Bad debts come to those who wait

IFR Asia 1134 - 18 Apr 2020 - 24 Apr 2020
5 min read
Emerging Markets, Asia
Steve Garton

Rising corporate default rates will create a wealth of opportunities for Asian distressed debt investors long after the Covid-19 pandemic has peaked, according to Michel Lowy, CEO of SC Lowy, the debt-focused banking and asset management group.

“I believe the first shock is now done. What we will see next is the impact on earnings, then downgrades and defaults,” said Lowy in an interview from his Hong Kong office.

The response to the global coronavirus outbreak has left thousands of companies fighting for survival, in Asia as well as globally. Distressed debt specialists, however, are being careful not to rush in.

“Six months further down the line we will be in a much better position to assess which companies will survive and which won’t,” said Lowy. “It’s a long process and then that’s where the opportunities will come.”

Lowy is not alone in predicting a surge of bad debts. Moody’s last week said that 11% of global corporate bonds rated below investment grade are likely to default over the next 12 months, warning that the default rate could hit an unprecedented 16% under its more pessimistic scenario. S&P predicts a US$600bn jump in non-performing assets across Asia Pacific in 2020, with bad loan ratios in China set to rise by two percentage points.

Credit spreads soared in March, leaving many Asian high-yield bonds trading well into double-digit yields. Distressed investors have picked up some heavily discounted positions, especially in well-known Chinese property names, but most are biding their time.

“Just because so many things are trading below 80 cents is not necessarily great for distressed debt investors,” said Lowy. “In a more traditional crisis you can step back and be rational. Today it’s impossible to predict when things will get back to normal, which companies will receive government support and which won’t.”

For distressed debt specialists, however, an uptick in Asian bad debt has been a long time coming. Despite the threat of a US-China trade war, slowing growth in China and India and persistently high leverage, 2019 ended up being a much stronger year for high-yield investors than it was for distressed debt buyers.

“Distressed investors really struggled for returns, because the few distressed opportunities have been very crowded. At the same time, high-yield investors have done really well because their deals have been refinanced, and spreads have gone tighter and tighter,” said Lowy.

All that has changed in the space of a few months. Bets on another move tighter in Asian credit spreads unwound dramatically in March, and downgrades are mounting rapidly. Lowy expects a record default rate later this year.

“The virus has accelerated the end of the credit supercycle,” he said.


After years of thin pickings, distressed investors are likely to find themselves spoiled for choice in 2020 as more companies are forced into restructuring.

China is a particular focus. The country accounts for the lion’s share of the Asian high-yield bond market and is opening its onshore bad debt market to foreign investors. The US-China Phase 1 trade deal in February allowed US firms to apply for local licences and acquire loans directly from Chinese banks, rather than specialist asset managers such as Cinda and Huarong. Oaktree, one of the world’s biggest distressed asset managers, has already set up a Beijing unit. Others are in discussions with local partners.

The challenge for distressed investors lies in picking the winners. Public information on Chinese issuers is often patchy and can be unreliable – a regular source of profit for short sellers in the equity market. Local conglomerates have often expanded into seemingly unconnected industries, and state backing cannot always be relied upon in times of stress.

HNA, which has routinely played down its state links, turned to the Hainan government in February after travel restrictions savaged its core aviation business. In contrast, China Energy Reserve & Chemicals Group, touted as a state-owned issuer, remains in restructuring after defaulting in 2018.

Lowy acknowledges that investing in China is “a lot harder than other markets” but has turned more positive, especially on the real estate market given its importance to the local economy.

“Probably the government will support the [property] sector, but through which companies and in what form is not clear. Until we can quantify that it will be very difficult,” he said.

Lowy, who has been investing in Asian distressed assets since 1998, sees some similarities with previous crises, though he argues that the level of uncertainty generated by the Covid-19 pandemic is much greater than during the Asian financial crisis or the aftermath of the 2008 Lehman Brothers collapse.

"You see the same kind of liquidity and behaviour in the markets for sure. It’s helpful to have some perspective of history, it helps keep a cool head.”