinese debt.
ADM Capital, also based in Hong Kong, has pared back its China debt exposure since 2014 on concerns about the impact of President Xi Jinping’s anti-corruption campaign, “which made investment analysis somewhat more dependent on relationships rather than on credit”, said Sabita Prakash, head of investor relations for ADM.
Before 2014, ADM lent mainly to the infrastructure and basic manufacturing sectors but has shifted focus. ADM also declined to reveal the size of its China debt exposure, but the group has a total of $1.5bn under management in four Asia-focused debt funds, according to its website.
“We are now exploring opportunities in different sectors, mainly those which are a priority for the government including technology, environment, social safety net, health care, and generally, consumption sectors,” said Ms Prakash.
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