On a road that winds through Hong Kong's posh Repulse Bay neighbourhood, a multistorey luxury residential building with Roman columns and sweeping views of the South China Sea has been put forward as collateral for a loan, before construction is even finished.

The loan was taken out by Luk Sin-fong, who owns 39 South Bay Road and whose husband is Chen Zhoulin, chairman of distressed Chinese developer Agile Group Holdings, according to a source familiar with the matter.

Although the amount is unknown, Luk, herself a former vice-chairwoman of Agile, had been shopping for a HK$500 million (US$64 million) facility, according to the source.

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That amount matches what she paid for the Repulse Bay land plot in 2011 at what was then the second-highest price per square foot ever paid in the city, HK$38,500 (US$4,900).

Agile, based in the Guangdong's provincial city of Guangzhou, has borrowed against more than one Hong Kong property.

39 South Bay Road in Hong Kong's Repulse Bay, on 25 January 2024. Photo: Xiaomei Chen alt=39 South Bay Road in Hong Kong's Repulse Bay, on 25 January 2024. Photo: Xiaomei Chen>

It took out a two-year, HK$894 million loan in June 2022 at an interest rate of 20 per cent per annum as part of a plan to trim a debt load that amounted to 59.49 billion yuan (US$8.3 billion) at the time.

Luk could not be reached for comment, and Agile did not respond to requests for comment.

The substantial gap between that 20 per cent rate and the current bank lending rate of 5.88 per cent underlines the desperation of borrowers who find themselves short of liquidity at a time when public capital markets are stagnant and banks are cautious about lending.

It also outlines the opportunities available to lenders willing to underwrite private credit - a market that has expanded 3.5 times in the last decade, according to data provider Preqin.

With interest rates at eye-watering levels, property valuations falling and the local economy recovering only slowly, an increasing number of distressed developers and wealthy families in Hong Kong are turning to the private market despite its higher interest costs.

As a result, the private credit asset class in Asia-Pacific, including Hong Kong and mainland China, reached US$81.3 billion in 2022 and is expected to exceed US$100 billion by 2027, according to Preqin.

"There are more potential borrowers," said Francis Ng, managing director and chief investment officer of Pacific Aegis Capital Management Group (PACM), a Hong Kong-based company specialising in real estate private debt investment.

"They are more in need of alternative and creative capital solutions than before, meaning the cash flow is getting tighter because the cost of capital has gone up."

The number of projects the firm has in the initial screening stage has doubled from last year, Ng added.

While Hong Kong's real estate sector is not in a crisis like its counterpart in mainland China, sluggish home sales, falling home prices and record-high office vacancy rates have weighed on companies and individuals.

The number of unsold units has accumulated over the past two years as demand slumped amid 11 rounds of interest rate hikes since March 2022.

The city's developers sold 49 per cent of their completed units in 2022 and 72 per cent last year, Citigroup estimated, adding that home prices are set to weaken by another 10 per cent this year.

Dwindling transactions and falling prices have also made it harder to find buyers, especially for properties tarnished by foreclosures. A US$192 million mansion on The Peak, linked to top China Evergrande Group executive Hui Ka-yan, has been on the block since November last year.

Meanwhile, Evergrande's US$1.6 billion building in Wan Chai has yet to find a buyer 15 months after it was seized and put on the market by receivers.

The China Evergrande Centre in the Wan Chai area of Hong Kong, pictured on September 20, 2021. Photo: Bloomberg alt=The China Evergrande Centre in the Wan Chai area of Hong Kong, pictured on September 20, 2021. Photo: Bloomberg>

While the environment is dire, the pain is not evenly distributed among developers, said Foster Lee, head of credit investments at private equity firm Gaw Capital.

Blue-chip developers have stronger balance sheets and enough support from commercial banks and bond and equity investors, while "smaller developers will struggle, especially those developing projects recently that have not yet disposed of their inventory", he said.

Banks have generally lowered their exposure to the city's real estate sector. Total loans for property development and investment started to drop in the second quarter of last year, and the tally in the third quarter was down 5 per cent from the first quarter, according to the Hong Kong Monetary Authority.

"Private credit in the real estate sector will continue to grow because banks are retreating," said Ryan Chung, head of principal investment at Hong Kong-based broker Huatai International.

"The wave of senior banks retrenching is not at its peak. Many borrowers cannot refinance their existing positions with the banks, or even if they do, the financing tends to be expensive, with lower leverage."

As falling rental yields and higher interest rates create cash flow pressures, private credit has become an alternative funding source for borrowers looking for extra leverage and payment flexibility - but at a cost.

A unit of debt-laden developer Country Garden turned to private credit lender Flow Capital (HK) to raise a HK$900 million loan in April last year. The loan carries a "double-digit rate", with an east Kowloon residential property, Allegro, as collateral, according to a source familiar with the matter.

Country Garden's Allegro residential development at 138 Carpenter Road in Kowloon City, pictured on March 19, 2022. Photo: Jonathan Wong alt=Country Garden's Allegro residential development at 138 Carpenter Road in Kowloon City, pictured on March 19, 2022. Photo: Jonathan Wong>

Agile, meanwhile, is now seeking to refinance its HK$894 million facility, for which residential projects on Mount Parker Road and King's Road in the city's Quarry Bay area serve as collateral, sources said.

