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Tighter liquidity in China opens door for PE funds

Forum Partners banking on likely surge in developer demand for funding
Monday, July 14, 2014 - 06:00

[SINGAPORE] Recent defaults of some Chinese property developers have made it harder for others to raise funds amid tight onshore liquidity. But for at least one optimistic property investment firm, this creates a "compelling opportunity" to enter the market.

Forum Partners, which manages US$6 billion in assets, plans to invest in China through its offshore private equity (PE) fund and is banking on a surge in developer demand for funding, Gregory Wells, head of Asia, told BT in a recent interview.

Forum Partners is currently investing in its third real estate fund in Asia, and although sector-agnostic, it sees the most opportunities in residential properties, particularly in first-tier cities such as Beijing and Shanghai. It raises funds from mostly US and European institutional investors, targeting returns close to 20 per cent.

"Right now, the cooling measures are creating constraints in liquidity, which gives us opportunities. We think the downturn on the macro level is cyclical, not structural, and it will pick back up again in the next 6-18 months. We don't think the property market is going to implode and give us liquidity issues, and now is a good time to invest."

The firm, he said, still believes in long-term Chinese growth - clearly not as robust as years before but still better than in much of the rest of the world. Going by private equity activity in the region, other such players in Hong Kong and China seem to think likewise, he added.

Forum Partner plans to invest another US$100 million in Chinese developers in the next 6-9 months, on top of its current portfolio of Chinese assets of around US$125-150 million.

This is despite the recent collapse of Ningbo developer Zhejiang Xingrun Real Estate in March, which fuelled speculation that other Chinese real estate companies could follow suit.

In April, Nanjing-based Sainty Marine Corp said that an entrusted loan (or inter-company loan) it made with a local property developer had gone bad. The latter failed to repay 90 million yuan (S$18.1 million) plus a dizzyingly high interest of about 18 per cent that Sainty was charging.

These are signs of a ticking time bomb in China's burgeoning shadow banking system, where alternative financiers (mostly trust companies) offer high-interest loans to businesses which are unable to borrow from banks.

Yet, Mr Wells is indifferent to the development of shadow banking in China - which he believes is "a natural progression that financial markets develop to disintermediate away from banks, so that not all flows of credit have to involve banks".

He noted that China's financial system is heavily weighted towards banks as the only financial intermediary. Typically, besides trust banks, shadow banking also includes other respectable lenders such as insurance companies and private wealth management firms.

Citing data from BCA Research, he said China's shadow banking segment - which represents about 30 per cent of the financial system - is in fact "underdeveloped" compared to the US - where the segment is 100 per cent, or equivalent, to the banking system. Insurance companies are also a huge shadow lender in real estate in the US.

"This isn't happening in China yet, but you will see over time more of that disintermediation away from banks in China occur," he feels.

What then warrants the market's concerns over shadow banking in China?

It is the astonishing growth of credit from the shadow banking system, coupled with the country's not-so-robust regulatory environment, which leads to the worry of a major blow-up in the loans made, Mr Wells said.

"But we don't think that will happen. If you look at real estate loans and the way trust companies are making loans, generally speaking, they are heavily over-collateralised.

"We expect more defaults to occur in industrial and natural resources. But even if you consider the likely worst-case scenario, the number of defaults and amount of losses shouldn't be significant enough to disrupt the financial system," he said.

Asked if he isn't worried about developers defaulting, he replied: "It's certainly something to be cognisant of. What we've seen is a couple of relatively small local developers who have had defaults, and there is usually not a good story behind them; maybe they were focused on a single city and became overextended."

Zhejiang Xingrun, for instance, is a small unlisted developer with projects mostly in Fenghua city in Zhejiang, a province which has experienced massive building in recent years.

"Some trust banks have undoubtedly made some loans to borrowers that will go bad just given the overall expansion in credit in the last few years," Mr Wells said.

"But most of the sponsors we work with tend to be larger regional players, have a broader sales base, and are not particularly focused (in one city or province). We would stay away from developers that are overextended irrespective of how much they are willing to pay for the money."

In the case of Singapore, the current property cooling measures and loan curbs could arguably create similar opportunities for the company, but Mr Wells said the company is not looking to actively invest here because the large local property firms that dominate the market have strong balance sheets and plenty of sources of capital.

"They can go to the local banks, which are cheaper sources of capital than ours. They don't need us," he said.

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