Gateway to Asia

Avenue Capital Group invests in Asia's distressed debt market through three of its funds

Avenue Capital Group's Avenue Asia International Asia ex-Japan distressed debt fund invests the vast majority of its assets in senior secured debt of distressed Asian firms outside Japan.

Avenue Capital buys up portions of specific debts directly from banks rather than purchasing portfolios of debts, and it manages the investments across three different Avenue funds.

The Avenue Asia International has a minimum investment of $1m, so is available both to institutions and private individuals.

To find the most attractively priced debt on the Asia ex-Japan market, Avenue has two people in Hong Kong, Indonesia and Thailand, and three in Tokyo. Once purchased, Avenue Capital aims to hold debt to maturity. About 50% of the debt in Avenue's Asia International portfolio is liquid ' that is, three independent brokers will offer a price on it. Marc Lasry, Avenue's managing partner, sees investments in the strategy as a five-year proposition.

Lasry says the average size of debt the fund buys is around $25m, although it will not buy more than 10% of the total debt of any firm. The debts he buys are spread throughout Asia, selected on a case by case basis. 'We have the people in Tokyo because Japan banks are one of the biggest sellers of debt and have made the decision to get out of Asia and focus on rebuilding Japan,' Lasry says.

He adds Asian banks are often 'non-economic sellers selling at huge discounts to the reserve price.' Because distressed borrowers may have loans from banks based throughout Asia, Europe and the UK, Avenue scours lenders for the best price.

According to the group, the strategy has produced some impressive returns since Asia International's inception in May 1999. In its first year it returned 20%, then 25.6% in 2000 and 21% in 2001. So far in 2002 it has returned 3.4%. Unfortunately, Avenue's fund lacks an exact benchmark mirroring its market and geography.

But there is no shortage of cheap debt for sale, and in Korea, Thailand and Indonesia, Goldman Sachs analysis shows the volume of distressed debt is larger than the nations' stock market capitalisation.

'In 1998 in the Asian crisis, anywhere between one and two thirds of the secured debt of all these companies ended up becoming non-performing loans. In Indonesia, 70% of bank debt was non-performing. In Korea and Malaysia you have in excess of one third but in the US, for example, you do not have more than 5%, in Europe it is between 5% and 7%,' Lasry says.

An additional advantage of Asian distressed debt, Lasry adds, is the lack of across-the-board, enforced write-downs or reserving such as that demanded of all lenders by America's Federal Reserve or England's Bank of England.

'In Asia, with different economies and countries, you have a large number of loans with perhaps 50 banks. You have Japanese, Thai, French, US-based banks all in on it, so every single bank in every single country has acted to reserve loans at a different level. You do not have uniformity and that is the opportunity.'

Intense stress on the reserves in some Korean banks also meant the Korean government did not force all Korean banks, for example, to write down non-performers to the same level.

'If we have done our analysis properly with supply and lack of demand, we may feel there is a credit we could buy at 75 cents on the dollar because that's what we feel the company is worth for a senior, secured unliquidated value.'

The main risk to the market, Lasry says, is the fact IMF and World Bank-imposed bankruptcy law has been enacted in most Asian countries only since 1998, and lack of precedent can leave creditors unsure how courts will rule on insolvencies and restructurings.

'Although we can buy the debt and use bankruptcy laws, we do not know what the courts will do because there is not enough precedent.'

The other primary risk is that of jurisdiction, of where debt problems will be sorted out in court.

The final risk, one well known to investors who have lived through the Asian crisis, is one of transparency, knowing a firm's complete assets and liabilities.

This is a difficulty restructured debt buyers may actually be less exposed to, Lasry says. This is because of all the information that comes from creditors such as banks and bond holders enlisting independent analysts and investment banks upon firms filing for bankruptcy.

'What you have on a filing and restructuring is the ability to find out all the evidence and whether the company had undisclosed balance sheet liabilities. The perceived risks are higher, the actual risks lower,' Lasry says.

But why should bank lenders to distressed firms restructure debt and then sell it for 30 cents in the dollar? Lasry says they do it simply 'so they do not find themselves in the position where they have made the wrong economic decision.

'If they are made to do this they then have to take greater reserves, and, at the moment, they are overwhelmed by the amount of non-performing loans. If you can sell the loan at the reserve price, you will. You only do that when you have too many non-performers, not when you have 3%, 4% or 8% non-performers.'

One disadvantage of the debt-buying process in Asia, Lasry says, is that Asian banks will not negotiate on price.

'In Asia, the way to overcome this is buying restructured debt. You only buy debt after banks have restructured it so you're buying senior secured bank debt at anywhere between 25 and 40 cents on the dollar,' Lasry says.

'It is all Libor based and this means today you are getting anywhere between 10% and upwards return. If you are buying 25 cents on the dollar and Libor is 2.5%, at 50 cents it would be a 5% return and at 25 cents it would be a 10% return so we are generating a 10% return on a big part of the portfolio.'

The fund's main competitors are families buying back debt and investment banks.

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