The company's total borrowings, including bank loans, senior notes and mainland corporate bonds, added up to 57.57 billion yuan as of June 30, 2023, down slightly from 59.49 billion yuan a year earlier. The company reported a loss of 4.48 billion yuan for the six months to June 30.

"Before mid-2023, it used to be a borrowers' market in Hong Kong, but the turnover has been dropping since then," said Kenny Chung, executive director and money manager at Astera Capital.

"Borrowers are scared of rising rates, while lenders also turned more cautious with property valuations falling fast. They would rather wait for more signs of stabilisation in the property market before deploying their money."

Private credit lenders are often able to offer loan-to-value (LTV) ratios higher than commercial banks because the HKMA requires the latter to cap its LTVs at 50 per cent against commercial properties.

Banks also tend to have sectoral limits, which makes them more conservative towards borrowers with constrained debt servicing capabilities.

Under the challenging market conditions, Luk's family is not the only wealthy clan borrowing against its Hong Kong properties to free up cash.

Ho Shung-pun, known as one of Hong Kong's "invisible rich", raised a short-term loan from Gaw Capital last year, which is securitised against his properties on Plantation Road on The Peak and Kowloon Investment Building in Mong Kok, according to two sources. The loan size is unknown.

Agile Property Holdings Limited Chairman Chen Zhoulin speaks at a press conference in Hong Kong in 2008. Photo: Felix Wong. alt=Agile Property Holdings Limited Chairman Chen Zhoulin speaks at a press conference in Hong Kong in 2008. Photo: Felix Wong.>

Additionally, Ho and other borrowers in his family on January 17 obtained a one-year, HK$85 million loan from X8 Finance, a wholly owned unit of Hong Kong-listed Termbray Industries International, a stock exchange filing showed.

A former professor at Hong Kong Polytechnic University, Ho and his family members are the directors of Kowloon Investment Company, a Hong Kong-based property investment and management firm established in 1955, according to the Companies Registry.

An unknown residential property the family owns in the city is the security for the HK$85 million loan, which carries an interest rate as high as 29 per cent in the first two months from the drawdown date and 18 per cent after that.

The loan is a refinancing of a HK$44 million facility the borrowers raised in June last year, which had interest rates of 25 per cent in the first month and 13 per cent thereafter.

The Post was unable to reach the Ho family for comment.

Defaults may increase among assets that are difficult to liquidate amid interest rate uncertainty and slow economic growth, according to private credit lenders.

"There will be more defaults in 2024," said Gaw Capital's Lee. "For some of the private credit transactions that have been done in the market, the situation has changed and perhaps deteriorated."

PACM has seen a 20 per cent increase in defaults year on year, according to Ng.

"It's taking a lot longer to liquidate loans that are secured by real assets," he said. "I think it's taking about twice the time it needs. And exit prices need to be further adjusted down.

"In our investment universe, we have to price in the possibility of default, which has at least 51 per cent chance of happening for each project."

Many defaults will be resolved behind closed doors.

This US$192 million mansion on The Peak, linked to top Evergrande executive Hui Ka-yan, has been on the market since November 2023. Photo: Handout alt=This US$192 million mansion on The Peak, linked to top Evergrande executive Hui Ka-yan, has been on the market since November 2023. Photo: Handout>

"Having spoken to investors in this space, it is desired by all parties involved to resolve all issues amicably, hopefully away from the public eye and on a low-key basis, whether it is in the secondary space or in the primary space where lenders could be willing to take a haircut to recuperate as much of the loan as possible," said Jonathan Chau, head of investment property and private office of capital markets for Hong Kong at CBRE Group.

Asia's fast-growing private credit market has attracted private-equity firms, asset managers, family offices and retail investors.

"Due to its attractive returns compared with traditional property investment, private family offices have rushed into this space over the past few years and have either invested passively into credit funds or have committed to larger 'club' lending deals with consortiums of private investors," Chau said.

The average annualised return for private credit is 12 per cent to 15 per cent, up from the 8 per cent to 12 per cent range before the interest-rate hikes, according to PACM's Ng.

The internal rate of return for private debt in the Asia-Pacific region stood at 11.17 per cent from 2019 to 2022, compared with 10.34 per cent in North America and 8.56 per cent in Europe during the same period, according to Preqin. For distressed debt, it jumped to 14.78 per cent in Asia-Pacific.

"The asset class is great for family offices and retail investors for a few reasons," Jeffrey Lau, head of private credit and special situations at Chinese private-equity firm Primavera Capital Group, said at the Private Equity Forum in Hong Kong on January 26.

"One is their familiarity with the local economies, which means, if we're dealing in Asia, it's often easier to talk to Asia-based investors because they understand the market dynamics.

"And secondly, we're achieving returns for which they would otherwise need to look at equity-type products."

Market participants remain optimistic about the continued growth of the private credit market even though interest rate cuts are anticipated later this year.

"Private credit will continue to be a spotlight in the currently grim market," said Maggie Kwok, Asia head of funds and regulatory practice at law firm Harneys.

"If the interest rate is going to come down, it will come down gradually. And there are always going to be businesses that need access to capital, which banks, frankly speaking, are not going to be able to satisfy."

"It will not be surprising to see more deal pipeline growth in the first half of 2024, but we don't envision seeing the market flooding with 'distressed' opportunities," said CBRE's Chau.

While some property owners are facing financial difficulty, most investment properties are in the hands of financially sound corporate and professional landlords, he added.

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright ? 2024 South China Morning Post Publishers Ltd. All rights reserved.

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