On a sprawling undeveloped wetland in northern Hong Kong, one of America’s most formidable distressed debt investors last week upended China’s biggest ever restructuring by capturing “the Castle”.
Oaktree Capital, one of the oldest specialists in chasing companies for unpaid debts, seized a vast plot of land that symbolises the folly of Chinese property developer Evergrande’s meteoric ambitions before it collapsed under its $300bn debt load.
The developer’s chair had for a decade planned to build his own Palace of Versailles-style mansion on the site — earning it the code name Project Castle — but in the end, Evergrande was unceremoniously stripped of the asset, after defaulting on $600mn it had borrowed from Oaktree.
Yet while the land grab stunned other foreign creditors to Evergrande, few — if any — were aware that Oaktree had already quietly seized another of the developer’s projects across the border in mainland China.
Despite being headquartered 7,000 miles away in Los Angeles, Oaktree had for months been discreetly pulling the strings on a sprawling tourist resort near Shanghai designed to look like the Italian city of Venice, after Evergrande defaulted on a second $400mn loan.
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It was just a “routine transaction”, Oaktree founder and co-chairman Howard Marks told the Financial Times.
“I don’t think it’s audacious,” he said. “To induce us to make the loan, the company provided us security. And with lots of collaboration and discussion, we are exercising our rights to that security.”
Oaktree would be “remiss” if it failed to seize the assets, he added. “It’s our clients who have the claim on those buildings.”
For many, the bravura involved in pulling off these land seizures exemplifies the attributes that have turned Oaktree into a $161bn powerhouse of debt investing. While most of Evergrande’s foreign creditors are likely to recover just pennies on the dollar on their $20bn of bonds, Oaktree could bank a windfall of more than $200mn if it is able to sell the assets it now controls.
“These are not your average lenders,” said one person close to the asset seizures. “These guys specialise in lending when they know a company is going into default and know they will take over the asset. It’s gone exactly the way they expected.”
But for others, the group’s decision to lend $1bn to a teetering Chinese property developer also highlights the shrinking opportunities in distressed investment — with fewer corporate defaults in developed markets awash with cheap money from central banks — and the big risk appetite needed to chase them.
The chief investment officer of another large US distressed debt investor told the FT that his company has a simple rule regarding China: “We don’t lend there.”
Oaktree has faced no challenge from Beijing in its takeover of the projects and has restarted construction of the Venice site, pictured © Qilai Shen/Bloomberg
But Marks, who is 75, has a different view: “When everybody else says China is uninvestable, that means the competition for Oaktree to make investments declines. We get better opportunities and more of them.”
Having last year closed the largest distressed investment vehicle of its kind — its $16bn “opportunities” fund — Oaktree has deployed cash in emerging markets around the world, including bailing out the Chinese owners of an Italian football club, helping a Chilean airline emerge from bankruptcy and propping up the heavily indebted business empire of an Indian commodities tycoon.
These varied global investments are a far cry from the US-focused loans Oaktree specialised in when Marks opened its doors in 1995 with a strategy of investing in “good companies with bad balance sheets”.
Over the ensuing decades, Marks has cemented his status as an erudite and avuncular debt specialist, setting out his investment strategies in a wildly popular series of memos whose regular readers include Warren Buffett. At the same time, his business has not shied away from bare-knuckle fights with delinquent companies or rival creditors.
“Howard Marks has this cuddly image,” said one rival, “but they do some pretty medieval stuff.”
Drinking the blood of its enemies
In the earliest days of his career, Marks learned the value of investing where others feared to tread.
At Citigroup and then Trust Company of the West, he was an early buyer of the high-risk “junk bonds” being sold by Michael Milken, the man who largely built that market in the 1980s and whose spectacular downfall culminated in a jail sentence for securities fraud in 1990.
In 1995, Marks set up Oaktree Capital Management with TCW colleague and former lawyer Bruce Karsh. While Marks became the public face of the company, Karsh worked behind the scenes and used his legal expertise to figure out how to take control of companies that had defaulted on loans.
Marks recalls: “People would say: you buy the debt of companies that are bankrupt? You’re crazy!”
Yet even as the market for distressed investing became more crowded, Oaktree distinguished itself with its take-no-prisoners approach.
A clash with $481bn private equity group Apollo over the bankruptcy of casino group Caesars led to Marks falling out with its founder Leon Black — a longtime friend and fellow Milken acolyte. During Caesars’ fraught final restructuring negotiations, one observer memorably declared: “Oaktree is here to drink the blood of Apollo.”
Oaktree went public in 2012 but remained listed for less than a decade, selling itself to Canadian infrastructure group Brookfield at a near $8bn valuation in 2019.
Investing in Asia is not new for Oaktree, which first began dabbling in the region three years after its launch. But it was after the global financial crisis that its eastward expansion began in earnest.
With falling numbers of distressed companies in the US and Europe, investors such as Oaktree were desperate for new opportunities.
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In 2019, betting on finding opportunities in China and India — which were largely untapped by global credit funds — Marks relocated one of Oaktree’s two most senior portfolio managers, Pedro Urquidi, from London to Hong Kong. A year later, the company opened a wholly owned unit in mainland China — the first foreign distressed debt investor to do so.
It made headlines in India last year after lending $1bn to a Mauritian investment company controlled by Anil Agarwal, one of the country’s richest men, propping up his debt-laden business empire that has interests ranging from oil to aluminium.
While the Evergrande loans are Oaktree’s latest distressed debt asset in China, last year it lent to a Luxembourg company that owns Chinese retailer Suning’s stake in Italian football club Inter Milan.
The $275mn loan helped Suning cover the club’s liquidity needs after the pandemic ravaged its finances, but has strict terms allowing Oaktree to call a default if, for example, Inter is disqualified from participating in certain competitions.
Battle with Beijing
Seizing two of Evergrande’s crown jewels at a time when President Xi Jinping has vowed to tame China’s booming property market in his push for “common prosperity” puts Oaktree in a politically tricky position with Beijing.
For China’s government, the real estate sector poses financial, social and systemic risks. A decades-long borrowing-to-build binge has resulted in 90mn empty apartments and total outstanding debts of $5tn — a third of China’s gross domestic product.
Oaktree now finds itself caught up in a government crackdown on property developers that has limited their ability to borrow and led to a slump in house prices. It will have to sell the Evergrande assets in a market where valuations are in flux and where Beijing has prioritised the financial interests of homeowners over builders.
If Oaktree sells the sites, it stands to recoup its $1bn investment plus interest in excess of 20 per cent, according to a person close to the details. This could bring bad publicity at a time when construction workers, homeowners and retail investors are all suffering from the fallout of the developer debt crisis.
In the case of the “Venice” mainland project, the legal strength of foreign investor claims on domestic Chinese assets has been unclear in the past.
However, Marks said he was certain Oaktree’s creditor rights would be respected by Beijing. “Things are progressing as they are supposed to,” he said. “We are working with the company and everybody, including everybody in China, says the law will be followed.”
“I personally believe China wants to be a member of the world financial community. And I think that desire will inform its actions,” he said.
“I hope I’m not being Pollyanna . . . but so far, there’s been no evidence to the contrary that we cannot count on the rule of law.”
Oaktree controls the Evergrande developments through a cascade of corporate entities that stretches from China and Hong Kong to Singapore and British Virgin Islands, which allowed it to take control of the land without money changing hands on China’s mainland.
So far, it has faced no challenge from Beijing in its takeover of the projects. It has restarted construction of the Venice site and has begun selling apartments.
Its actions could even be in alignment with Xi’s own policies, which have forced China’s wealthiest tycoons to redistribute their fortunes: in 2017, before its current problems, Evergrande’s founder and chair Hui Ka Yan was the country’s richest man.
“You don’t do that without some sort of green light from the authorities in China,” the rival credit manager said. “You need air cover to pull off a move like that.”
A person with knowledge of the matter even described Beijing as “quite happy with the situation”.
Whether or not Oaktree prevails where other debt investors have feared to go, its bold foray into mainland China is in perfect keeping with its founder’s investment philosophy.
It is a principle that has guided his entire career, Marks said: “Great investments are often made when you’re willing to do something no one else is.”
Additional reporting by Chan Ho-him in Hong Kong